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Michael's Blog: Money Matters

Our blog talks about current events that impact your financial reality and future prospects. We explain the implications.

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Getting Out of Your Expensive 401k Plan

A few weeks ago I wrote about some of the reasons why you wouldn’t want to invest in your company’s 401k plan.  The primary reason, by a long shot, was when the costs of the plan outweigh the benefits (sing along with me:  “if your expense ratio starts with two, then you, my friend, are screwed.”)

What about the poor sap who has been a loyal and active participant in his or her plan for decades?  Well, there may be a way out—and this way out may be attractive even for participants whose 401k plans are even “just okay.”  The way out goes by the enticing name of In-Service, Non-Hardship Employee Withdrawals, or just plain old in-service withdrawals.

In a nutshell, this allows employees who have met certain minimum standards to withdraw part or all of the vested balances in their 401k plan and roll it directly into their IRA.  In doing so, the yoke of the plan—whether it be high fees, limited investment choices or both—can be removed.  

Importantly, you can still participate in your 401k plan if you so desire.  But if you roll a substantial portion of the existing balance into an IRA, while the fee percentage may be the same, the financial hit to you would be lower.  Let’s say your fees are 2% a year, with a $1 million 401k balance you’ll pay $20,000 a year, but only $200 a year for a $10,000 balance.  The percentage may be the same, the amount differs greatly.

In addition to reducing your annual fees, most companies you might consider for an IRA such as Fidelity, TD Ameritrade or Etrade, charge little or nothing annually and have thousands of investment options with very low (or even no) annual fees.  If you want, you can also invest in individual stocks and bonds, something generally not available within most 401k plans.

Eligibility criteria differ, but for many plans this option is available for employees over 59½ and with at least  five or 10 years at the company.  A quick note:  if you are between the ages of 55 and 59½ and are considering withdrawing funds from your plan, an in-service distribution may not make sense, as you have greater flexibility to withdraw from a 401k plan without penalties during those 4.5 years than you do with an IRA.

Folks, a big caveat here:  this is a very significant financial transaction:  before doing anything other than pondering, talk with your financial and tax advisors.  This is not something you want to get wrong.  There are other possible fees and expenses such as charges by the 401k company to distribute, potential loss of protection from creditors of your 401k/IRA assets, possible penalties if you have an annuity within your 401k (though I surely hope you do not!), etc.  


Your 401k plan is a vehicle for tax-efficient savings….but hey, a hearse is a vehicle too, and I have little interest in being in one.  Look closely, and realize there may be alternatives!   

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The Rebirth of the Traditional Pension Plan, With a Twist

A recent Wall Street Journal article about Jeb Bush focused on his retirement plan contributions.  According to the article, over the last five years the former Florida government was able to contribute an average of $350,000 (before taxes) a year into his retirement plan.


Small business owners who have strong cash flow and who find that the $53,000 a year (for 2015, $59,000 if 50 or over) they can make in 401k and profit sharing contributions is easily achievable and want to do more should seriously consider a plan similar to Jeb's, known as a cash balance pension plan.


Pension plans must provide benefits to all employees who meet the eligibility criteria, so sometimes this makes sense and sometimes not.  Here's a particularly juicy example.  Let's say you're a 60 year old dentist with a 28 year old assistant (we'll call her Flossy).  You earn $400,000 and Flossy makes $35,000.  You're maxing out the 401k and profit sharing plan for $59,000 in contributions, and you're giving Flossy $2,500 in profit sharing and safe harbor contributions.


In this example, you'd be able to contribute an additional $197,000 in pre-tax retirement savings.  Here's the thing:  because the contributions are based on both age and salary, your required contribution for Flossy?  An extra $525.  I've had clients who have been able to put away more than $300,000 a year in such combinations, thus reducing their annual tax bill by as much as $140,000.


Another attraction to this plan:  unlike more traditional pension plans (think GM), these can be run for 5-10 years or so, and upon termination the assets can be rolled directly into one's IRA.  This effectively takes a defined benefit plan and turns it into a defined contribution plan, and the burdens of running a pension long-term are effectively terminated.


As with everything involving the Feds, this is not an easy plan to manage, but its complexity simply requires hiring an actuary, so while it adds in total fees for the plan, it greatly simplifies its creation and monitoring.


There are fewer and fewer tools available to make significant tax-advantaged savings.  If you're the owner of a very successful business (even as a sole proprietor) and your advisor hasn't looked at a cash balance plan for you find out why.  It's an excellent tool.


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The Three Facets of Risk

The Three Facets of Risk

OK, I'll admit it - I'm a risk freak.  


It's not that I love to take a ton of risk in my life (though some wonder whether surfing, downhill skiing, hang gliding and scuba diving are appropriate activities for someone in his 50s); it's that I contemplate the concepts of risk. A lot.  


That is not a typo. It's the concepts of risk, plural. There are at least three facets of risk that merit consideration: need, ability and willingness.


With the Fed's current zero interest rate policy, almost all of us need to take risk to accomplish our retirement objectives. The so-called "risk-free rate of return" is 2.4% per year (fully taxable), which is what the US government gives you for lending it money for 10 years. After taxes, you are probably guaranteed to lose only a little purchasing power over that decade after inflation in factored in. [Yes, that's right: risk-free means almost certain guarantee of losing real value in your investment!] All other things being equal, you'd need to take more risk. 


To fully understand your own need, think about what you want your money to do for you, and when you want it done. Want to retire at 65 with $10,000 a month in living expenses? Fine, that requires a certain amount of risk. Retire at 52 with $20,000 a month? No problem - as long as you have $15 million or want to assume a risk profile that makes climbing Mt. Everest look like a walk in the park.  


The ability to take risks reflects where you are in life. If you're 28 and starting a job, you have all the ability in the world to take as much risk as you would like. But if you're nearing retirement, or facing health challenges, or are living paycheck to paycheck, you simply do not have an ability to take much risk.


Need and ability are fairly quantifiable and objective. The challenge comes in assessing one's willingness to take risks, and this is where most uncertainty lies. Your nest egg, at its most bare, is there to give you peace of mind that you are able to do what you want when you want. But if there's so much risk in the portfolio that you're stressed when the Dow drops a few hundred points... well, that kind of defeats the purpose of peace of mind! [I'm reminded of the investor during the crash of '08 who told me he slept like a baby: woke up crying every few hours curled up in a corner.] 


Ask someone their long term risk tolerance when the market has been down six months in a row and you'll get a markedly different answer than you would when the market is roaring ahead (recency bias). Or notice reticence to change? That's status quo bias. Oh, there are plenty more, but here's the takeaway: understanding risk requires time and patience, and a recognition that it's a dynamic concept.   


The riskiest approach? Not knowing how much risk you need to take, you're able to take and that you're willing to take!

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Your 401(k) Plan:  A Great Savings Opportunity (Except When It’s Not)

Your 401(k) Plan:  A Great Savings Opportunity (Except When It’s Not)

We have all been told since our first job that saving for retirement through the workplace makes sense. By deferring a portion of your salary while you are working, you can not only make solid and notable strides toward funding your future, you can save on your taxes today.


That's because 401(k) plans - and their less well-known sister, 403(b) plans - are "pre-tax" plans. If you made $140,000 and deferred $15,000 to your company retirement plan, you would be taxed as though your salary was $125,000. Any gains in the plan are not taxed until you begin to withdraw funds, presumably later in life when you are retired. Chock that one up to the "no brainer" category, right?


Well, yes and no. [There are no yes or no answers in this field; it's why economics is called the "dismal science."] Nine times out of ten you will want to take advantage of this type of tax-deferred savings. At an absolute minimum, if you work for a company that matches any of your own contributions, by all means you should participate - failing to do so, at least to the maximum of the company match if you can, is equivalent to throwing away free money.


Let's talk about two of the times (there are others) when you may want to reconsider using your 401(k) as a primary retirement funding vehicle (if you work in the Pentagon, we'll call this your PRFV). The second is more prevalent, so skip ahead if you're time constrained. 


The first instance where it makes sense to forgo a 401k is if you are nearing retirement and you expect your marginal tax rates to stay the same or increase in retirement. Remember, long-term capital gains and qualified dividends are generally taxed at lower rates than income, so if your salary is lower (or maybe you've gone part-time), and your tax rates will increase in retirement because of Social Security, a pension or other income, take the tax hit now and pay lower rates than you would later, in retirement. Remember, all funds (whether original contributions or gains) withdrawn from a 401k or 403b and non-Roth IRAs are subject to ordinary income taxes at the state and federal level at the time of distribution.


The second and more likely reason why you might hesitate to fully participate in your company's 401k plan is fees. A long-time client of mine just switched jobs, so we were reviewing his new plan and found that the annual expense ratio for the "right" investment portfolio was at least 2.28%. That is utterly outrageous; although sadly, it is not uncommon. [There's a ditty in here somewhere:  "If your plan costs start with two, you, my friend, are screwed!"]


So how much is "too much"?  The first thing to know is that small plans - those with total assets of less than $10 million - are more expensive, simply because the plan maintenance costs are spread over fewer employees. A recent Deloitte Consulting study for the Investment Company Institute found that the typical annual fee is 0.67%, but for small companies the average cost is 1.27%. A similar study by the trade magazine Plan Sponsor showed the average plan cost for a plan with 50 participants and $2.5 million in assets was 1.46%. 


The good news is that the figures are declining, mostly because of regulations that now require making information on expenses available. The bad news is that a whole lot of smaller companies have not taken the time to look at their plans to see what they and their employees are paying. Two types of folks are happy about that: (1) the insurance companies and large brokerage houses, which are often the ones who are charging the usurious fees; and (2) plaintiffs' attorneys, who are seeing this employer breach of fiduciary duty as ripe pickings for class action lawsuits. [If you own a company with a 401k plan, then you are a fiduciary, and that's a high standard! This email address is being protected from spambots. You need JavaScript enabled to view it. to see if you are at risk!]


Mark my words: there will be a spate of lawsuits in the coming years that relate to exorbitant fees in 401k plans. If you are a fiduciary, please take a look at your plan - for your own sake and for the sake of your employees. The 401k world is changing, don't be left behind!


If you are not an employer fiduciary, but you're interested in reviewing your 401k holdings (and expense ratios) or consider other retirement planning, call me. I'd be happy to take an objective look and let you know if you are doing all you can to prepare for a successful retirement.

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The Fiduciary Standard, Last Straws and Your Financial Health

The Fiduciary Standard, Last Straws and Your Financial Health

Until a few weeks ago, few people outside the advisory world could tell you what a fiduciary standard is, much less why it mattered. But since April, when the Department of Labor proposed a new fiduciary standard for anyone giving retirement investment advice, the term and its impact on consumers have been the talk of the town. 


As a fee-only planner and a proud member of NAPFA (the National Association of Personal Financial Advisors) and FPA (the Financial Planning Association), both leaders in promoting fiduciary standards to serve the needs of consumers, I've been dedicated to the fiduciary standard of serving in my clients' best interests my entire career. But the whole discussion has me thinking about the other attributes that define a great advisor, and why working with a professional often makes such a significant difference in the retirement outcomes for individual investors. It's true that fee-only planners receive no commissions for the products we recommend. But that's only part of the picture, and there's so much more to the story... 


Many of the clients who walk in my door for the first time are couples who have hit a turning point in their finances. More often than not, one spouse has taken the lead in managing their money, and there's been a "last straw" that broke the do-it-yourself back of the couple's money management. A poor investment. A tax disaster. A layoff. The reasons are many, but the outcome is the same: they need an expert to turn things around. To begin the conversation, I ask two key questions: "When was the last time you lost sleep over money?" and "When was the last time you had a fight about money?" Inevitably, the answers I receive cut to the crux of their unique issues. The last straw if you will. And it helps me better understand their sensitivities, their goals, and, perhaps most importantly, their differences. When it comes to money, no two couples are alike, and no two couples define success in the same way. This is precisely why customized investment management is so vital to helping every investor reach his or her own financial "success." 


Whether you've experienced your own “last straw” or simply want be sure your portfolio is optimized for success (however you define it), you can count on an experienced fee-only advisor to explore the following questions—questions that are often overlooked by non-fiduciaries and do-it-yourselfers alike:


1. What's the annual cost of your portfolio?

The exciting part of investing is watching your assets grow. But it's easy to forget about the small details that can eat away at that growth. Even small expenses can have a big impact on your outcome—tens of thousands of dollars worth—over the long term due to the power of compounding. A professional advisor dives into the details to be sure your nest egg is as cost efficient as possible by working to keep fund management fees, taxes, transaction fees, tax preparation costs, and other expenses to a minimum. 


2. Is your portfolio tax efficient - today and post-retirement?

Taxes are typically the largest expense to anyone's savings. So even when your assets are growing nicely, if your portfolio isn’t designed to be as tax efficient as possible, it may not be climbing as high or as quickly as it could be. A professional advisor knows how to mitigate taxes within your portfolio by balancing gains and losses and carefully allocating assets (read more on this in my April 15 blog), as well as how to be sure your accounts are tax diversified so you’re paying the taxes you do pay at the optimal time, both before and after retirement.


3. Are your investments as diversified as they need to be?

Everyone talks about diversification - especially after a market crash - but few understand how to truly analyze a portfolio to ensure it's taking on the least amount of risk to accomplish the goals of the individual investor. A professional advisor not only has the knowledge and tools required to complete an in-depth analysis of all assets and holdings, but also how to synchronize that information with specific long- and short-term financial goals. 


Ultimately, investment management is a field where practice may not make "perfect," but it almost always beats out applying casual knowledge and hoping for the best. It's a lot like visiting a family physician - a general practitioner with years of practice and experience treating hundreds of patients - when something goes wrong with your health. You present your symptoms and, using his or her insight and medical wisdom, your MD can usually identify the problem and prescribe a solution. And when the problem lies outside the area of general medicine, the MD has a network of trusted specialists with extensive knowledge of your ailment. You put your trust in your physician because they have in-depth knowledge, extensive training, experience-based insight, and a trusted professional network. 


When it comes to your financial health, would you ask for anything less? 


Need some help to address your own "last straw" and improve your financial health? Call to schedule your financial check up.

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Contact Details

TAM Financial Advisors
1441 Pleasant Lake Road
Annapolis, MD 21409
Phone: 410-349-4484
Fax: 410-349-4480


All information contained herein is for informational purposes only and does not constitute a solicitation or offer to provide financial advice or investment advisory services.  Read more >

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