Category: Investment

Have money in a 401k at an old employer? What to do with your old 401k.

What to do with your balance in an old employers 401k or retirement plan.

Most people don’t work for one employer their entire lives anymore. The days of people relying on a pension from their employer are seemingly coming to an end.

401k’s came into existence in the 1980’s. Since then most employers have made the move from defined benefit pensions to defined contribution 401k’s.

  • Defined Benefit– A type of retirement plan in which an employee’s pension payments are calculated according to the length of service and the salary they earned at the time of retirement.
  • Defined Contribution– A type of retirement plan in which the employer, employee, or both make contributions on a regular basis. Future values fluctuate based on investment earnings and contributions.

Back in the 1980’s, 401k’s were presented as giving employees the power to choose their own investments. In reality, they were oftentimes a modest cost savings to employers over their defined benefit counterparts since all employers aren’t required to contribute to an employee with a 401k. Typically the total employer contribution amount is lower as the employee is expected to contribute as well.

The 401k is designed for employees to save for themselves for retirement. The money the employee contributed can go with the employee when they leave the place of employment. The employer contribution is also eligible to go with the employee if the employer contribution is vested.

34% of employees say they plan to leave their current employer in the next 12 months according to Mercer. So wondering what to do with an old 401k balance can come up quite often as there are many people changing jobs that have balances in an old employer’s 401k.

There are four options that may be available to you when it comes to your old 401k: You can leave your account alone, roll it into an IRA, roll it into your new employer’s plan, or cash it out. We will walk through each here.

1)   Keep your money in your former employer’s plan.

If you have a 401k balance over $5,000 you legally cannot be forced out of the 401k plan. If you have under $5,000, your employer has the option to cash you out of the plan which can potentially cause you issues you may not be aware of.

Good things:

  • You don’t have to do anything
  • You are already set up to view your account.
  • You can take penalty-free withdrawals from an employer-sponsored retirement plan if you leave your job in or after the year you reached age 55 and expect to start taking withdrawals before turning 59½.

Not So Good Things:

  • Once you’re no longer an employee, your access to your money may be limited, you are no longer eligible for any loans, and you cannot add more money to the account. You may have to go through your old employer for any changes or requests.
  • You have to remember to make sure your old employer has your current information such as your mailing address. This can be annoying if you have multiple 401k balances sitting out there. Plus, if your old company gets bought, changes plan providers, or the HR person changes, you may not have easy access to your login information or your new account number.
  • Investment advice is typically done at employee education meetings at the business, so once you are no longer employed typically you aren’t attending these meetings.
  • Plan may offer expensive investment options or lack investment options you want. Do you know the administrative costs the 401k passes to the participants? What about your mutual fund expense? See my blog about 401k fees here.

2)   Move your money into an IRA

This choice gives you the most control and flexibility. With a 401k plan, the employer chooses the investments that are available in the plan and has more rules, with an IRA you aren’t limited to what the employer has chosen for the plan.

Good Things:

  • Working with a financial advisor, you will have access to advice for your certain situation. This can be especially helpful if your 401k has been at your old employer for years and you are just now taking a look at the investments you were allocated into. It is also helpful if you are close to retirement age, to sit down with someone to discuss a course of action.
  • Ability to combine multiple employers’ old 401k accounts into one IRA.
  • Greater control over your investment expenses. 401k investment fees are in a participant fee disclosure, and in some cases they’re higher than what you’d pay for comparable investments outside the plan.
  • Greater freedom to name beneficiaries. The beneficiary of your 401k plan, by law, must be your spouse; you have to obtain a signed release from him or her if you want to name anyone else. An IRA can be more flexible.

Not So Good Things:

  • Taxes will be withheld unless you move the money from your 401k to an IRA via a trustee-to-trustee transfer. Not all recordkeepers will do this, and sometimes the check is mailed to the employee rather than the new IRA custodian. You have to make sure the money is in the account within 60 days, so the disbursement of funds aren’t treated as a withdrawal by the IRS.
  • It can take a bit of effort to figure out how to move the accounts by yourself.

3)   Move your money into your new employer’s 401k

You should certainly contribute to your new plan if your employer offers a match, but should you transfer your old account into it?

Most 401k’s allow you to transfer old employer’s 401k balances into it. Not all do though, so you should check with your new employer before you do so.

Good Things:

  • Consolidating your retirement money makes it easier to view and manage. When you’ve left a retirement account at a company you no longer work for, you may pay less attention to its performance or downplay its importance in your overall picture.
  • The new plan may offer more attractive investment options than the old one, as well as additional services, such as access to a financial advisor.

Not So Good Things:

  • The financial advisor on the plan may not be a fiduciary. The advisor may just do group meetings with little access to personal advice for your specific scenario.
  • The new plan may offer fewer investment options or investments that don’t meet your needs.
  • Fees can be high in 401k plans; do you know the administrative costs the 401k passes to the participants? What about your mutual fund expense?
  • Paperwork to move the money can be confusing and requesting certain documents and letters from the old 401k plan sponsor/recordkeeper can be tedious.

Generally, the smartest move is to evaluate the fees charged by the investments that you’d use in each plan and go with the plan that offers the lower-cost options. Again, the participant fee disclosure might not have all plan fees listed and it isn’t the easiest to determine.

4)   Cash out the account

Good Things:

  •  It’s money you can use for other purposes.

Not So Good Things:

  •  You could no longer have any retirement savings.
  •  Distributions from your 401k could also push you into the next tax bracket, giving you a bigger tax bill.
  • You will owe income taxes on your money.

If you’re in a 28% combined federal and state tax bracket, for example, and cash out a $40,000 account, you’ll have only $28,800 left after taxes. If you are under 59.5 there would also be a 10% penalty which would leave you with $24,800, far from the $40,000 you were expecting.

Not all of these options are available in everyone’s situation. If you find it confusing or overwhelming, I’d be happy to speak with you regarding your situation to help you with the decision, or to start the process.

The content of this article is provided for information and discussion purposes only. It is not intended to be a financial recommendation and should not be the sole basis for your investment or tax planning decisions.

401k plan fees – Do you know what they are?

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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The Dow, S&P 500, and Their Relevance – Part 3

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.

The Dow, S&P 500, and Their Relevance – Part 2

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.

The Dow, S&P 500, and Their Relevance – Part 1

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.

5 Long Term Investment Building Blocks

It is all too easy to lose your cool when the markets are rising or falling. When markets are rising we wonder if it can last forever, often times believing that it will go bad soon. When it is falling, it feels like things will never turn around and we worry about how much more it could drop.  Markets are volatile, and volatility on the up or down side can be scary.  If you can’t stay calm and make rational investment decisions in the face of this volatility you will almost certainly see the value of your investments suffer.  Legendary investor Shelby Davis once said, “you make most of your money in a bear (down) market, you just don’t realize it at the time”.  Because volatile markets are ripe with opportunity to either lose or make money it is important to have a strategy in place ahead of time, so you can make rational decisions while others around you are panicking.

Below are five fundamental blocks that you can build your investment philosophy on to help prepare you for the next round of volatility in the markets.

  1. Plan to live a long time – According to the Center for Disease Control a 65 year-old woman has a 20.3 year life expectancy, and a 65 year-old man has a 17.7 year life expectancy. This information might cause you some confusion if you’ve read that the average life expectancy in the U.S. is currently 81.1 for women and 76.1 for men. But these life expectancies are from birth — they don’t apply to someone who’s already reached age 65. If you are healthy and 65, don’t talk yourself into moving all your money into cash or CD’s.  If you are counting on income from these investments now and into your future, you will want to take some level of risk to make sure you don’t run out of money. Inflation is a big threat to your money and it is not easy to see it coming.  Plan for it.
  2. Diversification works – The old saying goes, “don’t put all of your eggs in one basket”.  This is fine for most things but when investing, the saying should probably be more like, “don’t just own eggs”. No one knows what the future for markets will hold. Even when one sector does well others can suffer, so own multiple classes of investments and multiple investments.  This will give you a more consistent return and help to reduce the volatility of the general market.  Although it is tempting to buy into whatever did well last year, don’t do it.  This is the equivalent of driving down the road looking through your rear-view mirror. Do this and you might find yourself in the ditch at the side of the road.
  3. Don’t follow the crowd – The crowd is often terrible at investing. Don’t get caught up in the hype of a stock or particular sector.  The average investor tends to buy high, sell low, and make decisions about their investing based on their gut reaction to a single piece of news.  We all know that is an easy way to lose money in the market, but we often forget that making money in the markets can be just as simple. Warren Buffet has said that he only invests in companies that he is comfortable holding for 30 years.  Buy investments that you believe will still be successful over the long term because of their fundamentals and don’t make decisions based on fear, greed, or hype.
  4. Block out the noise – 24-hour news and the internet are the wrong places to spend your time if you are trying to make good investment decisions. Don’t get me wrong, they are a wealth of knowledge and can add lots of value to your decision-making process but for most people, they are just NOISE. By the way, that is what they are designed to be, they are designed to catch your attention, keep your attention, and move you to action.  That is how their paying customers, advertisers, make money. When things look bad and you feel yourself getting nervous, turn it off!
  5. It’s about time IN the market, not TIMING the market –  We all want to make money in the market without losing any money in the market. That is a good strategy, for a fortune teller, but you’re not one.  If you were you wouldn’t be reading my blog on investing strategies. The cost of missing days in the market can be enormous and almost impossible to make back up.  If you missed the 25 best trading days (out of 11620) from 1970 to 2015 your return dropped from 1,910% to 371%. Ouch… Market investors should not be focused on day to day returns but instead on their long-term investment goals.  Stay invested in bad times or you might just miss out on the good times.