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I joined Martin Financial Group recently to work with businesses on their company sponsored retirement plans. I specifically have worked with many businesses on varied aspects of their 401k plans at my prior employer. This blog post is specifically geared towards business owners, plan sponsors, trustees, and people involved in human resources. Many 401k plan participants may be curious how 401k fees work on a plan as well.

My goal is to write a series of blog posts that will help you understand 401ks better and hit on topics that are relevant and important to employers and employees. Martin Financial Group’s goal is to make your organization’s retirement plan more effective, efficient, and align with your organization’s overall objectives. We are happy to help pull, review, and analyze your plans current fee disclosure.

When working with plan sponsors, I ask if they know the fees they are paying. Many times the plan sponsor can tell me the amount the business pays in hard dollar fees to the recordkeeper and the third-party administrator. What the plan sponsor typically doesn’t know or is unfamiliar with is the internal expense of the 401k plan. Typically, where you find these internal expenses is on a document or documents called a 408(b)(2).

What is a 408(b)(2)?

The 408(b)(2) should be received by the plan sponsor from each service provider who is receiving payment from the company’s 401k plan.

A “payment from the plan” means that the fees are being collected from the plan participants. Service providers can include advisors, recordkeepers, third party administrators, custodians, auditors, and anyone who provides a plan service. Employers might only receive disclosures from providers that are paid out of the plan and not necessarily from providers that they make a hard dollar direct payment to.

What is a 404(a)?

The 404(a) is a document that is distributed to participants and is intended to give plan participants a better understanding of the costs associated with the 401k so they can make more informed investment decisions. It typically does not lay out any specific asset based fee or any admin costs that are passed on to the plan.

Parties typically compensated by a 401k

  • Third Party Administrator- Usually a flat dollar amount plus a variable per head fee or sometimes a percentage of assets paid from the recordkeeper. Ex. ($1000-$5000)
  • Recordkeeper– Can be a % of assets fee, some providers are a flat fee plus a per participant fee,  or some also get compensated within the investments Ex. (A 1,200,000 plan with a .5% asset fee is $5000)
  • Investments- Different share classes have different fees. If sold by a broker the broker could be paid out of the investments. The same fund could range quite a bit depending on the share class. Ex. (American Funds Balanced R1- 1.37%, American Funds Balanced R6- .28%)
  • Advisor- Can be paid by the 12-b1 in the investments or if a fee based advisor it can be pulled separate. Ex. (Typically .25%-1.5% of the assets in the plan)
  • Fidelity Bond- A fiduciary bond provides insurance protection against the possibility of fraud or embezzlement by a fiduciary Ex. ($100-$300)

It’s worth pointing out that there are two methods used to collect service provider fees from participants. Some plans remove fees directly from a participant’s account. Such fees are transparent, making it easier for plan sponsor and participant alike to measure service value. However, some plans use a “revenue-sharing” method where the fees are removed from the participant’s investment returns before they become a part of the participant’s retirement account. Such “hidden” fees are not reported in a participant’s quarterly plan statement, are difficult to identify and have led some plan participants and plan sponsors to believe their retirement plans are free. I’ve outlined where the fee components are usually taken from in the section below.

Where do we find this 408(b)(2) document?

Typically, a good starting point is on the recordkeepers plan sponsor website (ADP, VOYA, John Hancock, Fidelity, Principal, etc.). This would be labeled as the plan fee disclosure or 408(b)(2). You can also request them from your financial professional.

Employers must comb through the 408(b)(2) documents in detail to first understand the services being provided and whether the service provider or the financial professional is a fiduciary. Service providers or financial professionals acting as fiduciaries must specifically state that they are doing so. If a provider is silent regarding fiduciary status, it is not a fiduciary.  

Fee components on a 401k plan usually include:

1. Take-over or conversion fees—Employer
• A one-time expense
2. Investment management fees—Participant
• Charge by money manager
• Asset-based charge
3. Administrative fees—Employer or Participant
• Annual fees for recordkeeping services
• Base fee and/or per-employee cost
• Asset-based charge
4. Transaction fees—Employer or Participant
• Activity-based charges—loans, distributions
• Dollar amount per transaction
• Asset-based charge
5. Insurance features—Participant
• Mortality and expense-risk fee
• Asset-based charge
6. Direct or indirect fees—Employer or Participant
• 12b-1 fees
• Advisory fees

 

Therefore the 408(b)(2) can be a long document that is not the easiest to understand. Understanding and compiling your plan fees from the 408(b)(2) and fees paid hard dollar can be confusing, but it doesn’t have to be with our experience and knowledge. A proper review of a plan’s provider disclosure report by a fiduciary can result in plan improvements to the benefit of business and the participants.

Martin Financial Group acts as a fiduciary on our clients 401k plans, discloses all fees, and can help you comb through your current provider to meet your fiduciary duties on benchmarking and reviewing the fees on the plan. You can read more about fiduciary responsibilities on the Department of Labor website . If you’d like help with your 401k or retirement plan, click here.

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Sarah Cattan is a 401k specialist and focuses on business owners and their retirement plans.

The Required Minimum Distribution

If you turned 70 on or before June 30th, 2018, you have moved into a new phase of retirement planning.  The IRS may now require that you take a minimum distribution from your retirement accounts beginning this year.

What is the RMD and when does it need to be taken?

RMD is an amount of money that is required to be removed from your qualified accounts each year.  The IRS allowed for money to be added over the years into a qualified retirement account [IRA, 401(k), 403(b), etc.] before tax and allowed the assets to accumulate tax deferred. The RMD is a way for the IRS to make sure that the account that you have deferred tax on to this point is withdrawn over your lifetime, or the lifetimes of your beneficiaries, so that the amount becomes taxable.

Each person with a qualifying account is required to make their first distribution by April 1st of the year following the year they turn 70.5.  After the first year, you are then required to take a distribution from the account by December 31st of each following year.

Example:

Stan is 70.5 on April 30th, 2018 and is now subject to the RMD rules. He is required to take a distribution for 2018 on or before April 1st, 2019.  He is also required to take a distribution for 2019 on or before December 31st, 2019 and so on.

If you are already taking a distribution that is greater than or equal to your RMD for a given year then that distribution completes your requirement.  If you are taking less than the RMD for a given year you will need to increase your distribution for that year to meet the minimum.  You can take this distribution in one lump sum, in monthly increments, or in any other fashion you like as long as it is all taken by the required date.

Which accounts does it affect?

Accounts that had assets added to it on a pretax basis and that have grown tax deferred are going to be subject to the RMD rules.  This includes IRAs, SEP IRAs, SIMPLE IRAs, 401(k)s and 403(b)s.

If you are working past 70.5, you cannot make contributions to an individual plan and you must start the RMD for those plans.  However, if you are 70.5 years old and still working at an employer that has a qualified employer plan, you may add to this plan and you do not have to take an RMD from that plan as long as you are not more than 5% owner of the company.

If you have both account types, are 70.5 and still working, you do have to take an RMD from your individual accounts but you do not have to take from your employer plan.  You are allowed this exemption to the rule while you are working.  Once you stop working the employer plan is now subject to the RMD rule.

Example:

Stan is still working with an employer that has a 401(k) and he has a balance in the plan of $500,000. He also has $500,000 in an IRA.   The IRA is going to be subject to the RMD and he will be required to take the minimum distribution from the account annually.  The 401(k), on the other hand, is not subject to the RMD because he is still employed at that company that holds the 401(k).

When Stan leaves the company both the IRA and the 401(k) are subject to the RMD rule and he is now required to take the minimum from both accounts.  It makes no difference whether Stan leaves the money in the 401(k) or moves it to the IRA, the RMD amount is the same and is required for both accounts.

How is it calculated?

Many people believe that the RMD is calculated as a percentage of the account value but that is not the case. To calculate your RMD simply take your account balance on December 31st of the previous year and divide it by the number that corresponds to your age at the end of the year on this IRS RMD Table.  Each individual account has its own RMD so you will want to calculate each account separately. If you are not comfortable performing the calculation yourself or want to double check, there are many online RMD calculators available.

Example:

Stan turned 70.5 on April 30th, 2018 (so he will be 71 by December 31st, 2018).  Let’s also assume that he is not working and has an IRA with an account balance of $500,000 on December 31st, 2017, held at one custodian and another IRA account with $200,000 on December 31st, 2017, held at another custodian. To calculate his RMD for 2018 he would go to the IRS RMD table and find the divisor that corresponds to his end of year age of 71.  Use this divisor to divide the account balances as shown below.

2018 RMD

$500,000/26.5 = $18,867.92

$200,000/26.5 = $7,547.14

How do I take it?

Stan would be required to take a total of $26,415.09 ($18,867.92 + $7,547.14) from his accounts by April 1st, 2019. He is only required to take the total, it does not matter which account(s) he takes it from and in what proportions.  He could take the amounts listed from each account or he could take all from one and none from the other.  As long as he takes the total by the deadline the IRS mandate is satisfied.

As discussed above, this first distribution is for 2018 and he has until April 1st, 2019 to take it.  After the first distribution, he is required to take an annual distribution by December 31st every year after, including December 31st, 2019.  Note that he will recalculate the RMD amount each year using the same method discussed above.

Taking two RMDs in a single tax year could have the effect of some income being subject to a higher marginal tax rate, reduced deductions or a change in the treatment of capital gains, qualified dividends and social security.  Taking that first distribution by December 31st, 2018, would have helped him avoid these pitfalls but would have increased his income in 2018, possibly causing their own pitfalls.  Speak to a trusted advisor regarding your situation to make sure you are making the best decision for you.

It is the responsibility of your custodian to calculate and report the RMD to you each year, but it is your responsibility to make sure that it is met.  Also, it is the account holder’s responsibility to verify that the amount given to them by their custodian is correct, so make sure to use the above-mentioned table to verify your RMD.  If you fail to take your RMD or any part of the RMD in a given year, you will be subject to a penalty on the undistributed amount of 50%.

Example:

Stan has an RMD of $26,415.09 for 2018 but has been busy with distractions this year.  He knows the amount but forgets to take the distribution by the April 1st, 2019 deadline.  He is now required to take the full RMD of $26,415.09 but he is also subject to an IRS penalty of $13,207.55 (50% x RMD).

The penalty will be taxable income to Stan which may affect the taxation of other income sources or could bump him to a higher tax bracket.  This is an easy mistake to make but a very expensive one.

What can I do with the money?

Once you have paid tax on the distribution you are free to spend it, save it or reinvest it in another, non-IRA account.  The point of the IRS requirement is not to have you spend the money, it is to have you pay tax on the money.

If you are charitably inclined, the IRS does allow your RMD (or a portion of your RMD) to be directed to charities of your choice.  If you distribute the funds directly to the charities through your custodian this amount will not be included in your taxable income but will satisfy your RMD for that year.  This is known as a Qualified Charitable distribution (QCD).  Be sure to speak to an advisor regarding this strategy as there are certain limitations that may affect the deductibility of the donation.

The RMD rules can be confusing with one account but, if you have more than one account or you are still with an employer where you have a 401(k), they can become downright overwhelming.  Be sure to give yourself enough time before your deadline to understand your situation so that you can satisfy your requirement and avoid a costly penalty.

*Stan’s example is for educational purposes only. Each individual situation is unique. The piece should not be seen as a recommendation.

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Ryan Eatherly has been with Martin Financial Group since 2004, dedicating his time and energy to educating his clients and helping them reach their financial goals. He has earned the designation CERTIFIED FINANCIAL PLANNER™ Practitioner through the Certified Financial Board of Standards, Inc.

In part 1 and part 2 of this series we talked about the Dow Jones and S&P 500 indexes.  In this final part of the series we will look at what is relevant to your portfolio and talk about what to look at when comparing your portfolio to a benchmark.

Understanding What You Should be Watching

If you want to follow a benchmark that is relevant to your portfolio you will first need to understand the makeup of your particular portfolio.  A diversified portfolio may include both US and international securities.  Keep digging and you may find that you have large, mid and small size companies.  Dig a little further and you will see international companies that are based in both developed and emerging market economies. If you are an aggressive investor you may only hold equities but as you become more conservative you may introduce fixed income and cash into your portfolio.

Each of these asset classes; large, mid and, small capitalization US equities, international developed and emerging market economy equities, fixed income, and cash, all have their own risk and return profile and, therefore, they are all benchmarked to their own indexes.

A benchmark that reflects the behavior of your portfolio would need to be built to mimic your holdings.  As an example, if your portfolio has 50% large US stocks and 50% US bonds you may look at a blended index of the S&P 500 (US large stocks) and the US aggregate bond index (representing most traded US bonds).  This is a blended index because you are combining existing indexes to create your own blended benchmark.

Calculating the Benchmark Return

When calculating the return of this blended index, you simply find the return of each index for a given time period and then weigh that return to the allocation in the portfolio.  For example, if the S&P 500 had a 10% rate of return over a given period and the Aggregate bond index had a 5% return over the same time period, your blended index would have a return of 7.5%.

S&P 500 – 10% return x 50% allocation = 5%

Aggregate Bond Index – 5% return x 50% allocation = 2.5%.

Blended Index – 5% + 2.5% = 7.5%

If your portfolio is half US stocks and half US bonds you would expect your portfolio to be close to the 7.5% rate of return of the blended benchmark. Anything above that and you are outperforming your benchmark and anything below that you are underperforming your benchmark. Withdraws from and contributions to the account, selling and buying securities, and allowing your allocation to drift away from the 50/50 mix, along with other factors, can affect your portfolios performance.

Benchmarking is Only Part of the Story

Benchmarking your portfolio is no doubt a useful exercise, but benchmarking correctly can be a tall order.  While it is important to know how your portfolio is performing relative to an expectation, it should not be the sole metric for measuring your success in the market.

When looking at your portfolio return take a step back and remind yourself of why you are invested.  What is your risk tolerance? What volatility are you comfortable with?  Is income or growth the primary objective?  What is my time horizon? Focusing only on return in your portfolio can cause you to lose sight of the primary objectives of your portfolio and could cause you to make mistakes.

Take the time to understand what the benchmarks you are looking at represent and which benchmarks are appropriate for you to measure against.  Then take inventory of why you are invested in the first place.  These steps will help you decide what is relevant information and what is noise.

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Ryan Eatherly has been with Martin Financial Group since 2004, dedicating his time and energy to educating his clients and helping them reach their financial goals. He has earned the designation CERTIFIED FINANCIAL PLANNER™ Practitioner through the Certified Financial Board of Standards, Inc.

Martin Financial Welcomes Sarah Cattan, Micah Lagowski, and Morgan Williams! 

We’ve been growing, and have added three new staff members to our team at Martin Financial Group.

Click on their picture to learn more.

 

 

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Ryan Eatherly has been with Martin Financial Group since 2004, dedicating his time and energy to educating his clients and helping them reach their financial goals. He has earned the designation CERTIFIED FINANCIAL PLANNER™ Practitioner through the Certified Financial Board of Standards, Inc.

The S&P 500

In our last post we briefly discussed the Dow, what it tracks, some of the criteria for allowing stocks in, and how it is calculated.  In today’s post we will discuss the S&P 500 and answer some of the same questions as in the Dow post.

The Standard and Poor’s 500, “S&P 500,” is another well-known and highly followed index* in the United States.  The S&P 500 differs from the Dow in several ways. First, the S&P 500 is an index made up of 505 stocks issued by 500 large U.S. companies.  These stocks are included in the index for a variety of reasons, including market cap (value), liquidity, and the industry they represent.  Second, it is a market value index which gives more weight to the largest stocks in the index when calculating return vs the price-weighted average that the Dow uses.

Because of these two factors, the S&P 500 is considered a much more reliable measure of the U.S. market.  Its limitations come in the fact that all the stocks that are tracked are “Large Cap” stocks, meaning they have a market value (all shares outstanding multiplied by the current stock price) of at least $6.1 billion dollars.  While that is a large percentage of the overall U.S. market it does leave many small and mid-size companies out of the index.

Our next post will discuss the final question. Are these indexes relevant to me and my portfolio?

*An index is not managed and cannot be invested into directly.

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Ryan Eatherly has been with Martin Financial Group since 2004, dedicating his time and energy to educating his clients and helping them reach their financial goals. He has earned the designation CERTIFIED FINANCIAL PLANNER™ Practitioner through the Certified Financial Board of Standards, Inc.

In the 21st century access to information is more readily available than ever before.  When it comes to the “markets” the Dow and the S&P 500 seem to be the most seen, talked about, and followed indexes in the United States.  But very few people know what they are looking at or stop to ask if what they are looking at is relevant to their situation.

So, what is the Dow and what is the S&P 500 and are they relevant to my portfolio? Over the course of the next three posts I will give a brief explanation of the two indexes and then finish up with the, “are they relevant to me” question.

Each of these indicators, the Dow and the S&P 500, is an index*.  The purpose of the index is to give a general idea of the movement of “the market” over a given period.   They are also often used either on their own or paired with other indexes to create a benchmark for an investor to measure their portfolio against.

“The Dow”

The Dow Jones Industrial Average is arguably the most popular and well known of the indexes in the market place.  It is made up of 30 large, well-known US stocks that are traded on the New York Stock Exchange.  The Dow was created in 1896 by Charles Dow and was originally 12 US corporations.  It was expanded to 20 corporations in 1916 and then moved to the current count of 30 in 1928.  It is owned and maintained by the Wall Street Journal. The 30 stocks that compose the Dow must satisfy a list of criteria to be added and included in the index.  If a stock that is in the Dow does not meet one of the criteria, over time it may be removed and replaced by another stock.

Though the Dow is popular among investors and the media, it has two weaknesses when it comes to using it as a benchmark for measuring your portfolio.  One, the way its return is calculated.  The Dow uses a price-weighted average for calculating its return which gives more importance to a stock’s price rather than its actual size in the portfolio.  Two, the Dow only represents 30 stocks in the US market which is a very small portion 4300 stocks that are traded on the US markets.

With the price weighted calculation and a small number of stocks, the Dow can vary widely day to day if one of its stocks has a volatile day.  This is why you may notice the variance in the Dow’s daily results compared the results of the other indexes or even your own portfolio.

In the next post I will discuss the S&P 500, looking at its pros and cons in the return calculation and the makeup of the index.  We will finish up the following week with the question of relevance as a portfolio benchmark.

 

*An index is not managed and cannot be invested into directly.

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Ryan Eatherly has been with Martin Financial Group since 2004, dedicating his time and energy to educating his clients and helping them reach their financial goals. He has earned the designation CERTIFIED FINANCIAL PLANNER™ Practitioner through the Certified Financial Board of Standards, Inc.