Bill, your wife should definitely contribute to something. If you don’t get matching dollars from an employer sponsored 401(k), you have to compare other factors. How much can you afford to contribute a year? In a 401(k), you’re allowed to contribute $17,500 a year, plus another $5,500 if you’re 50 or older. An IRA – whether Roth or Traditional – caps your contributions at $5,500, or $6,500 over age 50. (These numbers are for 2013, but the IRS has announced that in 2014, contribution limits will remain the same).
Then you consider the plan itself. What do you think of the investment options and expenses associated with your 401(k)? IRAs tend to have a wider variety of investments. Do you want the ability to pull out money tax free in retirement? You might consider a Roth.
After you’ve weighed all of these options, you can contribute to a combination of plans. Maybe you start by maxing out a Roth IRA, if you’re eligible — in 2014, that means you have an adjusted gross income of less than $191,000 if you and your wife file jointly. Single filers will need to have an AGI of less than $129,000. (Note, however, that contribution limits start to decline if your AGI is over $181,000 for couples filing jointly and $114,000 for singles). If you’re not eligible for that Roth, you can contribute to a traditional IRA if you like the investment options and fees there better. Once you’ve maxed out your IRA contributions, you can move back to the 401(k) and contribute there, since the limits are higher.
For those lucky readers who do earn 401(k) matching dollars from an employer, you would reverse the system — contribute at least enough to the 401(k) to grab those, since it is literally free money. Then if you’d like you can look at maxing out a Roth or traditional IRA.
Finally, I want to leave you with my general rule of thumb for how you should prioritize your savings. My hierarchy of savings needs looks like this:
- Emergency fund, with at least three to six months of expenses in cash reserves
- Matched contributions, like those to a 401(k) as we discussed above
- Tax-advantaged accounts, such as a Roth or traditional IRA and some 529 accounts (used for college savings)
- Discretionary accounts, which aren’t tax-advantaged but allow you to invest for the future
When Dan Otter from 403bwise.com reached out about contributing a guest post to the site, we were thrilled — as he mentions below, 403(b) plans aren’t as widely known — or understood — as 401(k) or IRA plans, and even those who have them may lack a clear understanding of how they work. Dan was able to break down some complicated information in a way we can all understand, and bring to light a warning about fees that is important for all investors. Read on for more.
Imagine you are at a retirement plan party. Not a retirement party — there are no gold watches being given out here. But a party attended by the various retirement plans. There’s the famous 401(k) and it’s quirky but increasingly popular sibling the Roth 401(k). There’s the modest IRA, with some of its cousins: the Roth IRA, the SEP IRA, and the Rollover IRA. Even the granddaddy of them all, Social Security, is in attendance. Then there’s this other plan. It’s kind of off by itself. You can’t quite place its name. Is it called the 401b? Or, wait, isn’t it called a tax sheltered something?
Close. The plan is actually called the 403(b). But it is commonly, and erroneously, referred to as a TSA or Tax Sheltered Annuity. Created in 1958, it predates the more famous 401(k) by twenty years, yet it remains a bit of a mystery. Why? Probably because the 403(b) covers a smaller subset of employees working in generally less glamorous positions: K-12 employees, college and university employees, pubic health care workers, and not-for-profit workers. Plus, public school teachers and administrators typically have pension plans, so for them the 403(b) is a supplemental plan.
Here’s what you need to know to make small talk with and about the 403(b):
The 403(b) works much like a 401(k):
- Contributions are pre-tax
- For 2013, participants may contribute up to $17,500 in regular contributions
- Those who are age 50 at anytime during 2013 may contribute an additional $5,500
- Able to invest directly into mutual funds
- Participants cannot invest directly in individual stocks
- Most plans offer annuity products (fixed and variable)
- Not all plans offer direct investment in mutual fund products (instead they must be purchased as part of a variable annuity)
- Most plans have multiple vendors which can lead to higher costs (vendors often employ a commission-based sales force in an effort to stand out from competition — can you imagine sales people from different financial companies pitching products in the lunchroom of Apple or GE?
- Many of the variable products sold have onerous surrender charges, some lasting as long as 15 years
Why so similar yet so different? Two reasons:
- When the 403(b) began in 1958, participants could only invest in annuity products. This is why the plan is often referred to as a TSA, or Tax Sheltered Annuity. This is a misnomer, of course, and gives the false impression that participants can only invest in annuity products. The mutual fund option was added way back in 1974.
- Public sector 403(b) plans (like those for public school teachers) fall outside the rules of ERISA (Employee Retirement Income Security Act), meaning there is much less employer oversight. Furthermore, unlike the ERISA-based 401(k), there are no fee disclosure rules for public 403(b) plans. This can leave participants in the dark about fees.
Retirement plan researcher The Spectrem Group reports that of the approximately $882 billion in 403(b) plans, the majority of the money sits in annuity products (approximately 46% in fixed annuities; 31% in variable annuities; and just 23% in mutual funds). Why should this matter? Most fixed and variable annuities are sold through commission-based sales agents. While variable annuities do offer access to mutual funds, they average about 2.25% in fees. This contrasts with index mutual funds, which can cost as little as 0.10%. This stark fee disparity can have a huge impact on return. Consider the fate of three hypothetical investors. Each contributes $250 a month over 35 years. Each realizes an 8% average annual return. However, each contributes to a different product. The result?
- The hypothetical Variable Annuity investor pays 2.25% in fees and accumulates $336,320 in savings.
- The hypothetical Mutual Fund investor pays 1.40% in fees and accumulates $409,585 in savings.
- The hypothetical Index Mutual Fund investor pays 0.18% in fees and accumulates $548,750 in savings.
It doesn’t take a math teacher to realize it is better to accumulate more savings.
If you find yourself stuck in a bad 403(b) plan, lobby your employer. Show them this and other fee impact information. Point out that employers are also participants. Point out that it is in their interest to have the best possible plan. Rally co-workers to your side. It may take time, but change can happen. Now, if you find yourself stuck at a party with retirement plans, you need to get a new group of friends.
About Dan: Dan Otter is a writer and teacher who operates the 403(b) education and advocacy website 403bwise.com. In 2012 Money Magazine named him a Money Hero for his efforts to improve the financial well being of others.
My 54-year-old husband has a 401(k) account with his previous company with approximately $300,000. It has been doing well, so should he leave it there or transfer it? For tax purposes, should we buy Roth IRAs in each of our names?
Hi Joanne, your husband probably wants to roll that 401(k) over to an IRA, which will give him more control over the money and possibly better — or at least more — investment options. He could roll it into a Roth IRA, but keep in mind you’ll have to pay taxes on any pre-tax assets you roll over, which is likely that entire $300,000 balance. I’d advise that you only do that if you have the money to pay the taxes out-of-pocket — in other words, don’t use funds from the 401(k) to cover the taxes. Once converted, you can pull that money out in retirement tax free, which is a nice perk.
The other option? You could roll the 401(k) into an IRA, then each open a Roth and make contributions there. If you don’t have income of your own, you can contribute as a spouse with your husband’s income. The 2013 contribution limits are $5,500 per person, but you can contribute an extra $1,000 if you are over age 50. That means collectively you could put $13,000 a year into Roth accounts, assuming you are both over age 50. It won’t give you any tax savings now — a Roth’s contributions are made with after tax dollars, so you don’t get a tax deduction — but again, you can pull the funds out in retirement tax free, which can be even better.
You don’t mention if your husband has a 401(k) at his new company, but if he does, he should contribute enough to that account to grab any matching dollars, then contribute to the Roth, then go back to the 401(k) with anything else.
This week we welcome Steven Lockshin, a frequent source in Jean’s reporting and the author of a new book, Get Wise to Your Advisor: How to Reach Your Investment Goals Without Getting Ripped Off. We receive a lot of questions about how to find a financial planner or investment advisor you can trust, so I know Steven’s advice will be helpful.
Investing is much easier than many investors fear it may be. However, like dieting, where we often may know what to eat but do not have the discipline to eat properly; investors often get carried away and make less than optimal decisions. And, with so many different ways to access investments — from stocks to bonds to ETFs, mutual funds, and a myriad of packaged combinations of these vehicles — it’s no wonder many investors hire an advisor or broker to help them sort through these decisions.
You can imagine how important it is to choose the right advisor, but that decision may prove equally as challenging as figuring out what to do on your own. There are almost as many choices in types of advisors as there are types of investments. There are brokers, insurance salesmen who sell investments, independent advisors (Registered Investment Advisors), banks, financial planners, and the list goes on. So, how do you find an individual or company to help you sort through this maze and avoid being sold a bill of goods from a seasoned salesperson, rather than a qualified advisor?
You Don’t Know What You Don’t Know. With so many different types of products and difficult to understand fees, simplicity is often the key. Be aware that complexity breeds risk for you. Simple solutions, including target date or asset allocation funds, do much of the work for you and without emotion. There are also online solutions like Betterment.com or Wealthfront.com that automate investing and savings for you at a fraction of the cost of retail advisors – and do it quite well!
Find a Fiduciary. The word “fiduciary” may not mean a lot to most investors, but it is an essential term that you should rely upon. In simple terms it means find an advisor who:
- Has no economic conflicts of interest. You can find this out by asking one simple question, “Do you make commissions on my account or do you make more by selling me one solution/product over another solution/product?” If the answer is yes, you need to ask additional questions or consider finding someone who can answer this question with a firm “no.” Chapter 8 of Get Wise to Your Advisor has an entire checklist of questions for your current or future advisor – with an answer key!
- Has the skills and qualifications to serve your needs. Check their history through the FINRA or the SEC website and ask questions to understand their level of education and experience in the financial services industry. You’ll be surprised to know that there are almost zero education requirements to become a financial advisor.
Understand Your Costs and Don’t Over-Pay. Good financial advice can be had for as little as 0.15% (that’s $150 per $100,000 invested) per year of your assets under advisement and shouldn’t exceed 1.0%. Make sure you understand what you’re paying. Trust, but verify. The industry is riddled with conflicts of interest, buried fees, and unnecessary complexity. However, by asking a few questions and doing just a bit of homework, you can find a true fiduciary advisor who will take care of your savings and investing needs while you take care of your family and your career.
About Steven: Steven D. Lockshin is the founder and former CEO of Convergent Wealth Advisors and author of Get Wise to Your Advisor — his effort to educate consumers on how to identify a proper advisor. Lockshin advises some of the world’s wealthiest families, professional athletes, and Hollywood “A-listers.” He has been ranked repeatedly as one of the top advisors in the nation by Barron’s magazine. Lockshin is an advocate for consumers when it comes to affording them the highest possible standard of care from investment brokers and advisors.
We’re a retired couple, doing well on our pensions with a small amount of cash and investments to supplement them. I inherited a house with no mortgage in another state when my parents died and I’ve been renting it out for the past twenty-five years or so. I’ve decided it’s time to sell it now and I’m concerned about the best way to deal with the proceeds of the sale.
Dave, do you mean the tax consequences of selling the home, or where to put the proceeds once you’ve sold it? For the former, I would speak to a good tax advisor, because while there are exclusions in place that eliminate taxes on the profits of a home sale — up to a certain amount — they generally will not apply when you have not lived in the home for at least two of the five years prior to the date of sale.
As for what to do with the money, keep in mind that you are eliminating a constant source of income — that rent. Will you need to replace that on a monthly basis to continue your standard of living? If so, one option is to put a portion of this money into an immediate annuity. This will give you a steady stream of income to replace that rent.
If you feel that you are covered as far as income for now and you’d like to invest it for a later date, you can do that in a taxable account. You’ll likely want to invest in tax-efficient investments like index funds or ETFs, and you should be careful about the amount of risk you take, taking into consideration when you think you will need this money.
Finally, I always think that a windfall is a great time to consult a financial advisor, and I generally advise sitting on the money for several months before doing anything, so you don’t make any rash decisions.
What’s your greatest fear? Spiders? Clowns? Something you encounter every day, like public speaking or using the elevator? Or perhaps, like the majority of respondents in a recent study, these frightening things pale in comparison to something that has the power to make or break a person’s fortune: the stock market.
According to a survey by Harris Interactive on behalf of Nationwide Financial, more people are afraid of investing in the stock market than they are of dying. Fifty-seven percent of survey respondents said they are afraid of dying, while 62 percent are afraid of investing in the market and 83 percent of people are afraid there will be another financial crisis. Nationwide Funds president Michael Spangler says that these fears are translating into fewer people seeking the help of a financial adviser and putting their money to work in the market.
“I think the flow of funds is very informative. We have a lot of cash on the sidelines through 2011 and 2012, so investors have missed out on a lot of growth in the equity markets, and have missed out on double digit returns thus far on this year,” he said. “I think we see people not planning, and not really developing or seeking a financial plan.”
Despite openly fearing the markets, the study found that only 43 percent of Generation X and 51 percent of Millennials are using a financial adviser to help manage their money. Dr. Michael Klein, a psychologist with a private practice in Manhattan, says that this behavior is a typical of people with fear or anxiety.
“The absolute signature response to anxiety is avoidance. In this case, the avoidance you see is people staying on the sidelines and not contributing to the market,” Klein said, noting that avoiding the markets because of investing anxiety is no different than people who fear spiders or elevators avoiding spiders and elevators.
Klein explained that the market crash of 2008 was a traumatic event for most people, and as such, that memory is overriding the brain’s ability to objectively analyze the market and see that, as a whole, investing can be a good thing.
“What we know about trauma is the availability of the memory of 2008 is very very fresh. It trumps [the idea] that over the past 100 years overall, overwhelmingly the historical evidence shows that investing in the stock market over the long run is a good idea,” he said. “Right now what you’re seeing is the fear memory trumping the slightly longer memory that says historically, you’ll come out ahead.”
While he’s never treated a client with an investing phobia, Klein says overcoming investing anxiety is similar to overcoming any other anxiety: gaining slow exposure to the feared thing, a little at a time.
“Rather than stay on the sidelines you dip your toe in,” he said. “A person could invest a portion of money that they’re comfortable with. You have to expose yourself to some of the fear and allow it to extinguish the past over time. You do it in steps that feel manageable.”
Klein and Spangler also noted that seeking the help of a financial adviser who seems genuinely trustworthy can be another way to overcome a fear of investing.
“Find an adviser that that acknowledges those fears,” Spangler said. “There are financial advisers [out there] that are really going to listen to you and act on your behalf and think about the whole picture.”
This morning on Today, I sat down with two couples on different ends of the retirement spectrum: one couple, in their 30′s, have not started saving. The other couple, in their 70′s, are finally both retired — but admit they wish they had started saving a bit earlier. To see what I said to both couples about jumpstarting their savings and making their money last, check out the video clip below.
Sometime in the beginning of 2010, Hardeep Walia and Tariq Hilaly were sitting in a coffee shop talking about trends that by now are old hat, but at the time were new and exciting: the rise of tablets, cloud computing and the mobile internet. Everyone was saying these ideas were going to be huge, but Walia and Hilaly — finance junkies with MBAs from The Wharton School and Harvard, respectively — realized that there was no way to invest in them. There were no cloud-computing mutual funds in which they could deposit money, no mobile-internet-focused ETF they could buy. Walia and Hilaly decided they wanted to change that.
“I think almost every start-up idea starts in a coffee shop,” Walia joked.
A little over two years after that coffee shop meeting, in June of 2012, Motif Investing was born. An investing platform that lets consumers invest in indexes (“motifs”) of 30 stocks centered around a similar theme — for instance, companies that produce technology that enables cloud computing — Motif’s mission is to make investing accessible and even a little fun.
“We’re an online broker, except we don’t want you to buy stocks,” Walia said. “We want you to buy the ideas behind the stocks.”
Investors can invest as little as $250 per motif, and will pay $9.95 to buy a motif of 30 stocks. Motif themes range from the lighthearted (there’s a “Pet Passion” motif containing 30 different pet supply or veterinarian care companies) to the technical (a “Buy the Dip” motif offers stocks in 30 companies that have recently taken a beating in the market). There are no management fees; Walia and his team make money on the $9.95 commissions.
“It’s 30 cents per stock. We’re making money selling you these 30 [stocks],” Walia said. He couldn’t get into the technology behind the platform because the patent is still pending, but on the subject of how he makes money, he could say this: “We have a set of trading algorithms. We’re able to bring down the cost of trading. We’re a high-margin business.”
All motifs are customizable, so if you don’t like a certain company or for employment purposes can’t hold specific stocks, Motif lets you sell that stock while still holding onto the overall motif. And when it comes time to rebalance your investments, some motifs come with the option to automatically rebalance annually, while others have the option to rebalance quarterly. But Motif won’t act on your behalf without your permission.
“You always have to click yes,” Walia said. “We want to empower the investor.”
If anecdotal evidence is any indication, the Motif investors like the empowerment — along with the freedom of investing in ideas they can relate to, rather than funds and stocks they need to closely research.
“I used to be real concerned with the details of investing — picking a company and pulling it apart and trying to figure out their earnings for the next quarter, said Don Haley, an air conditioning technician in American Fork, Utah. “With Motif, you focus more on trends and ideas and it takes away a lot of the burden of digging into each individual stock.”
Haley, who has invested just under $100,000 in Motif indexes, says that the process can be very fun — but he takes it very seriously. He focuses his attention on motifs dealing with alternative energy or natural gas, and estimates that in the past year of using the site, he’s earned a 32 percent return on his investments. (Returns vary depending upon the motif, so success like Haley’s is neither guaranteed nor standard across the site.)
“I don’t consider it play money at all,” he said. “It’s money I would have put into a brokerage account anyway, and instead of doing that I put it into a motif.”
Other investors like Motif because they find it more affordable than other investing options.
“It allows the little folks like me to play,” said Lois Mayerson, a 75-year-old Denver resident.
“For as little as $250, people can buy something they’re interested in. You can’t do that with the regular stock market,” Mayerson said. “It’s a wonderful advantage. And hopefully it will get more people interested in investing. Because nobody’s going to look after your money better than you do.”
This morning on Today, we had a little fun with money (and pop culture) trivia. Do you know how Downton Abbey illustrated one of the most essential investing mistakes? Test yourself with the video clip below!
I am 53 years old, have been a widow for five years, and the broker I’m with has lost half of what my portfolio was valued at five years ago (approximately $400,000). I’m beginning to get nervous. Who should I talk to? Another financial advisor? Can you recommend what direction I should take?
Hi Marcia, I understand how scary this is — handing control over your money to someone else is nerve wracking enough, but when you see losses like this, you start to panic. But I have to tell you, this is a red flag: more than anything, you want your portfolio to keep pace with the market, which has been rebounding. Over the last five years, a balanced portfolio should have grown, between 2 and 5% and possibly more, depending on investments.
A couple of questions for you: Does this reduction in your portfolio balance also include withdrawals, or is it all a loss? Have you given any sell instructions to your broker? It sounds like you need a second opinion. I would visit a fee-only financial advisor, for two reasons: One, you can have this person look over your financial plan without immediately taking the step to move your investments, and two, a fee-only advisor has no interest in selling you specific investments for a commission, and will instead look at your entire portfolio and your financial situation holistically to see whether you’re on track. Brokers typically just sell products, and are only limited by a suitability standard, which means they can sell anything as long as the product is “suitable” – a wide definition. A fee-only financial advisor who is also a registered investment advisor must act as a fiduciary on your behalf and will recommend products based on your needs to help you catch up after these losses. I would also review your Investment Policy Statement (IPS) – with that size portfolio, you should have one. It spells out the objective of the portfolio, expected returns, risk, and how much the portfolio can be expected to go down in any given year. If you don’t have a copy, ask your broker to provide one.