The part of the financial services industry that has largely escaped financial trauma has been life insurance companies.  Granted, AIG Corporate failed but their troubles were not related to “insurance” but to unregulated Credit Default Swaps. The insurance subsidiaries of AIG suffered “guilt by association” but have maintained their financial strength rating as independent entities.  No doubt these insurance subsidiaries will be the primary assets that are sold to repay the bailout loan extended to AIG Corporate by the federal government.  You’re probably asking questions about the solvency of the insurance industry and the safety of their products, especially fixed annuities.  Let’s take a safety tour of insurance companies.

First and foremost, insurance companies have an operating history of stability that is the envy of banks and brokerage firms.  Their investments are limited to conservative, boring options that rarely carry inordinate market risks.  The products they offer must first be approved by the state Insurance Commissioner to assure suitability for the general public and guard the insurance company’s solvency.  There have been failures – mostly small – that have occurred in troubling economic times.  When failure seems likely or actually occurs, the home-state Insurance Commissioner swings into action armed with powerful regulatory might. Insurance Commissioners have the power to levy fees on other insurance companies operating in the state to pay for rehabilitation, merger or liquidation of failed insurance companies.  This system has worked flawlessly, because not one insurance policyholder has lost a penny of their invested principal with an insurance company.  Bear in mind, insurance companies have survived world wars, global depressions, scandals, government failures and stock market meltdowns.  Americans have insured their homes, cars, health, life, business and retirement nest eggs without fear of safety.

What about fixed rate and index-linked annuities? Again, never has a fixed annuity holder lost a penny due to market losses.  Not only is there a clearly stated guaranteed minimum rate of interest, but index-linked annuities offer the potential to earn extra if the market-linked index rises.  What’s more, if the market index falls – and that has been the case in the current market meltdown – the annuity is guaranteed not to lose value.  In addition to no market losses, annuity owners get income tax deferral on earnings until withdrawal, protection from creditors in most states, probate-free transfers at death, the right to convert to a guaranteed lifetime income, penalty-free withdrawals to cover emergencies and total control over their money if circumstances change.

Fixed annuities, especially index-linked annuities, have gotten a bad rap from Wall Street in recent years, primarily because their popularity has taken mutual fund and variable annuity sales away from stock brokers. While the current meltdown has created massive losses for market investments, fixed annuities are loss free, earn a guaranteed rate at a minimum and will pay extra interest if the market recovers.  Annuity owners are not postponing retirement, leaving retirement to find jobs or spending sleepless nights worrying about market losses.  Savers will never get rich by choosing fixed annuities, but may very well stay rich.

Don’t be surprised if the financial professional who introduced you to annuities calls and says: “your money is safe, and you have no losses – if the market recovers, you’ll do even better”.  It might be a good time to think about converting more of your “market” money to fixed annuities.  Stock broker don’t have much good news these days because if you followed their advice you have massive losses.  Of course, they are still giving you advice about where to put, or keep, your money – I suppose the theory is “the more they’re wrong the higher the probability they’ll guess right next time”.  I don’t like that theory and neither should you.  Safeguard your retirement money because “retirement is the largest purchase you’ll ever make and you can’t borrow the money to pay for it”.  Your retirement nest egg will pay for the last one-third of your life…safeguard it wisely.

Shelby J. Smith, Ph.D.
November 2008

Related Topics: Wake Up Call for America (Video Seminar), Understanding Your Mutual Fund (eReport PDF & Video), Is Your Annuity Good or Bad? (Video & eReport)

Stocks, bonds, mutual funds, variable annuities and diversified portfolios are now recognized as risky and not for the faint of heart.  Investors have reviewed their risk tolerance and found their losses have greatly exceeded what they thought – and were told by their broker and Wall Street – were possible.  Standing tall and proud above the fray is the fixed annuity that has experienced no loss and has retained the potential for gain should the markets recover.  Added to the guaranteed safety of a fixed annuity is the deferral of current income taxes and the ability to “lock in” at any time a lifetime income.

For years now Wall Street, FINRA (the regulatory authority for broker/dealers), the SEC, brokerage firms and virtually every state Securities Commissioner have bad-mouthed, slandered and trashed fixed annuities as an unfit place to put retirement money.  They have insisted that fixed annuities are bad for the retirement-minded whereas “putting your money in the market” is the safe option.  So much for the “wisdom of Wall Street” because fixed annuities have passed the test of bad times without loss while mutual funds, stocks, bonds and variable annuities have suffered historical losses – and more could come. So why have fixed annuities been the object of so much criticism from Wall Street and their allies?

When a fixed annuity is purchased by a risk-averse, retirement-minded saver more interested in the return of their money than the return on their money, a competing security is not purchased, and Wall Street loses a sale and commission. They respond by trashing fixed annuities with a litany of objections intended to scare, confuse and threaten those brazen enough to purchase something they do not recommend.  Ironically, the securities regulators would like to have authority over fixed annuities which would lead a logical person to question whether they object to the product or the fact that they’re losing fees.  Self-preservation is a compelling incentive that can lead to dishonorable behavior.

The end of the story is that regardless of what you read, hear or see from Wall Street about fixed annuities, it will invariably be derogatory, because their loud voices in all media drown out the truth.  That is until recently!  The 2008 market meltdown exposed the risks of the investments peddled by Wall Street – the 40% plus losses in 401(k) accounts simply cannot be hidden from the working public.  Yet, fixed annuities have not lost one cent on paper or in reality – in fact they’ve continued to trudge forward like the infamous tortoise that eventually won the race with the hare.  The smart saver that rejected the “wisdom of Wall Street” and chose the fixed annuity is without loss – money or sleep – and without cracks in their retirement nest egg.  So the next time a broker says, “fixed annuities are (fill in the trash talk)” you’ll know the “rest of the story”.

Shelby J. Smith, Ph.D.
November 2008

Related Topics: Hold ‘em or Fold ‘em: A Retirement Decision (Video Seminar), Retired: Can You Afford the Risk? (eReport PDF & Video), Is Your Annuity Good or Bad? (Video & eReport)

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

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.

If the bailout occurs and massive amounts of money are injected to absorb bad loans and right the economic ship, the soaring deficit will further weaken the dollar, boost the need for tax hikes and ratchet inflation to an even higher level.  While these consequences augur poorly for folks on fixed incomes already in retirement, a south-sailing economy will dampen the need for employees of all ages.  As the economy grinds to a lower gear under the extra weight of higher prices, lower disposable income and slack job opportunities, saving extra for retirement to compensate for earlier over-consumption will be impossible for most.  What was once a tenuous retirement will develop into a dependency on others or continued employment.

What will be the fate of the retirement money currently invested?  If in the market, the purchasing power could be severely eroded by a depressed market that is struggling to climb the hill back to break even – assuming it was not exposed to total loss from bankruptcy, forced merger or regulatory confiscation.  If in the safest port of all – bank deposits insured by the FDIC – the rate of return is anemic when compared to inflation and purchasing power will suffer a torturous fate of shrinking in value.  The ace in the hole – home equity – could be difficult to unlock as buyers become scarce and/or the supply-demand imbalance melts away equity.

The bailout means higher taxes, increased inflation and most likely a weaken economy – none of which are good for retirees or the near-retired.  What’s more, the severity of the downturn and the period of adjustment needed to return to normal could indeed be steeper and longer than most economic cycles.

What if the bailout is aborted?  The credit markets are likely to freeze with the consequences that money cannot be borrowed and commerce cannot be efficiently conducted.  Credit to the economy is analogous to motor oil for an engine – the lack causes the engine to seize up and not function.  As money dries up so does the ability to finance the expansion of businesses and payrolls are more difficult to meet.  Again, the economy grinds to a lower gear with unemployment rising and payroll dropping.  The government will have the option of raising taxes to balance the budget or risk run-away inflation by monetizing the debt by printing more money.  The balancing act of just enough government intervention and the right amount of free market latitude will be exceedingly difficult to engineer. Accordingly, the economy is likely to head off in the direction of abyss or go the opposite way toward runaway inflation.  Either way, retirees and those near-retirement will be worse off.

Regardless of whether the bailout is funded or withheld, there will be undesirable consequences for the retirement-minded.  In the long-run the market will come back and many of the anemic investments will recover and be just fine.  The only problem is that when the “long-run” has played out most of retirement may be distant memory.  What you can do now is crunch the number to determine if you can afford to lock up an adequate guaranteed lifetime income that will give you a comfortable retirement.  Don’t leave your retirement in the market and watch it melt further if you still have enough to “buy” a good retirement – seek out your financial advisor and talk about converting what you have to a safe investment that can be turned into a guaranteed lifetime income.  Outliving your money is called longevity risk and most insurance companies will insure that risk by issuing you an annuity that can be converted – usually on your time frame – to a guaranteed lifetime income for you and/or your spouse.  Check it out before it is too late.  How you reward your elected politician when you cast your ballot is your business – but by my way of thinking we need a political housecleaning more than we do an economic makeover.  Cast your ballot wisely because our leaders do make a difference.

Shelby J. Smith, Ph.D.
September 30, 2008

Brokerage firms and plan administrators have done a good job of keeping secret from small businesses the ability to withdrawal or transfer certain 401(k) money while still working. In fact, when asked about withdrawing money from employer-sponsored defined contributions plans – even ones where the employer does not match or make profit-sharing contributions – brokerage firms and administrators have reported that withdrawals are not permitted prior to retirement. It is absolutely inexcusable that the brokers and administrators have not volunteered the information that a simple, no-hassle, cost-free change in a plan permits in-service withdrawals and transfers.

Any money rolled into a plan from another qualified plan can be withdrawn or transferred without restriction by the employee. Yet, the investment managers and administrators require a mountain of paperwork and refuse to cooperate with employees wishing to take advantage of this privilege. They delay and hassle employees until many give up in disgust. In the meantime high fees, risky choices and zero advice is provided. The government regulators and FINRA (the self-regulatory organization governing brokerage firms) turns a blind eye toward these abuses.

ERISA provides that matching contributions and profit-sharing provided by employers can be withdrawn or transferred at any age by employees while still working and participating in the plan BUT they allow employers to stipulate an age if they desire. On the advice of the brokerage firms and administrators, most smaller businesses have stipulated that normal retirement age must be reached before such withdrawal are allowed. The prohibition on withdrawals is only in the best interest of the brokerage firms because they charge fees based on the amount of money in the 401(k) plan. Naturally the small business owner is not aware of this ERISA in-service withdrawal provision and those charging the fees are not about to volunteer the information. In the meantime, employee participants, especially those nearing retirement, are taking unsuitable risks, paying high fees, choosing from very limited options and getting zero investment advice.

ERISA does not allow voluntarily employee contributions to be withdrawn from 401(k) plans while continuing to work at the employer until age 59½ is reached. However, the employer is permitted to stipulate an older age which most have done on the advice of the broker and administrator. Again, hard-working employees and employers are unaware of this more liberal withdrawal option permitted by ERISA. Employers are taking undue risk as trustees and fiduciaries of the 401(k) plan because the best interest of employees is not being served. The result is more risk, higher fees, fewer options and endangered retirements.

The greed of Wall Street is alive and well in most 401(k) plans for small businesses. The firms managing the money harass employees who want to transfer their money with extra paperwork, delaying tactics, misinformation and outright untruths. The ability to make in-service, non-hardship withdrawals is absent most plans of small businesses simply because money managers value their fees more than the best interest of their clients. It is shameful that the regulators sit on their hands and condone such behavior – yet they do.

Small business owners and their employees must rise up and take matters into their own hands. They employ the plan administrators and can fire them – the same is true for the brokerage firms that manage the money entrusted to them. To protect themselves and their employees, business owners must add the in-service withdrawal provision authorized by ERISA and they must insist that brokers and administers cooperate in helping concerned employees withdraw or transfer their money to more suitable options. The in-service withdrawal provision can be added at the direction of the employer at no cost and without delay by simply informing the third party administrator to change the prototype plan. To do otherwise is irresponsible and exposes the employer to undue liability as a trustee and fiduciary. Employees should absolutely insist in writing that employers make this change to their 401(k) plan.

Shelby J. Smith, Ph.D.

Yes!  The Social Security Administration allows you to pay back the money you’ve received in Social Security benefits – without interest and without adjustment for inflation – and reapply for higher benefits.  All you need to do is complete form 521, “Request for Withdrawal of Application”.  You’ll be asked the reason for your action but don’t worry because any answer is acceptable.  Let’s say you started at age 62 and have been drawing $1,000 a month for eight months but now want to reapply.  Along with form 521 you’d repay the $8,000 and then you can reapply when ready.  If you filed a tax return during the period, you’ll want to report any overpaid taxes on your next tax return.  If you wait until age 70 to reapply, your benefits will grow about 8% annually, plus cost-of-living adjustments, which means your benefits will more than double those at age 62.  My Guide to Social Security gives several other good reasons to postpone Social Security if you can afford to do so.  In fact, the typical family may be able to add as much as $200,000 to their lifetime retirement income if the primary breadwinner postpones Social Security until age 70.

Let’s look at Fred and Sue, both aged 66 (normal retirement age for both) and eligible to start SS benefits.  Both worked outside the home, and at age 66 each is entitled to $1,500 in monthly Social Security benefits, plus annual cost-of-living adjustments, for the remainder of their lifetime.  A Mortality Table shows that Sue is expected to outlive Fred by several years.  The Social Security regulations say that one spouse is entitled to what they qualify for based on their own earnings record or 50% of what the higher earning spouse will receive, whichever is greater.  Since Sue is expected to outlive Fred, wouldn’t it be nice if Fred postponed benefits until age 70 so that Sue would get a big raise in Social Security benefits if Fred dies first?  Is there a way for Fred to get benefits based on Sue’s lifetime earnings record and then apply at age 70 for higher benefits based on his lifetime earnings record?

Due to a little-known glitch in the Social Security regulations, there is a way.  Fred would apply for spousal benefits and receive 50%, or $750, based on Sue’s earnings.  He would draw this amount, increased annually for cost of living adjustments, and at age 70 reapply based on his earnings record.  Presto, he will get substantially higher benefits for postponing and these, too, will be adjusted annually for inflation.  At Fred’s death, Sue will be entitled to the greater of the two and her benefits will ratchet up to what Fred was receiving.  If you think this is “on the edge”, think about the combinations for divorced spouses.  If you were married for ten years, been divorced for two years, are age 62 or more and have not remarried, you are eligible to apply for dependent benefits based on the working record of your ex-spouse.  If you have several ex-spouses that meet the foregoing qualifications, they can all be drawing SS benefits simultaneously with no impact on your, or a current spouse’s, future benefits.  Even if a qualifying ex-spouse gets remarried and subsequently divorced, they can still file for dependent benefits based on a former spouse’s work record.

The foregoing shows two easy ways to maximize your Social Security benefits by taking advantage of little known glitches in the rules.  More and more married couples are realizing that postponing Social Security is the wise move, because there is an increasing probability that at least one of them will live well beyond age 90.  Since Social Security is a lifetime annuity promised by the U.S. Government with benefits indexed to inflation and tax-favored, making them a relatively larger part of your retirement income is smart.  This is done by postponing until age 70, if possible, and taking advantage of the two “loopholes” we’ve discussed.  By using these loopholes, you’re adding to the financial woes of the Social Security System, but until Congress closes the gate you should exercise your options.

Shelby J. Smith, Ph.D.

Likewise, the watchdogs of the securities industries (most pension plan assets are invested in mutual funds), the U.S. Securities and Exchange Commission and FINRA (Financial Industry Regulatory Authority), are more concerned with the health of the mutual fund companies and their brokers than they are with your financial well-being. Luckily, the Department of Labor and the courts has taken an interest in the abuses running amok in the pension plan business.

On February 20, 2008, the U.S. Supreme Court rules unanmously that individual 401(k) plan participants have a right to recover losses if their employer fails to uphold their fiduciary obligations. This landmark decision means that 50 million Americans now putting their retirement money into 401k plans sponsored by their employers have a right to recover their losses if those responsible for administering the plans don’t fulfill what’s considered their obligation to manage their plans wisely. No doubt the legal community will take this Supreme Court decision as a lifting of the lid on Pandora’s Box to go after employers, mutual fund companies, third party administrators, brokers and others that are enriching themselves at the expense of working Americans. In fact, this trend has already started as you can see by doing a search titled “401(k) Class Action Lawsuits”.

The Labor Department is proposing a rule that would require employers to disclose to workers the fees and expenses charged by mutual funds and other investments in a chart or similar format. Obviously the DOL thinks that the transparency of fees and charges are obscure or they would not be usurping the power of the securities industry regulators by taking the initiative to police 401(k) investment disclosures. How do you find out what type of fees you’re paying in your employer’s plan? For starters, you’ll not find them on your quarterly statement. Generally you can find them on the web site for the mutual fund in which you’ve invested. Look under Fund Facts. Also, if you would have read the prospectus of the mutual fund you purchased, you could have found the fees if you were willing to devote substantial time and effort looking.

The prospectus is a very long, legally-written and hopelessly complicated document supplied by the mutual fund company, and blessed by the SEC, which is totally incomprehensible by the average person. This gobbledegook’s real purpose is to provide a legal shield for the players who recommend, select and manage the mutual funds that are options in your 401(k) plan. The asset management fees and the administration fees are totally intertwined and the average worker will never be able to uncover the true cost. But, rest assured that in most cases the fees for the broker, administrator, investment company and everyone else who collect fees from your 401(k) comes out of your earnings. And, if you don’t have earnings — which as been the case lately — they come out of the hard-earned money you contribute monthly for your golden years.

Is there any way to lower your fees? Not really, you see your employer, or a committee set up by your employer, selects the investment options available in your plan. Suffice it to say, there is little thought that goes into such selection because your employer is indifferent since you pay the fees and your co-workers who participate in this democratic process are generally unqualified. Of course, the broker is there to make sure the correct options are chosen. You should know that the broker has a vested interest in having high fees because they determine his/her commissions.

So, what can you do? You can demand that low-load or index-linked or exchange-traded mutual funds are included in your plan. Ironically, not only are the fees lower on these fund selections but the performance is generally superior to those chosen by the high-fee, hyperactive managed dogs recommended by your broker. You can insist that your employer put an in-service, non-hardship withdrawal provision in your plan which allows you to take out of the plan the vested money your employer has contributed at an age below 59-1/2. Also, this non-hardship provision will allow you to take the money you’ve contributed at age 59-1/2 without penalty and without triggering taxes if done correctly. Sadly, your employer is generally not aware of such provisions and you can bet your last dollar that the broker or administrator are not going to break their silence. Here’s some reading material for you:

1. “The Smartest 401(k) Book You’ll Ever Read” by Daniel Solin.
2. “The Hidden Escape Hatch in 401(k) Plans” by Shelby Smith & Whet Smith.
3. “Plan Would Make Tending to Your 401(k) Easier” by Christopher S. Rugaber, Associated Press, July 28, 2008. Check out the following web sites:

• http://www.401khelpcenter.com/401k/meigs_classaction_summary_062005.html
• http://www.allbusiness.com/legal/legal-services-litigation/5359471-1.html
• http://www.401khelpcenter.com/cw/cw_planfees.html

Let me introduce you to Leon, age 58.  Leon is his family’s primary bread winner and very concerned about where his retirement money is invested.  He learned a valuable lesson from the dot.com meltdown in 2000-2002 because a sizable portion of his family’s savings and 401k assets were lost.  It has taken the past six years to recovery from these losses and he’s especially concerned about what might happen in the current uncertain economic times.  He views the credit-energy-dollar problems as alarming and wants to move his 401k money out of harms way because he doesn’t have time to wait for a market recovery.  Also, he expects income taxes to rise and would like to use this to his advantage.  What can he do?

Leon’s employer has modified the company’s 401k plan to allow for in-service, non-hardship withdrawals.  This is a simply procedure implemented by the administrator that will allow Leon, and other employees, to take their employer’s contributions, and associated earnings, out of the company’s 401k plan and put them in an IRA.  Additionally, Leon and several of other employees in rolled over other qualified money into the employer’s 401k plan when they joined the company and these can also be moved to an IRA.  There will be no tax due or withheld from the rollover to an IRA if they do a direct trustee-to-trustee transfer.  Also, the 401k Plan, as modified, allows the employees to continue participating in the company’s 401k.  What are the advantages to Leon?

Several of Leon’s co-workers are moving to an IRA but a few have selected the Roth IRA.  Leon would like to put his 401k money in a Roth IRA but he makes more than $100,000 annually and this disqualifies him; however, in 2010 when this restriction is temporarily removed he will be able to roll his IRA into a Roth IRA without penalty.  If taxes go up as he expects at the end of 2010, he’ll pay the Roth IRA conversion taxes at the lower rate.  He’ll get an additional break because only one-half the associated income taxes are due in 2011 with the remainder paid in 2012.  Since he’ll have to leave the money in the Roth for five years following the conversion to avoid withdrawal penalties, he has decided to put the money in a seven-year bonus index-linked annuity.  There are two reasons for his selection.

First, he has moved his retirement money out of the way of another market meltdown and gotten a bonus to boot. Granted, the market may do fine but Leon can’t afford to take the risk that the market involves.  In seven years he plans to review his, and the economy’s, financial position and re-invest the money.  Unless things change, he’ll consider a bonus index-annuity at that time because the bonus will be tax free and he’ll be immune to market gyrations.  Second, he has “locked in” the gain from his 401k because he has no downside exposure if he holds the annuity until maturity.  The added advantage is that the Roth IRA grows tax-free and has zero tax liability, plus Roth income will not increase the taxes on his Social Security.  His Roth money can be used at any time after the fifth year following roll over.  If not used during his or his spouse’s lifetime, it can be passed forward tax-free to this children and grandchildren at his death.  The payments of principal and earnings taken during their lifetime will also be tax free.

At age 59½ Leon intends to take his employee contributions and earnings out of the 401k since the in-service, non-hardship provisions, and the IRS, allows him to do so without penalty and also continue participating in the company’s 401k.  He’ll decide at that time where he wants to put it and also whether or not another Roth IRA is suitable.  He can then be totally insulated from market losses that could easily ruin his retirement plans.

Leon, like a lot of 401k participants, is in the “red zone” (search the phrase red zone on top section of this retirement blog for a few related articles) right before retirement and as a practical matter cannot afford to suffer market losses.  Many small business people and professionals (doctors, lawyers, executives, etc.) are in the same position.  The investment selections inside their employer’s plan do not provide them the flexibility, selection or protection they need during this phase of their working years; thus, they opted to take control of their investments outside of an employer’s plan.  Additionally, they’re prepared to take advantage of the upcoming temporary changes in the Roth IRA qualifications and can pay all associated taxes before they increase.  Index-linked annuities are the perfect vehicle for the journey to this tax haven.  If you’re in a similar position, ask your employer about an in-service, non-hardship withdrawal from your 401k and then contact your financial advisor.

Shelby J. Smith, Ph.D.

The problems in housing are not improving as the government pundits and Federal Reserve were forecasting. In fact, foreclosures are now over a million and continue rising, housing-related jobs are disappearing rapidly, and all businesses connected to housing (plumbing, appliances, carpet, lumber, lighting, etc.) have skidded to a halt. The investment banks of Wall Street are searching for new capital to stay afloat as are several name-brand banks: all because of the meltdown in housing. The housing problems will deepen, plus more credit card, auto and boat loans will soar as higher prices and fewer jobs take their toll. Markets will react negatively.

The stimulus package designed to bail out the economy will have a short-lived and anemic effect. In fact, inflation has already eaten away the extra cash most families will receive. Nothing short of massive new money infusion will move economic activity higher. But, more money circulating in a depressed economy only heightens inflationary pressures. The Federal Reserve sits on the horns of a dilemma: lower interest rates are needed to boost economic activity, but lower rates will further weaken the dollar and boost import prices. Higher priced imports allow American firms to raise their prices without fear of losing business. Of course, the biggest import of all - oil - has forced up prices of everything. Get ready for even higher energy prices because while U.S. demand is falling, it is rising rapidly in China, Asia and the Middle East. No amount of political rhetoric and finger pointing will provide a short-term solution. Higher energy prices are here to stay and no amount of jaw-boning will change this fact.

All these “symptoms” cause a highly volatile stock market. And, if you’re like most Americans, your retirement money is in mutual funds in the market. Far too many who can ill afford to take risk have been assured that “in the long term” the market will give them above-average returns. The assurances of Wall Street beg the question: does a retiree have a “long term”? In a market meltdown like 2000-02, many prospective retirees will have to delay or scale-down retirement.

If you’re unable to “handle the worse case outcome,” you might want to consider heading for safer harbors. The consensus is that market volatility will continue in the face of geopolitical unrest, inflation will persist, the weak dollar continue, taxes will rise and economic growth will remain under nourished. Your best strategy is to meet soon with your safe money advisor to shelter you from the winds of an ill economy. Timing is everything in uncertainty - so if you can’t afford the risk; do not procrastinate, because the situation could worsen.

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Shelby J. Smith, Ph.D.
June 2008