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Archive for April 2012

A Huge Number of Retirement Plans May Soon Become Prohibited Transactions.

The Independent Financial GroupJim Lorenzen, CFP®, AIF®

Few retirement plan fiduciaries can document that they are monitoring their providers or whether their decisions are delivering value to help participants help themselves.

We live in an age when everyone is online and information is easy to access.   Remember what happened to Bank of America when they tried to raise their fees?  When plan participants begin receiving disclosures, they’ll – as well as attorneys looking for clients – will begin looking around, and the questions will begin:

“Why are we paying so much in fees?   I saw on Vanguard’s website that their average expense ratio is 0.21% and that the industry average is 1.15%.   I’ve I’d been in Vanguard, I’d been able to keep 93% of my investment returns while non-Vanguard investors keep, on average, just 67% of their returns!” [Source: Vanguard website ad, April 3, 2012].

Disgruntled participants will have no trouble obtaining Brightscope’s  website, allowing them to compare their plan to others.   They’ll be able to see the ratings difference not only in dollars and cents, but in terms of how much longer they’ll have to work!  For many, a 7-point difference could amount to 5 additional years of work and over $100,000 of lost retirement income!

How many plan sponsors will be able to demonstrate why they made their choice of recordkeepers and investment options?   If employees learn the top executives received an allowance for financial planning, they’ll feel even worse if the same executives didn’t feel these employees didn’t deserve receiving a periodic gap analysis to measure their progress towards achieving their retirement goals.

It’s a shame, too.  Too many plan sponsors have been so used to cutting corners for so long, they don’t even realize there are easier solutions available – often less expensive and with far fewer headaches.

Jim

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Jim Lorenzen, CFP®, AIF®Jim Lorenzen is a Certified Financial Planner® and an Accredited Investment Fiduciary® in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors. Plan sponsors can sign-up for Retirement Plan Insights here.  IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional. 

Written by Jim Lorenzen, CFP®, AIF®

April 26, 2012 at 8:00 am

How To Calculate Retirement Needs

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

A Sample Case Study

While there is an abundance of software available to help planners and advisors in projecting financial needs for clients, the fact is few do an adequate job in this area.   It pays to know what’s “under the hood” of your software – or maybe better – to be able to do some meaningful calculations yourself, if only to demonstrate you actually do have a prudent process.  Anyone with a financial calculator (HP12-C or HP10B-II, for example) can perform these calculations.  Remember, however, even with these, there’s still some ambiguity.

 A Simplified Hypothetical Case Study Problem

Carl is 50 years old and has $500,000 in his 401(k).  He wants to retire in 13 years with $50,000 a year, in addition to Social Security, and wants his money to last 30 years (he isn’t worried about leaving money to his children).   He believes inflation over that period will average 3.5%.   He feels a long-term target of 6% is a realistic annual target return.   With that target in mind, is his $500,000 enough or how much more will he have to put away?    Note:  Let’s assume Carl is in the 40% (combined state and federal) marginal tax bracket.

Answer:

There are three steps:

  1. Calculate the first-year need ($50,000) in inflated future dollars to protect purchasing power.
  2. Calculate the present value of the total needed for 30 years in retirement, beginning in the fist year, at the assumed investment rate adjusted for inflation and taxes, if additional is to be saved outside a tax-deferred vehicle.
  3. Calculate the annual amount to be saved by the end of each year and convert to a monthly amount.

Step #1.  The First Year Need.

                  $50,000    = PV

                  3.5%  = I

                  13   =  n

                  (solve) FV=  $78,197 This is the amount needed for the 1st year.

Step #2.  Calculate the Present Value of total need at beginning of retirement for 30-year period with earnings discounted for inflation: 

                  Compute after-tax yield:             6% * (1-.40) =    3.6%

                  Compute PV of total need for retirement discounted with inflation-adjusted returns. 

                  (BEGIN mode)

                  [((1.036/1.035)-1) x 100]    =        0.0966 =  i  (Inflation-adjusted tax-deferred rate would be 2.41%)

                  $78,197     =      PMT

                  30   =    n

                  (solve) PV =  $2,313,376  Present value of required amount at retirement.

Step #3.  Calculate the amount to be saved by the end of each year to reach the goal:

                  (END mode)

                  $2,313,376  =    FV

                  – $500,000  =   PV  (HP12-C and HP10-B-II conventions require (-) sign

                  3.6   =  i  (note:  if post-retirement tax-bracket is different, adjust this figure)

                  13  =   n

                  (solve) PMT =  $93,838  (divide by 12 for monthly amount to be saved)

Can Carl really save over $90,000 a year?  Even if the annual amount inside tax-deferred vehicles dropped the annual requirement to $66,036, it would appear some adjustments might have to be made.  This is when prioritization and goal-based planning can be important.

Income Without Growth Equals Eventual Poverty

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

Don’t get panicky; but, you should be concerned. 

If you have Bill Gates’ money, you probably don’t need to worry about growth; but, most of the rest of us do.  The reason is simple:  Inflation and taxes can take a huge toll on purchasing power.

Last night at dinner,  I was asked about my first car and how much gasoline cost in those days.  Well, it was a little hatch-back with a ten-gallon tank, and gas was 35-cents a gallon.

“What?  You could fill your tank for $3.50?”

Yes, Virginia.  I remember when Coca-Cola was 5-cents – I think Grant was President, I forget.

But, you don’t have to go back that far.  When Reagan was president, a first-class postage stamp was 8-cents!  The lesson is simple and as unchanging as a politician’s desire to get reelected:  Every year everything will cost a little more than it did the year before because our money is worth less and therefore purchases less.

Wealth cannot be measured by how many pictures of presidents we have in our wallets; but by what those pictures of presidents will buy.

I remember when $2,000 a month was a good income; now it’s poverty level.  But real growth – the kind that’s achieved after the effects of both inflation and taxes – isn’t easy.

The sales pitches are everywhere, too.  Take the case of an executive who put more than $2.5 million into a tax-deferred annuity with a five-year contract!  This wasn’t some idiot; this was an executive making more than $600,000 annually who bought the annuity based on the insurance company’s sales pitch that he could invest in it like it was a CD.  He anticipated making a 2.8% annual tax-deferred return – more than a bank pays, right?

Not so fast.  Taking the proceeds at the end would have exposed him to high taxes – he was already in a high tax bracket – resulting in an after-tax net gain of 1.4%!  

That was about what he would have earned in a CD and, if you’ve been following inflation lately – you can do it at the grocery store and gas pump – you’ll notice he would have lost purchasing power on the money as well.  In other words, it was a sure loser.

What would have been better?   In my opinion,  sitting down with a fee-only Certified Financial Planner® professional,  and working through a plan instead of a sales pitch.

Jim

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Jim Lorenzen is a Certified Financial Planner® and an Accredited Investment Fiduciary® in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors. Plan sponsors can sign-up for Retirement Plan Insights here.  IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Written by Jim Lorenzen, CFP®, AIF®

April 17, 2012 at 8:00 am

Have You Had Your ‘Stress Test’ Done?

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

No, I’m not talking about getting on the treadmill; I’m talking about a financial stress-test!

Most people – okay, just the smart ones – get a routine annual physical every year simply to make sure if anything is wrong, they can catch it in time!  But, if you’re like most people, you haven’t taken a financial stress-test in years… even though many suffered the consequences of this neglect back in 2008.

During the Great Depression, market investors saw a 23% hit in one year followed by a 21% slide the year after!  While everyone would like to have a “bullet-proof” retirement strategy, the one most likely to help people realize their life goals during uncertain times – when have the times ever been certain? – may simply be the common sense approach most of us can easily accept as an intuitive truth:

It begins with this basic 4-prong philosophy:

  1. It’s not about managing investments; it’s about achieving goals.
  2. Managing risk is more important than reaching for higher returns
  3. You can’t control markets or interest rates; but you can control tax exposure and investment costs
  4. Monitor everything, revise as needed, and keep your plan current.

Did you notice #4?  It begins with a plan.  Your plan for financial health begins just like a plan for physical health:  It begins with a ‘physical’ – an assessment of your current situation and an understanding of the lifestyle you envision in the future.  You also have to take into consideration your limitations, whether physical, financial, and/or emotional.

But, don’t be like the person who buys the gym membership and never uses the facilities.  A financial physical, whether annual or semi-annual, can keep your plan ‘on track’ and, even better, prepare you for those not unexpected detours you’ll surely find along the way.

Jim

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Jim Lorenzen is a Certified Financial Planner® and an Accredited Investment Fiduciary® in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors. Plan sponsors can sign-up for Retirement Plan Insights here.  IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

401(k) Fee Disclosures On The Way

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

If you’re participating in a 401(k) plan, it won’t be long before you’ll be seeing brand new fee disclosures on your statements; and, if you’re one of those who thought your plan was ‘free’, be prepared for a big surprise.  As you may have guessed, there isn’t now, and has never been, a free lunch.

Employers will be obtaining new disclosures from all covered service providers (CSPs) and will be required under ERISA 404(a)(5) to make clear and useful disclosures to participants.

Whether your plan’s fees and expenses are too high is a relative question. The requirement for determining `reasonableness’ is mandated under ERISA (the Employee Retirement Income and Security Act).  Employers are required to periodically compare their current plans with what else is available in the marketplace, given the size of the plan, number of participants, and the number and level of services the plan is receiving.  There are two ways of doing that.

One way is to conduct a provider search request-for-proposal (RFP) process.  The only problem, of course, is that the process can take about 4-8 weeks and can be a little costly.  Despite this, it’s a process that probably should be conducted at least every three years.  If your plan hasn’t conducted at RFP in the last three years, it’s more than likely your plan can, and should be, made better.

Another way is to conduct a fee and expense benchmarking process.  This is less expensive and something all plans should probably do annually.  It’s simply a process of comparing your plans to others of like size, etc.   Two things to keep in mind about benchmarking:  (1) it’s best if the study can reveal what comparable plans – roughly same size, number of participants, etc. – are actually paying, not a bidding process, and (2) what’s `customary’ may or may not be `reasonable.’

What You May Not Know

If your plan is comprised of funds from a few fund families, you might want to take a look in your funds’ prospectuses.  Look to see if there are 12b-1, shareholder servicing, and sub-transfer agent fees (Sub-TA fees).  If so, it’s possible these fees are there to pay plan expenses that otherwise would be billed directly to the plan under `revenue sharing’ arrangements between service providers. 

These may not be unreasonable; but, I’ve always felt that transparency leads to greater competition and, therefore, lower prices.  I’ve never understood how hidden fees can be good; nevertheless, they do exist.  But, one has to wonder what the incentive would be to replace a high-fee fund that pays revenue sharing to the plan vendor with one that has no such fees and pays no revenue sharing.  How much would service providers charge then, if they had to use fully-disclosed billing?  Oh, well, that’s just me.

If your plan is one using an `open architecture’ platform – you can select from hundreds of funds and families, including no-load and index funds that don’t pay revenue sharing – consider yourself one of the lucky ones.  Just be sure you’re getting the education you need to make prudent decisions.  Remember, the best investment process isn’t exciting, entertaining, or even worth discussing with your friends.  The best process is often boring, but effective.

You don’t have to be brilliant.  All you have to do is be smart – and that’s the same thing as not being dumb.

Jim

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Jim Lorenzen is a Certified Financial Planner® and an Accredited Investment Fiduciary® in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors. Plan sponsors can sign-up for Retirement Plan Insights here.  IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Written by Jim Lorenzen, CFP®, AIF®

April 3, 2012 at 8:00 am