Updated - As I mentioned in a previous post in this retirement blog, if you have retirement money in a 401(k) sponsored by your employer, you’re agonizing over giant paper losses over the past year. If you’re retiring soon, these paper losses will become real. You’ve no doubt noticed that all the investment choices in your 401(k) are market related – meaning they all have risk. It doesn’t matter that you may be on the precipice of retirement and can’t afford to lose any of your nest egg to a temperamental market – your choices are still mutual funds and maybe the stock of your employer. Also, the fact that you can move some or all of your money out of your 401(k) into a self-directed IRA hasn’t been brought to your attention, or if it has the stipulated age set by your employer is 59½. At that age, you don’t have time to weather a bad market through recovery – so buckle up for a pared-down retirement.

Of course, moving under your direct control where you have safe-money options also means you could pay lower fees, take advantage of some favorable tax law changes and get a better return. Your “market only” choices and inability to move to safer shores is courtesy of the brokerage firm managing the 401(k) money and also advising your employer. Chances are your employer doesn’t know any more about the 401(k) plan than you – a rather cavalier stance since he or she is the trustee of the Plan and has fiduciary liability. How has this been allowed to happen? What are you not provided the freedom you deserve to protect your retirement money – especially as you near the finish line?

First of all, let me inform you up-front that ERISA and the IRS permit you to move all or some of your 401(k) regardless of age, and without triggering taxes by doing a trustee-to-trustee transfer from the 401(k) to an IRA. However, when ERISA was passed n 1974 the brokerage industry lobbyists were active making sure the employer had the right to prevent you from moving “your money”. You see if the money is moved under your self-direction, the brokerage firm no longer earns fees – no wonder they want to hold you hostage. Thus, they advise your ill-informed employer to set a very high age – like 65 or retirement – as the time when you can move your money under your self-direction. That way, they are able to continue fleecing you for sizeable annual fees to manage your money. The employer is indifferent because no employee has filed a lawsuit over the matter and they’re not paying the high-fees the broker is charging. Unfortunately, most employees think the employer pays the annual fees because they see no line-item on their quarterly 401(k) statement that indicates they are paying. Again, the brokerage firm that manages the money is very clever in keeping the fees off your statement which leaves you in the dark. As long as you’re in the dark, the brokerage firm can continue to fleece you and you won’t even object.

In early 2008 the U.S. Supreme Court unanimously ruled that an employer did have a fiduciary responsibility to employees when it comes to defined contribution retirement plans like 401(k) (see LaRue v. DeWolff, Boberg & Associates, Inc.). This has gotten the attention of large employer because there are now pending numerous class action lawsuits against employer for their complacent attitudes about the 401(k) plans they sponsor. Nonetheless, the small employer has not yet gotten the word because they don’t have dedicated human resources professionals and ERISA attorneys on their staff – they continue to rely on the brokerage firms who have a vested interest in remaining mute. After all it is not their neck on the legal chopping block – they’re not the trustee of the plan or the fiduciary, but only the manager of the money. When the employer is sued they’re defense will be “we were only managing he money”. What a shame.

In the meantime, you’re suffering with unnecessary losses from a titter-totter stock market driven by a recession-bound economy and your employer continue indifferent in their blissful world. Ironically, most small business owners have more than a casual interest in the performance of their 401(k) plan because they, too, are major participants. Too often when someone brings to their attention the ability to self-direct the investments and avoid the pitfall discuss above, they call their brokerage firm and the advice is “leave it like it is”. Far too many employers have not made the conflict of interest connection and continue to blindly follow bad advice. So, if you could move you 401(k) plan, why would you want to?

If you’re under age 55 and not in retirement’s red zone, then you’re not in as much danger as your older associates. You’ve got time for a bad market to recover – and over the “long term” you’ll probably do just fine taking risk in the market. On the other hand, if retirement is right around the corner and you can’t afford the ten-or-longer-year wait for a market meltdown to recover, you have no business exposing your family’s hard-earned nest egg to unsuitable risk. By transferring your money out of the 401(k) and away from the company that now manages it, here are some of the advantages you’d receive:

1. Get rid of unsuitable market risk you’re now taking in mutual funds and employer stock. With the money in self-directed IRAs you can invest in virtually anything except a life insurance policy: stocks, bonds, mutual funds, CDs, annuities, real estate, commodities, privately owned business and more.
2. If you don’t feel qualified to manage your money, work with a qualified financial planner that can give you personal, and unbiased, attention – something you’re not now getting from your plan’s broker even though you’re paying for it.
3. Lower your fees from 2% to under 0.5% if you want to stay in mutual funds. The high-fee funds you have selected inside your 401(k) can be traded for low- or no-fee index funds or exchange traded funds. What’s more, index-funds have outperformed the higher-fee managed funds.
4. Very few money manager match the market performance, let along beat it, over any five-year period. You’ll get better performance by firing your fund manager and going with index funds if you like to stay invested in mutual funds.
5. If your money stays in your 401(k) plan, you can’t take advantage of new openings in the tax laws. For example, in 2010 the income limit to convert to a Roth IRA is being suspended – this could be a one-year opportunity. You’ll miss the chance to have a lifetime of tax free income if your money remains in the 401(k) plan. By the way, you can pass forward tax-free Roth money to your heirs – and they’ll have a lifetime of tax-free memories.
6. Even your employer stands to benefit – not just as a plan participant but also as a business – by shucking the some of legal liability of being a trustee and fiduciary of the 401(k) plan. If the currently pending class action lawsuits go against employers, the lawyers are likely to start going after the smaller fish in the pond.

If you’d like the details of how to get all or some of your money out of your 401(k) plan, I invite you to read a report I co-authored with an attorney: “Tapping Into Your 401(k) Money Before Retirement”. Pass the report along to your employer in hopes they wake up and start giving you the freedom you need to protect your retirement money.

Shelby J. Smith, Ph.D.
October 03, 2008

Typical retirement-minded boomers along with most retirees, as mentioned in this retirement blog, are agonizing over the downward spiral in the value of their retirement nest eggs.  Their money was committed to mutual funds, stocks, bonds, variable annuities and other “securities” because they listened to the loud voices of Wall Street telling them about the safety and high rates they could expect.   Little thought was given to their risk tolerance because they were assured that “long term” they would do just fine by putting their money in the market. In fact, they were warned that unless they invested in the market they could not possibly keep up with inflation.  Most who followed this advice – whether in a 401(k) or another retirement plan, or with their life savings earmarked for retirement use – now find themselves down 30% or more from a year ago.  Over the past ten years they’ve also lost money in the market after accounting for inflation.  They now want to know where to put what money they have left.  To answer this conundrum, let’s look at the options.

There is currently underway a flight to the safety of FDIC-backed bank CDs.  Granted, this option is rock-solid safe if the FDIC limits are not exceeded, but rates are very low.  In fact, the interest rate on CDs will be significantly less than the rate of inflation.  What’s more, every dime earned is subject to ordinary income taxes and early withdrawal comes with penalties.  Also, CDs cannot be converted to a guaranteed lifetime income without being withdrawn and reinvested.  The only advantage of a bank CD is the safety and a set, albeit paltry, rate of return.  When the principal is returned at maturity, its purchasing power will be less than when deposited.  The CD’s declining purchasing power will lead to the self-fulfilling prophecy of a retiree’s greatest fear: outliving their retirement money.

U.S. Government bills and bonds are another favorite safe-harbor.  Again, rock-solid safe but even lower interest rates than bank CDs plus an added hazard.  If interest rates rise as most economic sages believe they will in the face of the rapidly expanding federal deficit, the price of bonds with below-market coupon rates will fall.  The longer the maturity of the bond, the greater the price drop when interest rates rise.  If a bond owner sells prior to maturity because they need the money, a loss will result.  While U.S. Government bonds are free from default, such is not the case with the bonds of private companies and other governments like municipalities.  There is widespread anticipation that bond defaults will escalate if the economy suffers a recession – and recession is the consensus opinion. If you look at the trend of past bond defaults, you’ll find many municipalities among the casualties.  Many bonds are far too risky for retirees.

Committing retirement money to the market in mutual funds, variable annuities, stocks and other securities is risky as millions of Americans now know.  Yes, the value may return in the “long run” but many retirees and soon-to-be-retirees don’t have the time to wait for the market to recover.  In fact, the market indexes (DJIA, S&P, etc.) are currently lower than they were at the start of the Millennium in 2000 – and the outlook is negative at this time.  Retirement money should not be placed at risk in market investments unless the risk of loss can be tolerated or the investor has the time to wait for a market recovery – to take unsuitable risk means jeopardizing retirement.  Most who now find themselves with massive paper losses are discovering too late that their risk tolerance is not as great as initially thought.  The recent market losses will result in continued employment or scaled-down retirement just as the market meltdown did in 2000-02 and 1973-74.  Sadly, losses could have been avoided with a better alternative: fixed annuities.

The fixed index-linked annuity has again proven to be a safe place to put retirement money.  There is no limit on the amount, taxes are deferred until withdrawal occurs, the worst result is a small guaranteed rate of return with the potential to do much better, 100% of the money is working since there is no “load” if held to maturity and the money can be withdrawn as a guaranteed lifetime income that cannot be out-lived.  There are other advantages as well, like: partial liquidity for emergencies, no withdrawal requirements, the bypass of probate, and choice of earnings crediting methods.  The best feature is the unconditional guarantee of global financial companies that have survived wars, depressions and failure of governments over the past centuries.  If the greatest fear of retirees is outliving their money (longevity risk), why not buy an insurance policy to offset the risk as is done with homes, cars, health, life, business and virtually every other asset?  Why take the low rates and pay taxes on bank CDs?  Why take unaffordable risk in the markets?  Fixed index-linked annuities are an alternative that can deliver safety and assure a better retirement.