Objective information about financial planning, investments, and retirement plans

What I’m Reading – March Madness Edition

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It’s a bit of a lazy Sunday here and I am half surfing the web and half watching the NCAA Men’s basketball tournament.  I’m not the college basketball fan that I once was, but I still love March Madness and watch every game that I can.

In 1939, H.V. Porter of the IHSA coined the te...

Here are some financial articles that I’ve read lately that you might find interesting and useful:

The Ultimate Guide to Understanding Your 401(k) A great piece loaded with information for those who might be new to 401(k) investing or who just want to learn a bit more by Harry Campbell on his blog Your Personal Finance Pro.

Five strategies to get the most Social Security another excellent and informative piece by Robert Powell at Market Watch.

And You Thought Just Tuition Was Expensive a nice piece on the Morningstar site that discusses how college expenses other than tuition can really put a strain on parents and students trying to pay for college.

Are You Paying Too Much For Mutual Funds?  Dana Anspach does a good job of addressing this important question at U.S. News.

The IRS Releases Their “Dirty Dozen” Tax Scams for 2014 was featured on Jim Blankenship’s excellent blog Getting Your Financial Ducks in a Row.

Americans and Retirement: 3 Worrying New Findings discusses EBRI’s most recent Retirement Confidence survey on Wall Street Cheat Sheet.

If you are new to The Chicago Financial Planner here are the three most popular posts over the past 30 days:

Your 401(k) is not Free

Life Insurance as a Retirement Savings Vehicle – A Good Idea?

7 Retirement Investing Tips

Well that’s it I hope you enjoy some of these articles and the rest of your Sunday.  I’ve watched a couple of good tournament games so far with hopefully more to follow.  Cool and sunny here today, but none the less good grilling weather, chicken is on the menu for tonight.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss  all of your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services. 

The Chicago Financial Planner is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com. If you click on my Amazon.com links and buy anything, even something other than the product advertised, I earn a small fee, yet you don’t pay any extra. Click on the Amazon banner below to go directly to the main site or check out the selections in our Book Store.

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Time Well Spent: Choosing an IRA or a Restaurant?

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Actually both can be a good use of your time in the right amount.  Living near a major city like Chicago, the dining choices are innumerable.  The worst that can happen is you have a bad meal should you choose the wrong restaurant.  Contrast this with choosing the wrong place for your IRA account and/or the wrong investments and you may end up with less in retirement than you had hoped for.

According to a recent survey by TIAA-CREF:

  •  Americans are more likely to spend two hours selecting a restaurant for a special occasion (25 percent), buying a flat screen TV (21 percent) or tablet computer (16 percent) than on planning an IRA investment (15 percent).
  • Fewer than one in five (17 percent) Americans are contributing to an IRA – a decline from 22 percent in 2012 – potentially missing tax and savings benefits.
  • What’s more, fewer than half (47 percent) of those not contributing say they would consider an IRA, down from 57 percent in 2013.
  • Even among those who already have an IRA, more than half (55 percent) said they spent an hour or less planning for the investment.

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According to the TIAA-CREF survey:

“An IRA can be an incredibly powerful savings tool that can boost retirement security and offer immediate tax and savings benefits. IRAs can also serve as a valuable supplement to an employer-sponsored plan and help fund a first home or education,” said Doug Chittenden, Executive Vice President, Individual Business at TIAA-CREF. 

Despite these benefits, the survey found that fewer than one in five (17 percent) of those surveyed currently contribute to an IRA, a decline from 22 percent in 2012. 

The survey reveals that the number of Americans who would consider an IRA as part of their retirement strategy has fallen sharply since 2013. Fewer than half (47 percent) of those not contributing say they would consider an IRA, down from 57 percent in 2013. 

It is possible that a lack of understanding is responsible for low IRA contribution levels. More than one-third (35 percent) of respondents do not understand what an IRA is or the difference between an IRA and an employer-sponsored plan. This percentage is even higher among the Generation Y (age 18-34) population surveyed (45 percent). 

“More and more people are unaware of the ultimate value an IRA can have in a building a stable and secure retirement,” said Chittenden. “Americans today bear much more responsibility for their retirement savings than previous generations did. There is a pressing need to educate Americans from all age groups and income levels on the long-term retirement benefits that IRAs provide through compounded investment growth and tax savings.” 

Even among those who already have an IRA, more than half (55 percent) said they spent an hour or less planning for the investment. 

Sixty percent of those who are contributing to an IRA also have an employer-sponsored plan such as a 401(k) or 403(b). Among those with both plans, more than half (53 percent) say they contribute to their IRA regardless of whether they have reached the contribution or matching limit of their employer-sponsored plan. This means they could be leaving money on the table if they are diverting money to their IRA before contributing enough to get their employer match. 

How does an IRA fit with my retirement planning strategy? 

TIAA-CREF is absolutely right in that an IRA can be a great tool in your retirement planning strategy.  If someone has access to a 401(k) or similar workplace retirement plan I generally suggest they contribute at least enough to capture any employer match offered.  This is true even if their 401(k) plan is lousy.

Beyond that it makes sense to contribute more than the amount needed to receive the match if your employer’s plan offers a menu of low cost solid investment choices.  Although 401(k) plans receive a lot of bad press, in fact there are many excellent plans out there.  One advantage to investing for retirement via a workplace retirement plan is the salary deferral feature.  This makes regular savings and retirement investing painless.

An IRA can be a great retirement savings vehicle in a number of situations:

  • You don’t have access to a retirement plan via your employer.
  • You have maxed out your contributions to your 401(k) and want to make additional retirement contributions.
  • You are a non-working spouse and your working spouse makes at least income to cover the amount of your contribution.
  • You are self-employed.  Note there are a number of retirement plan options for the self-employed including a Solo 401(k) and SEP-IRA.
  • You are looking to roll over your 401(k) after leaving a job and also possibly to consolidate several old 401(k) plans in one place to make managing these assets a bit easier. 

Considerations in choosing an IRA account 

In a recent post on this blog 3 Considerations When Opening an IRA Account I suggested the following things to consider when opening an IRA account:

When looking at the cost of an account at a particular custodian consider any annual account fees and transaction costs related to the types of investments you are likely to make.  For example:

  • How much is it to trade stocks, closed-end funds, ETFs or other exchange-traded vehicles?
  • Does this custodian offer a large number of mutual funds on a no transaction fee (NTF) basis? 

While researching a good restaurant can take some time and potentially yield some tasty rewards, time spent on finding the right IRA and on retirement planning in general can pay off handsomely down the road.  This can lead to many fine restaurant meals as well.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss  all of your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services. 

The Chicago Financial Planner is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com. If you click on my Amazon.com links and buy anything, even something other than the product advertised, I earn a small fee, yet you don’t pay any extra. Click on the Amazon banner below to go directly to the main site or check out the selections in our Book Store.

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Your 401(k) is not Free

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Several studies in recent years have highlighted the fact that a significant percentage of 401(k) plan participants don’t realize that their company retirement plan is not free.   Further they were not aware that they often pay all or a portion of these expenses out of their plan accounts.

401K - Perfect Solution !?

2011 study by AARP showed that 71% of the 401(k) participants that were surveyed were unaware there were expenses associated with their retirement plan.  The survey also showed a high level of misunderstanding of plan fees even by those who were aware of them.  More recent studies have also shown significant levels of both participants who are unaware of the fees and a high level of misunderstanding, even with the advent of required 401(k) fee disclosures in 2012.

Typical 401(k) plan fees and expenses

There has been an emphasis on the negative impact that high cost 401(k) plans have on the ability of participants to save for retirement via media.  The 2013 PBS Frontline program The Retirement Gamble, for example did a nice job of highlighting the negative impact of high fees on retirement savers.  Some of the expenses that are typical of a 401(k) plan include:

  • Investment expenses.  Here I am primarily referring to the expense ratios of the mutual funds, collective trusts, annuity sub-accounts, or ETFs offered as investment choices by the plan.  Using mutual funds as an example, all mutual funds have an expense ratio whether you invest within a 401(k) plan or outside the plan.  The key is whether the expense ratios of the choices offered by your plan are reasonable.
  • Administration and record keeping.  This includes keeping track of plan assets, participant assets, ensuring that salary deferrals and matching contributions are invested in line with the participant’s elections, generating quarterly statements, as well as various testing and external reporting functions.
  • Custody of plan assets.  This is where the money invested and the mutual funds (or other investment vehicles) are housed.  Examples of custodians might be Fidelity, Vanguard, Schwab, Wells Fargo, etc.
  • Investment advisor.  The fees here are for an outside investment advisor who provides advice to the plan sponsor in areas like investment selection and monitoring and the development of an Investment Policy Statement for the plan.  However, sometimes these charges are simply the compensation for a registered rep who sells the plan to company and may offer little or no actual investment advice. 

Other than mutual fund expense ratios (investor returns are always net of expenses) these expenses may be paid from plan assets (your money), by the company or organization sponsoring the plan, or a combination of both.  For example the plan sponsors who engage my services as advisor to their plan pay my fees from company assets so the plan participants bear none of the cost.

Additionally the delivery of these various functions can be fully bundled, partially bundled, or totally unbundled.  Generally (and hopefully) the outside investment advisor is independent of the other service providers.

Providers like Fidelity, Vanguard, or Principal are example of bundled providers.  They provide the investment platform, custody the assets, and do all of the administration and record keeping.  In an unbundled arrangement, the custodian, record keeper, and the investment advisory functions are all separate and provided by separate entities.

Neither arrangement is inherently good or bad, it is incumbent upon the organization sponsoring the plan to monitor the costs and quality of the services as part of their Fiduciary duty to you the plan participant.  Plan sponsors should insist on transparency regarding all provider expenses.

BrightScope 

BrightScope is a service that independently rates 401(k) plans on a number of criteria.  Check to see if your company’s plan is ranked by them at their site. 

Mutual Fund expenses 

The required fee disclosures that I mentioned above focus on the plan’s investment options and their expenses.  You should start seeing them in the near future.

While they may not look particularly informative and don’t delve into the plan’s total costs, the investment expenses can be telling none the less.

If your plan is via a large employer, you may see institutional share class mutual funds with very low expense ratios.  As an example my wife works for a division of a Fortune 150 company and some of the index funds available to her have expense ratios less than 0.05% which is very low.

In fact looking at the fund share classes offered by your plan is also revealing.

The American Funds offer six share classes for retirement plans ranging from R1 to R6.  Using the popular American Funds EuroPacific Growth fund as an example you can see the differences in the expenses and the impact on return below.

Ticker Expense Ratio 12b-1 5 Year return
R1 RERAX 1.61% 1.00% 15.35%
R2 RERBX 1.60% 0.74% 15.35%
R3 RERCX 1.14% 0.50% 15.90%
R4 REREX 0.85% 0.25% 16.24%
R5 RERFX 0.55% 0.00% 16.58%
R6 RERGX 0.50% 0.00% 16.62%

Source:  Morningstar as of 3/14/14

Looking at this another way, $10,000 invested in the R1 and R6 share classes would have grown to the following amounts by February 28, 2014:

R1  $20,915

R6  $23,022

I think you will agree that this is a rather significant difference.

The 12b-1 fees are included in the fund’s expense ratio and generally go to compensate the plan provider, the registered rep or broker who sold the plan or other service providers.  In the case of the American Funds you generally see the R1, R2, and R3 shares in higher cost, broker sold plans.

Similar share class comparisons can be made with other mutual funds in many other families including Fidelity, T. Rowe Price, and even low-cost Vanguard.

According to Morningstar* data as of 12/31/13 here are the median expense ratios for the following investment styles:

Large Blend 1.07%
Large Growth 1.15%
Large Value 1.07%
Mid Cap Blend 1.16%
Mid Cap Growth 1.24%
Mid Cap Value 1.24%
Small Cap Blend 1.23%
Small Cap Growth 1.36%
Small Cap Value 1.31%
Foreign Large Blend 1.23%
Intermediate Bond 0.79%

 

While these are median expense levels I would say that for the most part if the funds in your plan are at these levels they are too expensive.  Index funds across these categories should be 0.25% or less.

Several studies have concluded that the biggest determinant in retirement success is the amount saved.  None the less having access to a solid, low cost 401(k) plan as vehicle for retirement investing is a big plus.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss  all of your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services. 

The Chicago Financial Planner is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com. If you click on my Amazon.com links and buy anything, even something other than the product advertised, I earn a small fee, yet you don’t pay any extra. Click on the Amazon banner below to go directly to the main site or check out the selections in our Book Store.

* Affiliate link, I may be compensated if you enroll in Morningstar’s premium service at no extra cost to you.

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3 Considerations When Opening an IRA Account

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As we head toward April 15 it is now high IRA season for the major brokerage and financial services firms.   You will undoubtedly see many TV commercials and ads by these firms touting the benefits of opening an IRA with their firm.  Here are 3 things to consider as you evaluate your best IRA account options.

Understanding your retirement

How much will this cost me? 

Some firms may charge a fee just to have the account.  This might be on the order of $25 or $50 annually.  If your balance is relatively low this can be a significant bite.  Sometimes these fees are based on the size of your account balance.

Additionally you will want to understand any and all transaction fees.  This might include trading fees for buying and selling stocks, ETFs, or other exchange-traded investment vehicles.  Certain mutual funds might carry a transaction cost as well.

If you are working with a commission-based financial advisor understand how he or she is compensated.  Will the funds in the IRA account they are advocating carry sales charges or high internal fees to compensate them?

Is this custodian a good fit with my investing needs? 

This runs the gamut.  Certainly the fees mentioned above are part of this.  Beyond this look at how you invest and the vehicles in which you invest.

For example if you use ETFs extensively does this custodian offer any commission-free ETFs?  If so are these the ETFs that you would use?

As an example if you were planning on using Vanguard mutual funds exclusively it might make sense to house your IRA there.  On the other hand if you were looking to use funds from a variety of families perhaps a custodian that is more of a fund supermarket like Schwab or Fidelity is more appropriate for you.

Beyond an IRA account is this custodian a good fit for my needs in terms of other types of accounts such as a taxable brokerage account?  Do they offer the full array of services that I might need?  In my experience having an IRA at one custodian plus other accounts scattered around several other custodians is rarely a good idea.

Should I roll my 401(k) to an IRA or leave in my old employers plan? 

One of the primary reasons that investors open an IRA during the year is to roll their old 401(k) account over when leaving a job.

If you are leaving your employer whether to roll your 401(k) balance over to an IRA, leave it in your old employer’s plan, or roll it to your new employer’s plan (if applicable) is a critical decision.

There are good  reasons to move your account balance to an IRA which could include:

  • Your old employer’s 401(k) plan is lousy (as is your new employer’s if applicable).
  • A desire to consolidate all of your various retirement accounts into a single IRA to make management of your investments easier.
  • Access to a wider selection of quality investment options than might be available via your old employer’s plan.
  • Perhaps you are working with a trusted financial advisor and the rollover with allow them to better integrate this money with your overall investment strategy. 

On the other hand two reasons to consider either leaving your money in your old employer’s plan or rolling it into your new employer’s plan (if applicable):

  • The plan offers a menu of low cost institutional investments that might not be available to you via a rollover IRA.  This is often the case with very large employers with tremendous buying power, but also with smaller plans who use a competent outside investment advisor.
  • Similar to the last bullet, the plan offers specific investment options that you would be unable to match in an IRA. 

An IRA, either Traditional or Roth, is a great vehicle to help you win the retirement gamble.  Before opening an IRA account you need to do your homework just as with any investing decision.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss  all of your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services. 

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Year-End 401(k) Matching – A Good Thing?

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Tim Armstrong

AOL’s recent announcement that they were moving to a year-end once per year match on their 401(k) plan has sparked a lot of discussion on this issue.  AOL subsequently rescinded this change due to the public relations disaster caused by the firm’s Chairman tying this change to both Obama Care and specifically to two high-risk million dollar births covered by the company’s health insurance in 2012.  None the less other firms, notably IBM, have gone this route in recent years.  What are the implications of a year-end annual 401(k) match for employees and employers?

Implications for employees 

Ron Lieber wrote an excellent piece in the New York Times entitled Beware the End-of-Year 401(k) Match about this topic.  According to Lieber:

“AOL’s chief executive, Tim Armstrong, drew plenty of attention earlier this month when he seemed to attribute a change in the company’s 401(k) plan in part to a couple of employees whose infants required expensive care. But what was mostly lost in the discussion was just how much it would cost employees if every employer tried to do what AOL did. 

The answer? Close to $50,000 in today’s dollars by the time they retired, according to calculations that the 401(k) and mutual fund giant Vanguard made this week. That buys a lot of trips to see the grandchildren — or scores of nights in a nursing home.” 

According to the Vanguard study, assuming an employee earns $40,000 per year and contributes 10% of their salary for 40 years, the investments earn 4% after inflation, and the employee receives a 1% salary increase per year, the worker would have a balance that was 8.7% lower with annual matching than with a per pay period match.  Of note, the Vanguard analysis assumes that this hypothetical worker missed 7 years worth of annual matches due to job changes over the course of his/her career.

Lieber also discussed the case of IBM’s move to year-end matching that also proved controversial.  IBM, however, offers all employees free financial planning help and has a generous percentage match.

Additional implications of an annual match from the employee’s viewpoint:

  • One of the benefits of regular contributions to a 401(k) plan is the ability to dollar cost average.  The participants lose this benefit for the employer match.
  • Generally employees have to be employed by the company as of a certain date in order to receive their annual match.  Employees who are looking to change employers will be impacted as will employees who are being laid off by the company.
  • If the annual match is perceived as less generous it might discourage some lower compensated workers from participating in the plan which could lead to the plan not passing it’s annual non-discrimination testing which could lead to restrictions on the amounts that some employees are allowed to contribute to the plan. 

Note employers are not obligated to provide a matching contribution.  Also note that the above does not refer to the annual discretionary profit sharing contribution that some companies make based on the company’s profitability or other metrics.  Lastly to be clear, companies going this route are not breaking any laws or rules.

Implications for employers 

I once asked the VP of Human Resources of one of my 401(k) plan sponsor clients why they chose a particular 401(k) provider.  His response was that this provider’s well-known and respected name was a tool in attracting and retaining the type of employees this company was seeking.

While not all employers offer a retirement plan, many that do cite their 401(k) plan as a tool to attract and retain good employees.

There are, however, some valid reasons why a plan sponsor might want to go the annual matching route:

  • Lower administration costs (conceivably) from only having to account for and allocate one annual matching contribution vs. having to do this every pay period.  Note that in many plans the cost of administration is born by the employees and comes out of plan assets, in other plans the employer might pay some or all of this cost in hard dollars from company assets.
  • Cost savings realized by not having to match the contributions of employees who have left the company prior to year-end or the date of required employment in order to receive the match.
  • Let’s face it the cost of providing employee benefits continues to increase.  Companies are in business to make money.  At some point something may have to give.  While I’m not a fan of these annual matches going this route vs. reducing or eliminating a match is preferable. 

Reasons a company wouldn’t want to go this route:

  • In many industries and in certain types of positions across various industries skilled workers are scarce.  Annual matching can be perceived as a cut in benefits and likely won’t help companies attract and retain the types of employees they are seeking.
  • Companies want to help their employees to retire at some point either because they feel this is the right thing to do and/or because if too many older employees don’t feel they can retire this creates issues surrounding younger employees the company wants to develop and advance for the future. 

Overall I’m not a fan of these annual matches simply because it is tough enough for employees to save enough for their retirement under the defined contribution environment that has emerged over the past 25 years or so.  In many cases the year-end or annual match simply makes it just that much tougher on employees, which is not a good thing.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss  all of your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services. 

Please check out  
for books on financial planning and retirement as well as any Amazon shopping needs you may have.  
 

The Chicago Financial Planner is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com.  If you click on my Amazon.com links and buy anything, even something other than the product advertised, I earn a small fee, yet you don’t pay any extra.

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Target Date Funds: Does the Glide Path Matter?

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Most Target Date Funds are funds of the mutual funds of the fund family offering the TDF.  The pitch is to invest in the fund with a target date closest to your projected retirement date and “… we’ll do the rest….”  A key element of Target Date Funds is their Glide Path into retirement.  Stated another way the Glide Path is the gradual decline in the allocation to equities into and during retirement.  Should the fund’s Glide Path matter to you as an investor?

Glide PathTarget Date Funds have become a big part of the 401(k) landscape with many plans offering TDFs as an option for participants who don’t want to make their own investment choices.  Target Date Funds have also grown in popularity since the Pension Protection Act of 2006 included TDFs as a safe harbor option for plan sponsors to use for participants who do not make an investment election for their salary deferrals and/or any company match.

These funds are big business for the likes of Vanguard, Fidelity, and T. Rowe Price who control somewhere around 70% of the assets in these funds.  Major fund families such as Blackrock, JP Morgan Funds, and the American Funds also offer a full menu of these funds.  Ideally for the fund company you will leave you money in a TDF with them when you retire or leave your employer, either in the plan or via a rollover to an IRA.

What is a Glide Path?

The allocation of the fund to equities will gradually decrease over time.  For example Vanguard’s 2060 Target Date Fund had an equity allocation of almost 88% at the end of 2013.  By contrast the 2015 fund had an equity allocation of approximately 52%.

This gradual decrease continues through retirement for many TDF families including the “Big 3” until the equity allocation levels out conceivably until the shareholder’s death.  T. Rowe Price has traditionally had one of the longest Glide Paths with equities not leveling out until the investor is past 80.  The Fidelity and Vanguard funds level out earlier, though past age 65.

There are some TDF families where the glide path levels out at retirement and there is some debate in the industry whether “To” or “Through” retirement is the better strategy for a fund’s Glide Path.

Should you care about the Glide Path? 

The fund families offering Target Date Funds put a lot of research into their Glide Paths and make it a selling point for the funds.  The slope of the Glide Path influences the asset allocation throughout the target date years of an investor’s retirement accumulation years.  The real issue is whether the post-retirement Glide Path is right for you as an investor.

On the one hand if you might be inclined to use your Target Date Fund as an investment vehicle into retirement, as the mutual fund companies hope, then this is a critical issue for you.

On the other hand if you would be inclined to roll your 401(k) account over to either an IRA or a new employer’s retirement plan upon leaving your company then the Glide Path really doesn’t make a whole lot of difference to you as an investor in my opinion.

In either case investing in a Target Date Fund whether you are a 401(k) participant saving for retirement or a retiree is the ultimate “one size fits all” investment.  In the case of the Glide Path this is completely true.  If you feel that the Glide Path of a given Target Date Fund is in synch with your investment needs and risk tolerance into retirement then it might be the way to go for you.

Conversely many people have a number of investment accounts and vehicles as they head into retirement.  Besides their 401(k) there might be a spouse’s 401(k), other retirement accounts including IRAs, taxable investments, annuities, an interest in a business, real estate, and others.

In short, Target Date Funds are a growing part of the 401(k) landscape and I’m guessing a profitable way for mutual fund companies to gather assets.  They also represent a potentially sound alternative for investors looking for a professionally managed investment vehicle.  The Glide Path is a key element in the efforts to keep these investors in the Target Date Fund potentially for life.  Before going this route make sure you understand how the TDF invests, the length and slope of the Glide Path, the fund’s underlying expenses, and overall how the fund’s investments fit with everything else you may doing to plan for and manage a comfortable retirement.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss your 401(k) plan and all of your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services. 

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YOU RECEIVED A PINK SLIP AND SEPARATION AGREEMENT – NOW WHAT?

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The end of the year is a time to celebrate the holidays with family and friends.  Sadly it is often the time of year when many employers look to reduce employee headcount.  My thanks to Chicago attorney Daniel N. Janich for contributing this guest post with his thoughts and suggestions on what you should do if you find yourself being let go by your employer now or at some point in the future. 

Okay. So you have just been notified that your employment has been terminated. Perhaps you just came back from a meeting with the boss, or you received an email or other written notice from the HR department simply informing you to clean out your desk.

Lady Justice

 

Overcoming the initial shock

After overcoming the initial shock of this news, you soon realize that you were handed some papers from your employer to sign. Among them is a proposed separation agreement with the terms of your severance package.  Upon your brief initial review of the agreement you learn that you will receive your severance only if you agree to sign a release.

What are the issues that you should watch out for before putting pen to paper? Should you sign the severance agreement “as is” or do you believe you have any leverage to negotiate for a better deal and perhaps modify some of its terms?  What should you do before signing a separation agreement?

First, before doing anything else, thoroughly read through the entire separation agreement.  Make notes if necessary of provisions which may be of concern or which you do not understand or you think you might want to modify or even delete. You should also review any other employment or compensation related agreements that you may have signed with your former employer in the past as well as your Employee Handbook. The purpose of this review is to ensure that all the terms in your separation agreement are consistent with those in other documents. If they are not, your separation agreement will most likely expressly provide that its terms supersede those of any earlier agreement or understanding, thus effectively nullifying these earlier agreements if and when you sign the separation agreement.  In such case you need to be keenly aware of exactly just what it is that you are giving up by signing the separation agreement.

If you are at all uncomfortable with any of the provisions in the separation agreement, and there is a big enough severance amount involved in your deal, you will likely benefit by hiring an experienced attorney to review the agreement for you and provide you with an analysis and recommendations. You may also want the attorney to negotiate with your former employer on your behalf. The fees involved may be money well spent because you will be made aware of potential problems with the agreement that you did not spot on your own, and you will be provided with practical solutions that will not only preserve your severance benefits but might also provide you with more favorable terms for your agreement. Additionally, the attorney may also uncover claims against your former employer you may not even been aware you had.

Review the agreement

Second, regardless of whether you hire an attorney, determine if the agreement presents issues that either need to be resolved or clarified before you are ready to sign it. Here is a list in no particular order of importance—and by no means exhaustive—of the typical provisions in a separation agreement which might cause problems for employees, and therefore, which you should review very carefully:

  • Termination date.  Your termination will end your participation in the company’s benefit plans.  When will you be required to transition your health coverage under COBRA?   Under COBRA the entire cost of your health insurance premiums under the company’s group coverage will generally be paid out of your own pocket. (See COBRA discussion below).
  •  Severance amount.  Is your severance consistent with the company’s severance policy and practice? Are you being downsized and perhaps entitled to participate in a company sponsored severance plan?  Is the severance amount that is being offered sufficient to justify you signing a release?
  • Method and manner severance is to be paid.  For how long will you be receiving severance payments?  Does the structure of your severance payouts comply with Internal Revenue Code Section 409A’s deferred compensation rules? (Ask the company’s HR department or your lawyer about this issue as the penalties for non-compliance could be great.) When will severance payments begin and under what circumstances might they end before you receive the entire amount?
  • Scope and duration of the noncompete. A noncompete provision in your separation agreement means that you might be prevented from seeking other viable job opportunities in your field within your former employer’s industry for a certain period of time and within a designated geographic area after signing the separation agreement. What is the duration of your noncompete? How big is the geographic area?  You should ascertain whether you could obtain a waiver of these restrictions if necessary.
  • Nondisparagement.  Will you be prevented from saying anything negative, even if it is truthful, to anyone either orally, in writing or through social media regarding your former employer or the products and services provided by your former employer?  Is this provision mutual, which would prevent your former employer from saying negative things to others about your character or job performance? Should you negotiate receiving a letter of recommendation from your former employer or a positive recommendation if a prospective employer should contact your former one?
  • COBRA coverage.  When will your COBRA coverage begin? Have you received your COBRA notice and election form? When is your election form due?  When is your first premium payment due? You might be able to negotiate that a portion of your COBRA premiums be subsidized by your former employer.  Are there any circumstances that might extend your COBRA coverage, if necessary, beyond the initial 18 months following your employment termination?
  • Continuing Cooperation.  Are you required under the separation agreement to be available to your former employer if needed as a witness or to participate in a legal investigation on behalf of the company?  If so, how will you be compensated for your time and your out-of-pocket expenses?  Is there flexibility in the amount of time you are required to provide and when you must make yourself available to your former employer?
  • Scope of general release.  Is the general release that you are required to sign prepared broadly to cover any possible claim of any kind and at any time in the past, present or future, in connection with your former employer?  Or does it address only claims relating to your employment relationship and its termination?  When must you sign and return the release? Is this at the same time as the date your separation agreement must be signed and returned?

Some additional pointers

If the provisions of your separation agreement require negotiation of its terms, then you should seek at the outset a written extension of time to sign and return the separation agreement and release.  In fact, it is a good idea to obtain a written  extension as soon as the need for it is apparent to give you sufficient time to resolve issues of concern in the agreement or release without undue pressure to accept terms you might not otherwise agree upon simply to avoid forfeiting the severance amount that was offered to you.

Prior to signing any release you should consider and discuss with your attorney whether you have any potential claims—which would most likely be employment or benefit related—that you would be giving up by signing the release.  Your attorney should confirm with you after reviewing your employment related documents, including your written employment agreement if any, and copies of any retirement or welfare plan documents, as to whether the severance payout under the separation agreement is a sum that justifies your signing the waiver of claims under the release.  To this end, any compensation and benefits that you already earned prior to the termination of your employment should not be counted as part of your severance amount.

If you are participating in various stock-based compensation plans and programs, you should assess prior to signing your separation agreement whether you are “leaving money on the table” in the form of appreciated but unvested shares, options or units as of your effective termination date.  If so, you may consider whether some or all of your unvested interests can be vested as of your termination date, or whether you can receive an extra amount of cash to compensate you for this forfeited benefit.

Your qualified and non-qualified retirement benefits are generally governed by plan documents other than your separation agreement. Again you will need to assess whether and how your employment termination will affect your vested interest in these retirement plans. Although not of immediate concern, you should also eventually determine whether it might be best to rollover any retirement benefits from your 401(k) plan into an IRA or another 401(k) of your next employer.

Before signing the release you should understand exactly what it is you are signing.  Once the release has been signed, you will have permanently given up your rights in exchange for the severance payment agreed upon in the separation agreement.  There cannot be any lingering doubts or other second thoughts about whether you should have signed the separation package and release.  Once it is done there is no looking back.

This blog post is certainly not intended to be a complete discussion of all potential concerns and issues that may arise in connection with your decision whether to sign the proposed separation agreement.  In fact, your circumstance may call for your separation agreement to be dealt with differently from the way your co-worker deals with an identical separation agreement.  That is why when your livelihood and rights are at stake, consulting with an experienced attorney may, in the long run, be the right decision for your career.

Daniel N. Janich is a Partner in the Employee Benefits and Executive Compensation Practice Group at Greensfelder, Hemker & Gale, P.C. in Chicago.  He has extensive experience representing clients in a broad range of benefits and compensation matters, including the drafting, negotiation and litigation of employment agreements and separation packages.  He can be reached at dnj@greensfelder.com or 312-558-1070.  Check out Dan’s profile on LinkedIn as well. Dan is an excellent resource should you find yourself in this position.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss all of your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services. 

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7 Year-End 2013 Financial Planning Tips

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Thanksgiving is behind us and we are in the home stretch of 2013.  While your thoughts might be on shopping and getting ready for the holidays, there are a number of financial planning tasks that still need your attention.  Here are 7 financial planning tips for the end of the year.

Use appreciated investments for charitable donations

 If you would normally contribute to charity why not donate appreciated stocks, mutual funds, ETFs, closed-end funds, etc.?  The value of doing this is that you receive credit for the market value of the donated securities and avoid paying the capital gains on the appreciation.  A few things to keep in mind:

  • This only works with investments held in a taxable account.
  • This is not a good strategy for investments in which you have an unrealized loss.  Here it is better to sell the investment, realize the loss and donate the cash.

 

English: A bauble on a Christmas tree.

 

Harvest losses from your portfolio

The thought here is to review investments held in taxable accounts and sell all or some of them with unrealized losses.  These may be a bit harder to come by this year given the appreciation in the stock market.  Bond funds and other fixed income investments might be your best bet here.

The benefit of this strategy is that realized losses can be offset against capital gains to mitigate the tax due.  There are a number of nuances to be aware of here, including the Wash Sale Rules, so be sure you’ve done your research and/or consulted with your tax or financial advisor before proceeding.

Establish a Solo 401(k) 

If you are self-employed and haven’t done so already consider opening a Solo 401(k) account.  The Solo 401(k) can be an excellent retirement planning vehicle for the self-employed.  If you want to contribute for 2013 the account must be opened by December 31.  You then have until the date that you file your tax return, including extensions, to make your 2013 contributions. 

Rebalance your portfolio

With the tremendous gains in the stock market so far this year, your portfolio might be overly allocated to equities if you haven’t rebalanced lately.  The problem with letting your equity allocation just run with the market is that you may be taking more risk than you had intended or more than is appropriate for your situation.

Rebalance with a total portfolio view.  Use tax-deferred accounts such as IRAs and 401(k)s to your best advantage.  Donating appreciated investments to charity can help.  You can also use new money to shore up under allocated portions of your portfolio to reduce the need to sell winners.

Review your 401(k) options 

This is the time of the year when many companies update their 401(k) investment menus both by adding new investment options and replacing some funds with new choices.  This often coincides with the open enrollment process for employee benefits and is a good time for you to review any changes and update your investment choices if appropriate.

Be careful when buying into mutual funds 

Many mutual fund companies issue distributions from the funds for dividends and capital gains around the end of the year.  These distributions are based upon owning the fund on the date the distribution is declared.  If you are not careful you could be the recipient of a distribution even though you’ve only owned the fund for a short time.  You would be fully liable for any taxes due on this distribution.  This of course only pertains to mutual fund investments made in taxable accounts.

Required Minimum Distributions 

If you are 70 ½ or older you are required to take a minimum distribution from your IRAs and other retirement accounts.  The amount required is based upon your account balance as of the end of the prior year and is based on IRS tables.  Account custodians are required to calculate your RMD and report this amount to the IRS.

Note beneficiaries of inherited IRAs may also be required to take an RMD if the deceased individual was taking RMDs at the time of his/her death.

If you have multiple accounts with multiple custodians you need to take a total distribution based upon all of these accounts, though you can pick and choose from which accounts you’d like to take the distribution.  Make sure to take your distribution by the end of the year otherwise you will be faced with a stiff penalty of 50% of the amount you did not take on top of the income taxes normally due.

If you turned 70 ½ this year you can delay your first distribution to April 1 of next year, but that means that you will need to take two distributions next year with the corresponding tax liability.  Also if you are still working and are not a 5% or greater owner of your company you do not need to take a distribution from your 401(k) with that employer.  You do, however, need to take the distribution on all remaining retirement accounts.

For those who take required minimum distributions and who are otherwise charitably inclined, you have the option of diverting some or all of your distribution via a provision called the qualified charitable distribution (QCD).  The advantage is that this portion of your RMD is not treated as a taxable income and may have a favorable impact on the amount of Social Security that is subject to income taxes for 2014 and other potential benefits.  Note that you can’t double dip and also take this as a deductible charitable contribution.  Consult with the custodian of your IRA or retirement plan for the logistics of executing this transaction.

With all of the strategies mentioned above I recommend that you consult with a qualified tax or financial advisor to ensure  that the strategy is right for your unique situation and if so that you execute it properly. 

Certainly year-end is about the holidays, family, friends, food, and football.  It is also a great time to take execute some final year-end financial planning moves that can have a big payoff and in the case of RMDs save you from some hefty penalties.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss all of  your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.  

Photo credit:  Wikipedia

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