Archive for the ‘Savings’ Category

Why Most American Workers Do NOT Participate in 401(k) s

Saturday, March 10th, 2012


67 percent of Americans workers aged 21-64 with access to employer-sponsored 401(k)’s do not participate in the pre-tax retirement plan.

 

I was absolutely floored when I read this stat published by the Employee Benefit Research Institute. There had to be a typo in there somewhere. (I double checked; there wasn’t.) Virtually then, more than two thirds of the working population (with access), don’t do 401(k)’s?

 

Know Thy “K”

 

While I often resist approaching this subject at the risk of “beating a dead horse”, it is now crystal clear; the horse is nowhere near the end of its days. Next question: Why isn’t the majority of the working population taking advantage of this benefit?

 

After much consideration, my ventured guess is this: employees opt out because there is a lack of true understanding for the machinations of 401(k) plans, benefits of participation, and costs. Of these, perceived cost may be the biggest stumbling block.

 

Deductions & Reductions

 

Deductions taken from your pay check will reduce your take home pay, but it will not reduce it in the dollar for dollar manner many assume. Because these employee contributions are made on a pretax basis, any amount contributed to the plan will reduce your taxable income. Therefore, every dollar contributed to a 401(k) will result in a reduction in take home pay of 72 cents for an employee in the 28% Federal Income Tax bracket: $1.00 – $ .28 = $ .72. Think about how that multiplies.

 

Many states will also compute their income taxes based on this adjusted figure. In Illinois, if you are in a 28% Federal Tax bracket and the 5% State Tax bracket, the true cost of your dollar contribution would be 67 cents. ($1.00 – $ .28 – $ .05 = $ .67.) Federal Tax Credits available to lower income people may reduce these relative costs even further.

 

Market Ease

 

I also believe many people opt out because they don’t understand the markets, how to invest, or much of anything having to do with finances. While that used to be a somewhat valid excuse, modern day benefit management methods are proving otherwise.

 

Investment programs have become much more automated than they used to be. Most plans now offer portfolio programs professionally managed to selected specifications. For example,  the direction of your plan can be focused on the actual target date you have in mind to begin withdrawing funds when you retire.

 

Current benefit management systems take the task of portfolio construction out of your hands and into those of professionals who balance risk and reward within the elected set of demographics. The days of having to select individual market accounts and balancing them yourself are over.

 

Deferred Advantage

 

In addition to paycheck reductions and managed assistance, another major benefit of 401(k) plans is tax deferrals.

 

All growth in these products is deferred until they are withdrawn from the account. Therefore, if you contribute $3000 per year for thirty years, a total contribution of $90,000 would have been made. If the account balance is $500,000 after this time, none of the additional $410,000 would have been taxed as it was growing.

 

Keep in mind these funds will become federally taxable as ordinary income in retirement. State treatment of retirement income varies; Illinois does not tax retirement income from 401(k)’s.

 

Bonus Benefit

 

Because most people are in a higher tax bracket while working than they are in retirement, 401(k) participation is even more beneficial.

 

Contributions for participants who fall into this norm will: allow deductions from taxable income at a relatively higher tax rate and have receipt in retirement at a relatively lower tax rate. Ultimately, you’ll be paying less tax on the income you earned.

 

One Final Nay

 

Take advantage of employer match plans! (I.e. When employers offer matching contributions to your fund when you elect to participate.) Not taking advantage of this is literally passing up free money. Opt in now and cash in later!

 

Kurt Rusch  CLU, ChFC

 

Follow Your Money For Answers

Monday, February 27th, 2012

 

 

According to the Bureau of Labor Statistics, more than half of the money we spend goes to housing and transportation. Reading about the breakdown of consumer spending, started me wondering…

 

1)      Why do we naturally bristle at the thought of saving money?

2)      Why does the discipline of wise money management overwhelm us?

3)      Why are we so great at finagling funds for fun, funky and frivolous stuff?

 

If you can relate (and honestly, who can’t?), you might be interested in knowing there is quite a plethora of documented theory that speaks to these questions and more published under “Behavioral Economics” and “Behavioral Finance”.  In simple terms, these theories address how social, cognitive and emotional factors affect our economic decisions. If you care to read historical timelines and academy, find them here: Wikipedia, AOBF and Neuroeconomics – yes, there is such a thing as Neuroeconomics – it is a focus for explaining “human decision making”.

 

 

Mental Accounting

 

Investopedia.com offers insights as to why we do and don’t spend certain resources under the auspice of, “Mental Accounting”. This concept suggests that much can be learned from the way we separate and allocate our money.

 

Mental Accounting is a subjective view of money. For example, when we earmark paychecks for monthly living expenses but think of “found” or unexpected money, such as tax refunds and lottery winnings, as money that can be freely spent, it is a subjective allocation.

 

Conversely, unemotional and logical money management does not recognize a difference between a $2,000 paycheck and a $2,000 winning lottery ticket – $2,000 dollars is $2,000 dollars regardless of source. (See the full tutorial here.)

 

Follow the Money

 

How can we nip Mental Accounting in the bud? Try following your money around for the next month in words – literally. If you’ve ever dieted, you know how helpful keeping a food diary is. No one likes doing them, but it is the most telling tool you can give yourself. Write down what you spend, allocate, and save every day – what, where, and why you spent it too. This includes the checks you write on your monthly bills.

 

At the end of the month you will be able to detect the way you think about money and possibly find some red flags you hadn’t seen (or thought of as such) before. For example, are you holding onto low interest bearing accounts and making high interest rate credit card payments? Could you pay off a small debt right away by using some of your ‘fun’ money? Are you keeping spare change in a can or buying dollar scratch offs?

 

Brace yourself, all those trips to Starbucks, Subway and Super K may just rise up and slap you silly across the face. Good luck.

 

Kurt Rusch  CLU,ChFC

 

Why Work With An Advisor?

Thursday, February 16th, 2012

 

There is nothing worse than a home improvement project gone wrong. You waste a ton of time running back and forth to Menards because you know you can do-it-yourself and end up wasting way more money in the long run more often than not. (Been there, done that, more times than I want to admit.) That’s exactly what I thought of when I read this stat from a recent Franklin Templeton survey:

 

78 percent of 35-44 year olds are concerned about managing their retirement plans to cover expense, yet only 23 percent work with a financial advisor.

 

Findings like these are a red flag in my industry. When I read reports like this I get the same look on my face that our handyman gets when he sees something I tried to do on my own. On second thought, that’s not true because he usually laughs at what I try to do and I’m not smiling right now.

 

66 percent of those who map out retirement strategies with an advisor understand what they will need to withdraw each year in retirement.

 

Now, I’m smiling.

 

No Wealth Requirements

 

Ask 10 different people why they don’t work with a financial advisor directly and you’ll get 10 different answers. Reasons, beliefs and excuses come in all kinds of shapes and sizes:

 

41 percent of those who don’t use an advisor say it is because they think they don’t have enough money to do so.

 

Now, I’m mad. Having enough money is what this is all about. Planning is building, and we all start from different places. There is no level we have to reach before we can seek help.

 

So, why would the surveyed respondents feel this way?

 

There are three reasons I can think of: 1) It’s just one those many (erroneous) assumptions we make about things, 2) They met an advisor who only works with high value accounts – strictly a business prerogative, or 3) A carnival barker told them so. Enough said.

 

No Instruction Manuals

 

Unlike putting in a new sink, planning for retirement, or any other monetary based goal, does not come with an instruction manual. Variables affect money management:

 

65 percent of Americans aged 65 or older said they will have to work between one and 10 more years before being able to retire.

 

The top two retirement concerns cited in the survey, after “running out of money”, were healthcare expense and changes to Social Security that would reduce or delay benefits. Both variables; add to these: societal change, market fluctuation, the cost of living, interest rates, and job opportunities.

 

30% percent of people who don’t use an advisor say it is because they want to do it themselves.

 

If I were to give the number reason why you should work with a financial advisor, it would be because of variables. Professional advisors understand actuarial concerns as well as they do the concerns of their clients. Matching peoples’ personal needs and goals with the right mix of financial instruments is tricky. There is no one size fits all approach; nor should there be.

 

Navigate the variables with the help of a financial advisor and put a smile on your/my face!

 

Kurt Rusch  CLU, ChFC

 

Defined Benefit VS. Defined Contribution

Wednesday, February 1st, 2012


In speaking with a client recently, I was asked to describe the difference between Defined Benefit Plans and Defined Contributions Plans. I was a bit taken a back because I assumed these were commonly understood concepts.

 

Investigating further, I discovered my assumption was wrong. The differences between Defined Benefit Plans and Defined Contribution Plans are not very well comprehended – even among many astute financial people.

 

Defined Benefit Plans

 

DBP’s are typically thought of as “old school” pension plans. When you enroll in these plans, the employer makes a promise to make specific payments based on formulas with variables such as number of years with the company, wages, age at retirement etc.

 

Companies will then fund these plans according to their own formula. Some companies have 100% company contributions to fund these plans while others will require employee contributions.

 

One of the main differences between these plans and Defined Contribution Plans is that the burden of investment return is with the employer. Any shortfall in the contractually promised benefit must be made up by additional contributions in a defined benefit plan. Contrarily, any surplus can be utilized to reduce future contributions to meet these obligations. These plans are becoming less and less prevalent as employers look to avoid the extra liability of making up contributions if investment returns lag.

 

Defined Contribution Plans

 

DCP’s are the plans with growing popularity. An example of these types of plans would be: SIMPLE, 401(k), 403(b), and Section 457 plans. Employees are able to set aside a portion of their pay on a before tax basis. In some cases the employer will have a matching contribution that will be added in addition to the employer contribution.

 

The employee contributions are always 100% vested if that employee leaves employment. The employer contribution usually has a vesting schedule where a portion of the employer contribution will be forfeited by the employee if their years of service are not sufficient.

 

Other Comparisons

 

Defined Benefit Plans typically promise a lifetime of contractual income once you enter retirement. Defined Contribution Plans offer no such promises. Once your funds are depleted, your income stream is over. On the other hand, Defined Contribution plans will generally have a beneficiary designation where any remaining funds in the account can be passed to a beneficiary upon death.

 

Defined Benefit Plans provide choices as to how you prefer your lifetime income would be paid out. For example, you could receive the highest payout if you select a lifetime option with no provision for spousal continuation. You can also typically select a lesser amount with the remainder paid to a spouse if they survive you. These plans have no provision for leaving unused assets to non-spouse beneficiaries.

 

Retirees can select payment options as they see fit with Defined Contribution Plans. People can choose to take as little as is required by the IRS minimum distribution requirements all the way up to redeeming the entire account. Defined Contribution Plans offer the opportunity to pass assets along to beneficiaries for any unused balances.

 

Take Away

 

The biggest difference between DBP’s and DCP’s lies in the responsibility for investment return. In a Defined Contribution Plan, the onus of return lies with the employee. If their returns are not sufficient, it is up to them to increase their contribution rate or have fewer funds available at retirement.

 

Minding today’s terminology is half the battle.

 

Kurt Rusch  CLU, ChFC

 

Retirement Planning: New Year, New Rules

Saturday, January 21st, 2012

 

A plethora of legislative change became effective on the first of the year. Some of these changes will affect individuals planning for retirement as well as those already retired.

Here, is the short list:

 

1. Social Security checks will be getting larger. Recipients can expect to see their gross check increase by 3.6% with only small increases in their Medicare Premiums.

 

2. Standard Medicare Part B coverage will increase to $99.90 for 2012. This is an increase of $3.50 per month. For Part B enrollees who signed up in 2010 or 2011 and were charged an initial premium of $110.50 or $115.40, their premiums will decrease to the standard $99.90.

 

High Income recipients will continue to pay a higher portion of their Part B premiums with their rates being anywhere from $40.00 to $219.80 per month higher than the standard rate. (High Income Recipients are defined as: an individual with Adjusted Gross Income over $85,000 or couples with Adjusted Gross Income over $170,000.)

 

3. The Part D donut hole gap is shrinking. The biggest complaint about the Medicare Part D is the fear of hitting the donut hole where coverage is limited severely versus coverage prior to and after the hole.

 

Previously, drugs were discounted by 50% for brand name and 7% for generics while in the donut hole. These percentages are rising to reflect a 50% discount for brand name and 14% for generics in 2012. Eventually the donut hole is scheduled to be phased out.

 

4. Income subject to Social Security Taxes will increase. For 2012, Social Security will be incurred on earned income of up to $110,100, up from $106,800 in 2011. However, at least for January and February, Social Security withholding rates for the employee will continue to be 4.2%.

 

5. 401(k), 403(b) and Federal Government Thrift Plan contribution limits will increase. The 2012 limit will be $17,000, up from $16,500. The catch up provision available for employees 50 and older remains $5500.

 

6. IRA contribution limits will remain the same but the threshold for income to make these deductible contributions will increase. Contributions of up to $5000 or $6000 if aged 50 and older, will be fully deductible if the modified adjusted gross income is under $58,000 for individuals or $92,000 for couples.

 

A phase out occurs between $58,000 and $68,000 for individuals and $92,000 and $112,000 for couples where only a portion of a contribution will be deductible. For individuals without a retirement plan at work, the income limits are set at under $173,000 for full contribution to fully phased out at $183,000.

 

7. Roth IRA income limits will also remain the same with contributions of up to $5000 or $6000 for aged 50 and older. However, these will also see an increase in the income limits that will be able to participate. Individuals with adjusted gross incomes of up to $110,000 will be able to fully contribute to a Roth for 2012.

 

There will also be a phase out of the amount of contributions that can be made until no contribution can be made if income exceeds $125,000. For couples, the thresholds are income under $173,000 and phased out until income reaches $183,000 where a Roth IRA will not be a viable option.

 

8. Qualifying income limits for the Saver’s Credit will increase for 2012. This credit which can amount up to $1000 for individuals and $2000 for couples, will now be available to individual taxpayers with an AGI under $28,750, for Heads of Household with an AGI under $43,125, and for couples with an AGI under $57,500. The credit will apply to contributions to retirement plans whether individual or employer based.

 

This overview may provide changes which could affect your planning for this year and beyond. The uncertainty of anyone’s future, combined with changing laws and financial environments, dictates the need for dedicated and diligent review.

 

Kurt Rusch CLU, ChFC

 

Review, Retool & Renew

Wednesday, December 28th, 2011

 

It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to Heaven, we were all going direct the other way- in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only. –Charles Dickens

 

Was 2011 the best of times or the worst of times? The answer to that depends upon whether your glass was half full or half empty.

 

Review

 

Don’t let frustration cloud the path of renewal. There’s nothing worse than basking in what you didn’t accomplish – look to what worked first.

 

Take out a sheet of paper and draw a big “T” across and down the page. Write WORKING on the left side  and list the things you have in place you’re happy with. Consider whether you want to build further on any of these and make a note to do so.

 

Retool

 

Now write NEEDS WORK on the right side of the paper and list any financial concerns/objectives you’d like to address/reach in the coming year. What simple steps can be taken to start working on these?

 

Savings and cash flow are priority objectives for most people. Here are some easy things to do to rev up for the New Year:

 

Kitty Jar – Throw $5 bucks into a jar each week. A year from now you’ll have an extra $250 to pay bills, invest, or splurge with.

 

Automated Savings Account – Consider opening an automated savings account. Most banks have programs where you can designate a certain amount of money to be automatically transferred from your checking account each month into a savings account.

 

“Keep the Change” accounts are also an easy way to save automatically through your debit card transactions. Every time you buy something, the change is rounded up to the next dollar with the difference automatically deposited into the separate account. An additional amount of money may be required for auto transfer each month too, usually a $25 minimum. If you use your debit card in lieu of cash or check, an account like this can easily add up to far more than you might think over the course of a year.

 

Invested Savings – Mutual fund accounts can be opened for as little as $25 per month and set up on an automated basis. Naturally, this type of account carries no guarantee for positive results but if investing is a goal you have yet to reach, small accounts like these may be the best thing to do to get started.

 

Boost Cash Flow – There are numerous things you can do to increase cash flow: pay down/off revolving debt with the highest billed interest rates first, shop wiser, bag your lunch, etc. Now is also definitely the time to revisit the U.S. tax code. Taking advantage of every exemption, credit and deduction available to you can save hundreds to thousands in taxes. Ear mark your refund (ahead of time) for something on your list this year.

 

Embrace Economic Trends – Economies void of high interest rates of return provide affordable opportunities. Make low interest rates work for you! If you haven’t refinanced you home, do so. Financed items are cheaper now.

 

Renew

 

Work both sides of your “T” sheet and take simple steps to welcome in the New Year, clarity and resilience are on your side.

 

What was and what wasn’t becomes what can and what will in one quick tick tock. It’s really magical when you think about it.

 

We wish you a very Healthy & Prosperous New Year!

 

Kurt Rusch  CLU, ChFC