Posts Tagged ‘401(k)’

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

 

Top 3 FAQs on 401(k)s

Thursday, December 1st, 2011

 

The top three questions I am asked most often these days with regard to 401(k) accounts are:

 

Should I leave my 401(k) in a prior employer plan while out of work?

Is it best to roll my account into a new employer plan every time I change jobs?

Can I cash my 401(k) in if I need the money now?


Leave It

The main benefit of leaving 401(k) accounts at your former employer is that you don’t have to do anything. While this method is very convenient, it is not void of drawbacks. 401(k)’s typically come with a limited number of investment choices available to their participants. Leaving your accounts at former employers, may not serve you best, and can get confusing if you leave several or more accounts at various different companies.

 

Bring It

When you do get a new job, one option would be to roll your 401(k) over into the new employer’s retirement plan, if that is an available option. Obviously, this would make keeping track of your assets easier.

 

Some people find this an attractive option when their employer offers employee loan provisions for 401(k) accounts.  (These types of provisions allow employees to borrow against plan assets and pay the loan back via payroll deduction for return of principal and interest.) It is important to note that assets which have been lent out will be deprived of any growth on the loaned portion of the portfolio they would have received has they not taken out a loan.

 

Move It

Whether you leave your accounts at various employers, or bring them all to a new employer, investment options can be limited through workplace plans. Alternatively, there are numerous choices available if you opt to transfer your account into a Rollover IRA. This option gives investors the most flexibility if executed properly.

 

The first step in properly executing this exchange would be to assure that the account is a custodian to custodian transfer. By doing so, you eliminate the possible tax ramifications of not having the moneys properly transferred within a 60 day period as required by the IRS.

 

It is important to make certain that you do not comingle these funds with separately funded IRA’s you may have if you want to roll them into a new employer plan at some point in time. Comingling will render the account incapable of subsequently rolling back into a 401(k) plan; keeping the funds in a separate IRA Rollover Account will allow redeposit into a current 401(k).

 

Cash It In

If, and that’s a really a big ‘IF’, you really need the money before retiring, you can cash in all or part of your retirement plan. BUT, the IRS will make you pay dearly for early access. The IRS levies a 10 % penalty on anyone under age 59 ½ who cashes in all or part of their retirement plan. On top of that, you will also have to pay Federal Income Taxes on the amount withdrawn.

 

What most people don’t realize is how costly early withdrawal can be. For example, if a 40 year old in the 28% income tax bracket cashes in their $10,000 401(k), the after tax net proceeds would only be $6200. This is because they would owe $1000 in penalty for taking an early distribution plus $2800 in Federal Income Taxes. In reality, the liquidation of this retirement account yields a 62% pay out and a 38% tax and penalty on the total account value.

 

One other thought regarding early withdrawal – there are some situations where the IRS will waive the 10% penalty on early withdrawal. An example of this would be for dire and non-reimbursed medical expenses which do not exceed 7.5% of your adjusted gross income.

 

It is extremely important to tread carefully when manipulating any type of “qualified” account. Check additional rules and exemptions for early distribution on the IRS tax topics page.

 

Kurt Rusch, CLU, ChFC

 

 

Retirement Confidence Survey

Tuesday, March 8th, 2011

 

Up three percentage points up from an all time low in 2009, the percentage of American workers who feel “very confident” that they will have enough money for a comfortable retirement is 16%.

Not to play Devil’s Advocate, but we really need to rephrase that: 84% of the American workforce doesn’t think they’re going to have enough money to retire comfortably.


When the Employee Benefit Research Institute (EBRI) sent out a press release on the 20th Annual Retirement Confidence Survey last week, the headline read “New Research from EBRI”: Between 4–14% More U.S. Households “At Risk” of Running Short of Money in Retirement Due to 2008–2009 Recession.

 

Choosing their copy wisely, EBRI notes that: the likelihood of becoming “at risk” because of the economic crisis depends to a large extent on the size of the retirement account balances the household had in 401(k)-type plans and/or individual retirement accounts, as well as their relative exposure to fluctuations in the housing market.

 

No matter how you slice it, way more than the majority of us working folk have little confidence life will be grand after we stop working. This is not a good thing. Further workforce results provide:

Covering Basic Expenses 29% are very confident they will be able to cover their basic needs

Unaware of  Goals 46% don’t know how much money they will need to retire comfortably

Not Enough Savings 54% say the total value of their savings and investments excluding their home and any defined benefit plans is currently less than $25,000

No Savings At All 27% say they have less than $1,000 in savings (up from 20% in 2009)

 

In 2010, 33% workers were polled as saying they expect to retire after the age of 65. For workers who fall into some of the categories above, the amount of money they will need to save from unpreparedness and unawareness will be overwhelming to say the least. But what of the people who did/do have good plans in place? How much will these workers need to save to recoup their losses from the economic crisis?

 

“Early Boomer households, will generally need to save between 1 and 4 percent of compensation  more each year between now and retirement age”,  provides EBRI. (These amounts will vary to the personal and market profile of each worker.) While another 1-4% may not sound that bad, it may become quite challenging in a climate of increased taxes, higher employee benefit deductions and every changing inflation rates.

 

When it comes to providing for retirement, overall confidence may not be high, but it is changeable. Decide what you would like to have, try out some online tools such as, retirement calculators, to get a feel for your  goals and sit down with a professional advisor to construct the best plan for you.

 

Kurt Rusch  CLU, ChFC