Figuring Out Your New 401(k)

It just happened to be the end of 2013 when I was riding bikes around town with my friend Anna. She was heading to grad school after living and working in Jackson for a couple of years. Being the nosy finance nerd I was pestering her with questions about her student loans, current salary, expected salary range and her past job benefits (being a helpful and caring friend I was also giving her my best advice on these matters too!). He old job had a 401(k) plan with a generous match and I was relieved to hear that she had been contributing at least enough to get the full employer contribution. She knew that it was important to save for retirement and knew to take advantage of the benefit.

"Yeah, the stock market scares me though, so I have it in what they said was the most safe option. I think it is called a money market."

Cash.

She had her whole 401(k) in cash in a stretch of time when the S&P 500 returned over 50%! Even a moderate, can't go wrong choice, balanced fund returned 14% in 2012 and 21% in 2013! If she had invested her money, her $200/month savings could have grown to over $6,000 instead of being just $4,800. This would have been an amazing return for such a short time.

This just happened to be a time with particularly high returns. Other stretches of time and other investments would produce different returns.

Retirement is the biggest financial decision most people will make. In recent history, employers have typically provided some sort of mechanism for people to have income or assets after they finish their careers. With people living longer and longer these days, employer sponsored retirement plans have become more and more important, although unfortunately, they have become more and more rare too.

WHAT IS A 401(K)?

The 401(k) is a type of plan known as a deferred compensation plan. It is called this because you are deferring income from your current paychecks until later - hopefully until you retire. Essentially it works like this:

1. You decide an amount of money that you want withheld from your paycheck. Sometimes you can choose if you want this deferred before you pay taxes on it or after.
2. This money is withheld and placed in an account for you.
3. Your employer may or may not add a contribution on top. Typically contributions are matching contributions up to some percentage of your pay, but can also include flat contributions or profit sharing contributions.
4. The money in the account is invested according to to your instructions.
5. Money accumulates as you work.
6. When you retire, you have essentially free access to the money.

If you deferred the income before you paid tax on it, when you withdraw it in retirement, you will owe taxes on it like income. If you did post-tax contributions, also known as Roth contributions, you will never owe taxes on it again.

There are also some limits to the amount of income that you defer into your 401(k) each year. For 2016, you can defer up to $18,000. You can never contribute more than your income. These limits may change from year to year so if you are looking to max out your contributions, check with your HR or the IRS about your limits.

There are a few key considerations to make when starting with a new 401(k), this should help guide your decisions. Also, for the record, there are a bunch of different names to retirement plans at work, I will just use the term 401(k) liberally and generically to cover defined contribution plans. These may include Roth 401(k)s, the TSP, SIMPLE IRAs, 457(b)s or 403(b)s or others.

HOW MUCH SHOULD I CONTRIBUTE TO MY 401(K)?

All of it.

Contribute as much as you can.

As a rule of thumb, you need to save somewhere between 16 and 20% of your income to fund your retirement. At 16%, saving and investing over a 40 year career will result in a balance that can support your likely expenses in retirement.

If 16% is too steep for you right now, here is how to get started: Take advantage of any matching contributions your employer makes. It is reasonably common for employers to make a matching contribution of some sort. This can take many shapes, but is generally a match up to a percentage of your income. If you company says they offer a 3% match, that means that if you defer 3% of your income, they will contribute another 3% on top. If you defer 4% or more, they will stick with the 3%, but id you defer less, they will match your lower contribution.

So, take advantage of the employer match.

Next you need to save more tomorrow. Every time you get a raise, defer a little bit more into your 401(k). If you get a 2% raise, split the gain - increase your contribution 1%. Even if you didn't get a raise, look at your budget annually and serif you can afford to raise your contribution. One feature that a lot of plans are starting to offer is that they will raise your contribution for you automatically every year. Automation in the 401(k) industry are excellent behavioral tools for saving that you should take advantage of.

Target deferring 16% of your income, but don't hesitate to keep climbing.

Once you have worked your way up to the basic target of 16%, you can start aiming higher. The more aggressive you get with your saving, the earlier you can retire. Early retirement is the dream, right? I ran the numbers and if you save 20% of your income, 35 years of work should support a comfortable retirement. Saving 33% will bring that down to 25 years of work. If you save 50% of your income, you only have to work about 16 years to retire with enough money to cover your expenses! These numbers are really loose, obviously, as it depends on how much you plan on spending in retirement and other costs not being considered, but that is the general idea - if you save more, you can meet your financial goals faster.

All that being said, the percentage to save is independent of the vehicle. If your 401(k) is not actually that good, it may make sense to save in a personal IRA or a taxable account for the same purpose. That is a topic for another chapter, however.

HOW DO I INVEST MY 401(K)?

The 401(k) is many peoples first experience with investing. They are handed what is called a plan menu and told to select some investments that match their investor profile. If you have never invested before, you probably don't know what any of that means. You may have heard of the tradeoff between risk and reward, and your 401(k) paperwork may indicate that as well. The basic idea is that higher returning investments are more volatile in the short run. So while stock investments may give you 8% returns over ten or more years, they do have the risk of significant loss in any given month or year. Bonds, on the other hand, may only promise to return 3%, but won't fluctuate in value quite so much from month to month or year to year.

Your plan menu is a list of investments available in your 401(k). There are a few different types of funds available.

• Stable Value or Money Market funds. These are basically cash.
• Fixed Income. These are funds with bonds of various types. They may contain US Government Treasury bonds or corporate bonds but the idea is that they will all pay interest to you and a supposedly reliable pace. A much deeper dive for a different day reveals that this is not the case when they are pooled into funds.
• Stocks. These may be divided up into US and International funds. Or maybe divided by size and shape. Stocks are shares of companies. The value fluctuates with the successes and failures of the company. Funds can be either actively managed by someone trying to pick the companies with the best future, or can be a passively managed index fund, just keeping track of a basket of stocks without much interference or cost.
• Balanced Funds. A mix of the other types of funds.
• Target Date funds. These are a special flavor of balanced fund that adjusts as you age. They typically have a retirement year in the name. They start off with aggressive, risky investments in stocks to drive return when you have a long time to grow, and get more conservative moving to bonds and cash as you retire.

Target Date Funds are usually an acceptable default option. Just pick one that matches up with when you think you will retire and call it a day. If you have a little more experience or are working with an advisor, you might want to assemble a portfolio of low cost index funds that are appropriate for the long term nature of the 401(k). Generally speaking, the longer before you need the money, the more aggressive or risky your investments can be. The closer to retirement, the higher proportion of bonds and cash you want in your portfolio.

WHAT IF I CHANGE JOBS?

If you leave your employer, you will no longer be able to contribute to their 401(k). Each 401(k) is tied to both the individual and the company. You have a few options once you move on. This where vesting comes into play. If your employer has been making contributions, particularly if they have been making profit sharing contributions, you may not be entitled to parts of those. Some employers will contribute to your 401(k) but have a vesting schedule dictating when the money becomes yours. Typically this is done over a period of 5 years. This is not the case with every employer, and the money you contribute form your paycheck is always yours.

The worst thing you can do is take all of your money out and spend it. Even if you don't spend it, you will owe income tax and possibly an early withdrawal penalty of 10% if you take the money out. Don't do this.

If you have a 401(k) with your new employer, you may be able to roll your old 401(k) into it. This makes sense if you knew plan has good, low cost investments that are the best for your situation. As this is rarely the case, the last, and often best option is to roll your 401(k) into a personal IRA.

Roll your previous employer's 401(k) over into a personal IRA. This is the best option if you can invest the money better in a personal IRA than you can in the old 401(k) or your new 401(k). If you already work with an advisor, they would likely be able to manage that for you as well. There are a lot of options here, but 401(k) providers typically have a very limited slate of investments and you can find a more complete, lower cost account elsewhere.

OK, I'VE GOT IT. CAN I FORGET IT?

Hopefully! The idea with 401(k)s now is that you can set them uno and forget them. You can set your contribution to automatically raise up to your target savings rate and you can set investments to rebalance to your original allocation periodically. All of these tools mean that without a major change in your situation, your account will be adequate without any more input from you.

But that isn't quite right. I advice people do a deep dive into their personal financial situation at least once a year and the 401(k) is an important part of that deep dive. If you have not had a major change in your life, won the lottery, lost all of your worldly belongings or planned a retirement party for yourself, you probably will not need to make any changes, but here are a few things to look at in an annual review:

1. Are you contributing enough? Are you hitting the 16% target? Can you contribute more?
2. Have the investments changed in your plan? Plan menus do change, if an old option is not available, search for the next best alternative. If your plan had target date options, it is unlikely that these have changed without keeping you up with the times.
3. Do the investments work with your total portfolio? You cannot view your 401(k) in isolation. It is an asset like your other assets and needs to be viewed in that context. Say you have $100,000 in your 401(k) and $100,000 in outside investments and your overall allocation, based on your needs and risk tolerance, is 50% stocks 50% bonds. If both accounts are 50/50, fine, but if your outside investments are all stocks, then your 401(k) should be all bonds.

BUT WAIT, I DON'T HAVE A 401(K)!

Slow down.

You read this whole post knowing that it was completely irrelevant to your life? Thank you for the views! Please share!

As I said, retirement is the biggest financial decision that most people will make. It is important that you prepare for it and by prepare I mean save money. Self employed workers or people just not covered by a 401(k) or other retirement plan at work have a few options to avail themselves to.

Self employed workers can save in a SEP IRA. This is useful as it allows you to defer as much income as a W-2 employee gets to defer, PLUS what the company could add.

If your company just does not have a plan, you can open a personal IRA. This can either be a Traditional IRA that is Pre-Tax or a Roth IRA that is post tax. For younger worker and people who will face a higher tax bracket in the future, the Roth is the best deal going in tax avoidance. While you pay taxes on it now, while you have a low tax bracket, you will never pay taxes on it again, even when it has grown and you withdraw it in your wonderful golden retirement.

So there you have it, retirement is a big decision, and it is important that you face it prepared. There are a number of tools available and the 401(k) is fast evolving to be one of the best tools you may have. There are a lot of features and facets to consider, to be careful and work with a professional if you have any questions. Most importantly, however, save!

Driving Economic Development the Tate Reeves Way

There are differing schools of thought on how a State Government can best to drive economic development. One way is to put together incentive packages to attract specific businesses. These make great headlines and fill everyone with excitement over the future. It is fun to add incremental revenue to GDP projections and make graphs point more skyward than they did before! This requires the government to select projects to invest in and offer enough to industries to come make an investment. The downsides have been apparent through the years as companies structure themselves to take advantage of the incentives without committing to permanent presence and investment. Secondary and tertiary benefits do not always appear as advertised. Lieutenant Governor Reeves admitted that this was a common "done" approach around the country, but was not the ideal approach. It appears that for the country, this is partly a zero sum game as states compete against each other for the same companies.

Our Lieutenant Governor Tate Reeves belongs to a different school of thought on economic development. In his words:

Our number one priority is job creation, bringing better and higher paying jobs to our state. But I also  have a political philosophy which says Government does not create jobs. Government's role is to create an environment which encourages those of you in the private sector to invest capital and create jobs.

Mr Reeves believes that a fiscally conservative government is the first step to increasing economic growth in our state. The idea is that a fiscally irresponsible government now means a higher taxes in the future to pay for current mistakes. This is fairly uncontroversial, but of course, the implementation is where philosophies can differ again.


The second thing that he addressed was having a tax code that is fair, flat and encourages economic development, not discourage. he spoke about eliminating taxes like the inventory taxes and corporate franchise tax. He believes that this will reduce costs to business owners thereby making Mississippi a more attractive environment for businesses and making our existing business more competitive in the region.

He did note that Mississippi will eliminate the lowest tax bracket, effectively saving all Mississippi taxpayers $150 if they had more than $5,000 in income.


Thirdly, we must improve the educational attainment level of citizens of the state of Mississippi. Whatever your political beliefs, you must agree with this point. While there are many approaches to HOW to improve attainment, the great thing is that education is a fairly rigorously measured thing anywhere, so it should not be difficult to tell if we are making progress or not. Here  Lieutenant Governor Reeves and I agree fairly well at the top level. He repeated that one of the core functions of government is to provide public infrastructure, and I believe that education is one of the most important public infrastructures that a government can help provide.

There are a few methods that the state is currently using to improve education in our state. He spoke most proudly about the requirement for students to be able to read on a 3rd grade reading level before passing third grade. The importance of this should not be understated. Third grade was selected as one should be functionally literate for the classes beyond that grade. If a student cannot read at a third grade level, they will struggle in all other classes beyond that point. This was not an unfunded mandate, he pointed out, as the state spent $50 Million dollars on reading coaches and other resources for teachers and students alike. To back this up he also spoke of the Early Learning Collaborative programs that the state provided $9 Million of matching funds for local early learning solutions.

Without citing how many students were able to read on a third grade level before the act, he said that 95% of Mississippi students were passed this new level in the second year that the requirement was in place. It is impressive what the state can accomplish in education when they dedicate the resources to a specific goal.

He also mentioned school choice and the introduction of charter schools, but again, it is too soon to have enough data to talk about.

In his tenure as Lieutenant Governor the state has eliminated 13 school districts through consolidation. In one extreme case, a school district with only 120 students had a superintendent that was paid $128,000. With consolidating school districts, schools get access to a bigger pool of resources and hopefully can reduce administrative costs overall. While consolidation clearly has limits as the public school board movies further from the community, there may be some benefits. It is too soon, he said, to have data here. Again, there is clear potential for growth in achievement here, but it depends on what actually gets done in the classroom.

One important theme with improving results while not spending more is spending resources in a more creative way. One example is career track education. More career track education has helped improve graduation rates from 72% to 80%.


Overall it was fairly positive being able to listen to the Lieutenant Governor speak. While he did not really reveal anything groundbreaking, he was very clear and positive on progress made and being made. Reeves has had 13 years in public service since first becoming Treasurer and there is always speculation that he is aiming higher. To that - a couple of people did keep calling him "Governor Reeves" an amusing slip of the tongue that may presage more.

Check out the full audio of his statement on our Soundcloud below!

#TBT "Approaching retirement? It's a scary world"

Our topic this week is the 401(k). (Not $401k...) The 401(k) is a retirement savings account which gets it's name from a section of the tax code: Section 401. I'll let Nancy explain the plan in her 2005 column. Enjoy!

It's a scary world out there for someone approaching retirement. Lay-offs and forced early retirement, corporate scandals and disappearing stock value, shrinking pension benefits, and, now, a Social Security system heading for hard times. What's a body to do?

The most valuable asset anyone can have is their ability to work and earn a living. For those who are already retired, the scariest thing is knowing there are no more paychecks to be had. Whatever you generate must come from assets you have built up through a lifetime of saving and investing. What if you didn't save enough? What if you picked the wrong investments? What if rising healthcare costs eat into your stash? What if inflation skyrockets and leaves your earnings in the dust? It's a scary world out there.

In 1950, General Motors started the first pension plan for its employees. The idea was simple. GM would set aside a certain amount for each employee, investing it, and adding to it until the employee retired. Upon retirement, the employee would receive a monthly check from GM until his death. Company loyalty was rewarded with guaranteed payouts in your old age.

Taking the risk

Sometime in the 1970s, companies started offering 401(k)s and profit-sharing plans. As an employee, you would set aside money from your paycheck, choose investments, and add to it until retirement. Upon retirement, whatever had accumulated in your account is what you had to live on in your old age. This change marked a shift in risk. In the old plans, the employer took all the risks. In the new plans, the employee took all the risks.

When the employer was shouldering the risk, there was a need for some sort of protection. So, the Pension Benefit Guaranty Corporation (PBGC) came into being. This is a government agency, which acts as an insurance company on pension plans. Should a company go bankrupt, PBGC would step in to cover those guaranteed payments to employees. This seemed like a no lose proposition.

Then, times changed. The steel industry went through hard times, and, time and again, the Pension Benefit Guaranty Corporation was called on to fill the gap. Tough economic times combined with tough times in investment markets leave many pension plans in a pickle. The latest company to fall back on PBGC is United Airlines. PBGC has $39 billion in assets, but now owes over $62 billion in benefits to 1.1 million people. Although United States retirees will continue to receive a check thanks to PBGC, many are finding that check reduced considerably.

Getting the opportunity

Many old line companies offer both types of plans, but newer companies only offer 401(k)s or profit-sharing plans. There are no guaranteed payouts, only an opportunity to save and invest at will. As scary as the situation is with the old pension plans, academics are concerned about employee behavior with the new plans. When those employees retire who only have a 401(k) and Social Security to depend on, will it be enough? Will those employees cry foul, saying the didn't know enough to handle the risk thrust upon them?

In studying employee behavior in these plans, research has found most people to be lacking in knowledge. The average contribution rate is only about 4%, a rate which will leave many in poverty at retirement. Also, most adopt a fund selection strategy called conditional naive diversification. No matter how many funds are offered within a plan, employees, on average, select three or four funds. That may not be so bad. Any more than that can be difficult to track, but most employees simply divide their contribution evenly among all chosen funds. If you select four funds, you tend to allocate 25% to each fund. Here's something interesting researchers have found... if you select only three funds, the math is not so easy (100% divided by three), so, instead employees put more in one fund, then divide the rest equally between the other two. So much for a reasonable allocation among cash, stocks and bonds based on time horizon and risks. Just split it up evenly and run with it.

We also know that few people change their original allocation. They rarely adjust to accommodate changing markets or their own aging. They're just not paying attention. Also, if company stock is offered within the plan, employees consider that separately. They don't even think of that in light of the allocation to other funds. It's just something extra.

Enron and WorldCom employees know the danger of depending on company stock too heavily. Should the company disappear, your retirement goes down the tube. That may not be so horrible if you're 30 when it happens, but what do you do when it happens at age 50? Throw in the solvency problem with Social Security, and we're back to a scary world. What should you do?

Words of wisdom

The best thing is to follow the old adage, "Don't pull all your eggs in one basket." Don't give up on those pension plans, but invest outside of them, as well. Invest in your company 401(k), but do it wisely. If you need help, find an advisor. Give your plan an annual check-up to make sure it's doing what you want it to do. Don't load up on company stock. Invest outside of retirement plans, too. Add to regular savings on a disciplined basis. Save and invest like you'll never draw another paycheck. One day, that will be the case.

And last, but not least... don't factor in Social Security. Think of it as icing on the cake. If it doesn't come through, you won't go hungry.

--Nancy Lottridge Anderson, Mississippi Business Journal, May 30 - June 5, 2005

#TBT 2005 Newsletter Volume 41

Last night, we witnessed a once in a lifetime event. The Cubs won the World Series. Even people who don't follow the sport - namely me - tuned in to watch the game unfold. My Twitter feed conveyed all the nail biting stress of fans in the best way possible, through memes, gifs, and hilarious commentary; so I closed my laptop, turned on the television, and watched them play ball.

The night wore on, and I switched the lamp by my bed off but stayed up, tucked in bed waiting to see if a century-year-old curse would be broken. On top of that, I wanted to be sure I was awake in the event of the Apocalypse.

I didn't see the world end, but I did look on as the Cubs made history. After I watched a couple of players be interviewed on the field, I switched off the TV and fell asleep feeling happy for no particular reason. I hadn't been a Cubs fan - or a baseball fan - but there's something magical about an event like last night's game. It's hopeful.

This week, our topic has been retirement - saving for retirement. Saving for retirement isn't impossible. We just have to make it a priority and make use of the magic of compounding.

Today's throwback takes us back over a decade to 2005. Nancy sent out a newsletter cautioning young people to make saving for retirement a priority. She noticed the fragility of Social Security and warned those in the younger age range not to include a dependency on Social Security in their retirement plans. The system would need to be fixed somehow if it were to last for them.

It seems dire. It seems particularly pessimistic if you can't imagine a solution to the problem. But, last night should serve as a reminder: a century long curse can be broken. Anything is possible. The Cubs just won the World Series!

Enjoy our throwback!

I'm on the backside of my 40s. In my mind, I'm still 29, fit and youthful and ready to take on the world. Of course, when I get out of bed in the morning, my bones remind me they've seen a little more wear and tear than the average 29 year old.

I'm slathering on more cold cream these days and reading books on anti-aging techniques. I look for senior citizens who can be role models, those who are still active and healthy well into their 70s and 80s. I watch geriatric specials, looking for the key to health and longevity. Meanwhile, I sit and wait for my AARP card.

I'm not sure how I'll feel when it appears in my mailbox. I'll love the discounts. I'll appreciate the access to services and the opportunity to be a part of a powerful lobbying group. But really... I can't be that old. Then, I get my latest Social Security statement. I'm closer to collecting benefits, and I know that, if any younger, my hopes of getting anything out of this system would be nil. And then I think of the magic of turning 65 and being eligible for Medicare. You know, being a senior citizen might not be so bad!

Social Security is up for grabs. There's no doubt the system needs a shot in the arm, but the sky is not falling... yet.

Those over 55 need reassurance their benefits are secure. After all, it's a little late in the game to prepare for anything less. Despite this, the upper earnings group may face an adjusted formula on the taxation of their benefits.

For those of us still years away from retirement, Social Security should be an afterthought. Yes, it's part of the mix, but we shouldn't bank on it too heavily. The system was meant to be a cushion (a small one at that).

Younger people should focus on building up employer plans, using Roth and Traditional IRAs when possible, and learning to live within their means as they prepare for their golden years. Plan for no Social Security. If the system survives, you'll be that much better off.

As for privatization... it won't fix the cash flow problem. To keep this going, benefits must be cut and/or taxes must be raised. There is no other way around it. So prepare, and don't worry about getting old. When it comes to Social Security and Medicare, the sooner the better!

--Nancy's New Perspectives Newsletter, Volume 41, March, April 2005

"Social Security is a little like putting quarters into a nickel slot machine."