More Proof that Higher Contributions Are Most Important to Retirement Plan Success

A study by the Putnam Institute, “Defined Contribution Plans: Missing the forest for the trees?” contends that while a number of variables, such as fund selection, asset allocation, portfolio re-balancing, and deferral (contribution) rates all contribute to a defined contribution plan’s effectiveness — or lack thereof — it is deferral rates that should be placed near the top of the hierarchy when considering ways to boost retirement saving success.1

As part of its analysis, the research team created a hypothetical scenario in which an individual’s contribution rate increased from 3% of income to 4%, 6%, and 8%. After 29 years, the final balance jumped from $138,000, to $181,000, $272,000, and $334,000, respectively.

Even with a just a 1% increase — to a 4% deferral rate — the participant’s final accumulation would have been 30% greater than it would have been using a fund selection strategy defined as the “Crystal Ball” strategy, in which the plan sponsor uses a predefined formula to predict which funds may potentially perform well for the next three-year period. Further, the 1% boost in income deferral would have had a wealth accumulation effect nearly 100% larger than a growth asset allocation strategy, and 2,000% greater than rebalancing. Of course these results are hypothetical and past performance does not guarantee future results.

One key takeaway of the study was for plan sponsors to find ways to communicate the benefits of higher deferral rates to employees, and to help them find ways to do so.

Retirement Savings Tips

The Employee Benefit Research Institute reported in 2014 that 44% of American workers have tried to figure out how much money they will need to accumulate for retirement, and one-third admit they are not doing a good job in their financial planning for retirement.2 Are you? If so, these strategies may help you to better identify and pursue your retirement savings goals:

Double-check your assumptions. When do you plan to retire? How much money will you need each year? Where and when do you plan to get your retirement income? Are your investment expectations in line with the performance potential of the investments you own?

Use a proper “calculator.” The best way to calculate your goal is by using one of the many interactive worksheets now available free of charge online and in print. Each type features questions about your financial situation as well as blank spaces for you to provide answers. But remember, your ultimate goal is to save as much money as possible for retirement regardless of what any calculator might suggest.

Contribute more. At the very least, try to contribute enough to receive the full amount of any employer’s matching contribution. It’s also a good idea to increase contributions annually, such as after a pay raise.

Retirement will likely be one of the biggest expenses in your life, so it’s important to maintain an accurate cost estimate and financial plan. Make it a priority to calculate your savings goal at least once a year.

If you would like to review your current deferral rate(s) or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Sources:

1Putnam Institute, Defined Contribution Plans: Missing the forest for the trees?, May 2014.

2Ruth Helman, Nevin Adams, Craig Copeland, and Jack VanDerhei. “The 2014 Retirement Confidence Survey: Confidence Rebounds–for Those With Retirement Plans,” EBRI Issue Brief, no. 397, March 2014.

Massive withdrawals from 401(k)s thwart Americans’ retirement planning efforts

As the IRS released the 401(k) contribution limits for 2015, attention turned, as it has in prior years, to the large number of plan participants who come nowhere close to contributing these amounts. In contrast, many individuals use their 401(k) accounts as a means to pay off loans and other current expenses.

The amounts withdrawn are not negligible. According to a recent study by Vanguard, the average withdrawal represents one-third of the participant’s account balance. Additionally, most withdrawals are not for hardship — non-hardship withdrawals outnumber hardship withdrawals 2-to-1, and the rate of new non-hardship withdrawals doubled between 2004 and 20131.

So, why are so many withdrawals occurring? One reason is to pay off debt, including student loans. Another may be to help make ends meet when people are between jobs. Fidelity reported earlier this year that 35% of participants took all or part of their 401(k) savings when leaving a job2.

No matter the reason, the long-term implications of early 401(k) withdrawals can be considerable. In withdrawing from the account, plan participants will miss out on tax-deferred compounding of that money, which can add up over time.

Alternatives to Raiding Your 401(k)

Withdrawing from a tax-deferred retirement plan to meet short-term needs should be a last resort. Before doing so, consider alternatives such as the following:

  • Savings accounts or other liquid investments, including money market accounts. With short-term investment rates at historically low levels, the opportunity cost for using these funds is relatively low.
  • Home equity loans or lines of credit. Not only do they offer comparatively low interest rates, but interest payments are generally tax deductible.
  • Roth IRA contributions. If there is no other choice but to withdraw a portion of retirement savings, consider starting with a Roth IRA. Amounts contributed to a Roth IRA can be withdrawn tax and penalty free if certain qualifications are met. See IRS Publication 590 for more information.

If withdrawing from a 401(k) is absolutely necessary, consider rolling it over to an IRA first and then withdrawing only what is needed. According to the Vanguard study, fewer than 10% of withdrawals were rolled into an IRA; more than 90% were taken in cash1, which typically generates withholding taxes and IRS penalties.

If you would like to discuss your retirement investments or any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Sources:
1Vanguard Investment Group, How America Saves 2014, June 2014.
2The New York Times, “Combating a Flood of Early 401(k) Withdrawals,” October 24, 2014.

Understanding the Fees Associated With Your Retirement Plan

I hope you’re enjoying a safe and fun Memorial Day weekend as we remember those who sacrificed with their lives. We sincerely appreciate the service and sacrifices the women and men of the armed forces make every day to help keep us safe.

There’s a little secret associated with your workplace-sponsored retirement plan. Most participants think their plan is free — that it doesn’t cost them anything to join, contribute, and invest. Unfortunately, that’s not entirely true.

While employees typically aren’t charged any out-of-pocket costs to participate in their plans, participants do pay expenses, many of which are difficult to find and even more difficult to calculate. New regulations from the Department of Labor (DOL), which oversees qualified workplace retirement plans, should make it easier for participants to locate and comprehend how much they are paying for the services and benefits they receive.

Here’s a summary of the information you should receive.

1.     Investment-related information, including information on each investment’s performance, expense ratios, and fees charged directly to participant accounts. These fees and expenses are typically deducted from your investment returns before the returns (loss or gain) are posted to your account. Previously, they were not itemized on your statement.

2.     Plan administrative expenses, including an explanation of fees or expenses not included in the investment fees charged to the participant. These charges can include legal, recordkeeping, or consulting expenses.

3.     Individual participant expenses, which details fees charged for services such as loans and investment advice. The new disclosure would also alert participants to charges for any redemption or transfer fees.

4.     General plan information, including information regarding the investments in the plan and the participant’s ability to manage their investments. Most of this information is already included in a document called the Summary Plan Description (SPD). Your plan was required to send you an SPD once every five years, now they must send one annually.

These regulations have been hailed by many industry experts as a much-needed step toward helping participants better understand investing in their company-sponsored retirement plans. Why should you take the time to learn more about fees? One very important reason: Understanding expenses could save you thousands of dollars over the long term.

Calculating Fees and Their Impact on Your Account

While fees shouldn’t be your only determinant when selecting investments, costs should be a key consideration of any potential investment opportunity. For example, consider two similar mutual funds. Fund A has an expense ratio of 0.99%, while Fund B has an expense ratio of 1.34%. At first look, a difference of 0.35% doesn’t seem like a big deal. Over time, however, that small sum can add up, as the table below demonstrates.

Expense ratio Initial investment Annual return Balance after 20 years Expenses paid to the fund
Fund A 0.99% $100,000 7% $317,462 $37,244
Fund B 1.34% $100,000 7% $296,001 $48,405

Over this 20-year time period, Fund B was $11,161 more expensive than Fund A.1 You can perform actual fund-to-fund comparisons for your investments using the FINRA Fund Analyzer.

If you have questions about the fees charged by the investments available through your workplace retirement plan, speak to your plan administrator or human resources department.

When considering whether to roll over your former employer’s 401(k) or other qualified retirement plan to an IRA, keep all these plan fees in mind, in addition to the limited choice of investments in most employer plans. In most cases, the large selection of funds and lower fees at most discount brokerages should tilt the decision towards rolling over your plan when you leave an employer. A fee-only fiduciary advisor can help you evaluate your options and decide whether a rollover is the best choice for you.

If you have any questions about this or any other financial matter, please don’t hesitate to contact us. We are fee-only fiduciary advisers who put your interests first. Not all advisors adhere to this highest standard.

Source/Disclaimer:
1Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so you may lose money. Past performance is no guarantee of future results. For more complete information about any mutual fund, including risk, charges, and expenses, please obtain a prospectus. Please read the prospectus carefully before you invest. Call the appropriate mutual fund company for the most recent month-end performance results. Current performance may be lower or higher than the hypothetical performance data quoted. The hypothetical data quoted is for illustrative purposes only and is not indicative of the performance of any actual investments. Investment return and principal value will fluctuate; and shares, when redeemed, may be worth more or less than their original cost.

%d bloggers like this: