401k Q & A

Through my membership in NAPFA, I received a press request from a reporter with MSN. The questions he posed were so good I though it would make a good blog post.

How can a person tell if their employer sponsored defined benefit plan is good?
Wow, a very subjective question. It is hard to make generalizations but the first place to look is the fees charged to participants. Many 401k providers "wrap" administrative and reporting fees into an "asset fee" or "annual maintenance charge" that are billed against the individual participants investments. While this is legal, a "best practice" is for the plan sponsor to pay these fees directly on behalf of the plan. It is a deductible item for the sponsor and allows better returns for the participants by lowering the expenses charged to their tax deferred account. Another area to examine is the total fees paid by participants, which include "asset fees" and the expenses of the investments a participant chooses to use in their account.

If not what can they do to remedy the situation?
Many employers are not aware of their options. The employer has made a financial commitment to their employees by offering the 401k, and they are almost always participants themselves. I am sure they want to offer the best plan they can. A good resource for plan sponsors is www.dol.gov/ebsa/fiduciaryeducation.html. Here sponsors can download booklets and forms to help them evaluate different 401k proposals.

Can you have a Traditional IRA if you have a 401k or 403b plan at work?
Yes, if you meet certain income limits. For single filers with modified adjusted gross income of $52,000 and under for joint filers with income of $83,000 and under if you participate, or income of $156,000 and under if your spouse is the participant, you can make fully deductible contributions. For single filers with MAGI between $52,000 and $62,000 and joint filers with MAGI between $83,000 and $103,000 if you are the participant and between $156,000 and $166,000 if your spouse is the participant you can make partially deductible contributions. Another option is a Roth IRA contribution which you can use if you would qualify for a fully or partially deductible Traditional IRA contribution.

Longevity Insurance

According to the National Center for Health Statistics a man living in the United States who reaches age 65 has a life expectancy of another 17 years and a woman who reaches sixty five has a life expectancy of 20 years. In fact according to Wikipedia 1 in 50 women and 1 in 200 men living in the United States will attain the ripe young age of 100.

Statistically, life expectancy is the point where 1/2 of a group will be dead and of course the other half will continue living. So half of the women living in the US that are 65 will live to be older than 85, and half of the men will live to be older than 82.

That is a long way to get to where I wanted to start. With expanding longevity in the US, making sure your money lasts longer than you do becomes increasingly harder. Defined benefit pensions are going the way of the dinosaur so individuals have to shoulder an increasing risk of longevity (which I believe is a good problem to have as far as problems go).

Enter your friends from the insurance industry who are willing to sell you longevity insurance.
Some think the policies are over priced but I believe it is an option that some should consider. here's how it works:

Let's say a 65 year old male needs $50,000 a year of income in addition to his social security benefits. Guessing that inflation will average about 3% annually this gentleman will need just over $90,000 to buy the same amount of groceries when he reaches age 85. For about $131,000 he can buy a longevity insurance policy that will guarantee him $90,000 a year in income beginning at age 85. Doesn't sound like too bad of a deal so far, but remember less than half of the men age 65 today are expected to live long enough to collect even one cent (that's right if you die before age 85 you get nothing and the insurance company keeps all the money).
Still if you are one of the lucky ones who lives long enough to collect you'll be ahead after about a year and a half.

If you have reason to believe you'll live a long time this could be a good deal. If like Mickey Mantle you feel "If I had known I was going to live this long I would have taken better care of myself" then maybe it's not for you.

Understanding Your Variable Annuity

Variable annuities are often confusing and hard to understand. In addition to the fees charged for managing the sub- accounts (read mutual funds) within the policy consumers also pay for the insurance portion of the policy (mortality expense) and various riders and options offered with the policy. If you want to compare the expenses of owning or buying a variable annuity, this months issue of "Money Magazine" offers up a simple grid that you can take to your insurance agent ( yes your broker is an insurance agent if she is offering you an annuity) for help comparing.

E-Z annuity fee disclosure checklist

Before you buy any annuity, ask your advisor to fill in the blanks.

What you pay each year Annual fee (as % of account value) for: Number Typical The insurance (a.k.a. mortality and expenses) _____% 1.35% The investments within the annuity _____% 0.95% Riders and options _____% 0.65% Total annual fee: _____% 2.95% What you pay to get out Max. surrender charge (as % of withdrawal) _____% 7% Number of years before surrender charge expires _____ 8

Source:Morningstar, National Association of Variable Annuities, Money research
Note: Max. surrender charge may not apply to all withdrawals.

You can read the full story here.