A new level of responsibility has been brought to light with further investigation of the fees that employees are being charged.   Regardless of validity of the accusations of inflated fees, the dialogue has prompted the Department of Labor to further regulate fees charged to employees in retirement plans.  Those new regulations detailed under Section 408(b) go into effect in 2012.  Those new regulations discuss fees that are charged to employees a great deal, but do not go so far as to say exactly what is too high.  As sometimes happens, the court system has taken that extra step.  For example The LA Times reported in October of 2010: District Judge Stephen Wilson said in an 82-page decision that Rosemead-based Edison (International) did “substantial” harm by failing to negotiate lower prices with the outside firm running the 401(k). A large company such as Edison easily could have gotten a better deal on three of the mutual funds in its plan, but simply didn’t try, the judge said.[i]

If you read the blogs that accompany many of the recent newspaper articles about retirement plan fees you get two views of the public’s perception.  First, those that say everyone should be charged the same fee as is charged for the lowest index fund.  Then there are those that say you have to compare apples and oranges, low price index funds don’t have the same reporting and administrative issues as investments inside of a retirement plan.  What do you think?  An employer must keep track of employees’ assets, make exchanges (between different fund families or even different types of investments), make deposits, make distributions, issues tax forms to some employees, is responsible for auditing the plan, keeps the retirement plan up with the most recent tax and labor laws,  and is responsible for the variety of investments available.  Can they charge the same fees as a mutual fund company that just collects money and makes distributions? 

So how do you know how much is too much?  There is no concrete answer to that question.  The best answer should be framed by what is called the “prudent man rule”.  The beginnings of the rule go back to a Massachusetts court in 1830, but the most modern version applicable here would be the Department of Labor’s version:

with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.

In today’s times, it would be prudent of an employer to compare their fees to other company’s of similar size and operation.  That does not mean that all companies should have the same retirement plan.  It does mean that employers should be able to show that they have made changes to the operation of their plan with the best interest of the employees in mind and in the business environment of that time.  No one should be expected to work for free.  But to the antithesis of that thought would be that no one should willingly allow employees to be overcharged.  Employers should create a record of their efforts and give a basis for their actions. 

Finally, it’s important for you as the reader to understand that this blog is intended to be general in nature.  It is not, investment, legal or accounting advice.    

 The average audience of this blog is individuals who are saving for their retirement and trying to plan for their family’s future.  If your main asset is the investments in your company retirement plan and your are trying to be a trader with that account, STOP.  There is a better way.  If you are an individual investor and you want to try your hand at trading stocks, by all means give it a go.  But give yourself some limits.  Years ago I had a retired elderly lady as a client that loved to watch CNN and trade stocks she heard about in the news.  Her husband had predeceased her and left her a tidy sum in municipal bonds that I helped her manage.  As time went by she began to liquidate more and more bonds to trade stocks.  After several losses we had a conversation about how much she was spending through trading.  She understood the risk and liked the idea of trading stocks.  In that respect, she was a “trader”.  To stabilize her cash flow, I suggested that she set some limits on how much she would obligate to trading.  If she made profits, that was great.  But if she had losses, she agreed not to dive into here municipal bond accounts to make more trades.  She would wait until she had the liquid assets to do so.  It is like walking up to a slot machine and putting in the change you have in your pocket.  If you lose, walk away.  Don’t empty your bank account to feed the slot machine.     

If you like trading, don’t try to do it with your company retirement account.  Be an investor with those funds.  That doesn’t mean to never sell an investment.  But set a strategy for your retirement savings that focuses on your long term goals.  ere Here is an approach that has worked for many investors over many years. 

1. Define your retirement.  Not all people see retirement the same way.  Some may never retire.  Some may want to travel.  Some may want to change careers.  There is no wrong answer.  Making a plan will give you more control over your life today and in the future.
2. Plan on how you are going to get to where you want to go. What will be your sources of income?  In all of your plans expect to be flexible.  Understand that in all that you do, the end result will be harder than you expected and it will probably take longer than you thought.  This doesn’t apply to just retirement planning but all of life!
3. Make an investment plan.  You know what you want, you know some of the sources to use, now plan on how to make your investments. What is your time frame?  What are the risks you will face?  How will you manage or tolerate the risk?
4. Check in at least annually to see how you are doing.  Early 20^th century humorist, Will Rogers, was in 71 movies and wrote over 4,000 newspaper columns in his life.  He knew how to plan and get things done.  He said “Even if you’re on the right track, you’ll get run over if you just sit there.”  Advice that will serve you well in planning your financial future.

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One thing that the SPD does not do is describe the investments, educate employees on investing and detail the fees that are charged to the plan participants.    Employers will usually have a variety of investment education material and/or a representative that will offer assistance to plan participants.  If fees are not detailed, ask for more information.  In coming months, employers will be required to be much more detailed with fees.  So don’t be surprised.  Remember investing does have a cost.

After highlighting the structure of their plan for these new 401(k) participants, my first advice was to determine how much they could save in their retirement plan.  If you don’t have a personal budget, it’s time to create one.   There are lots of ways to do it, from websites to software programs, personal financial planners or just as simple as creating a list of your income and expenses from you bank statement.  How much you spend monthly is referred to as your expenses, subtract that from your income.  What is left over is referred to your discretionary income.  New 401(k) plan participants should consider saving at least up to the limit of their company’s match on their retirement plan.  If you have a match contribution from your employer and you do not meet that match, you are leaving money that you can never get back.

I always advise first time investors to start small.  Usually you can increase your contributions quarterly.  You can always go to zero at any time. Just contact your payroll department within an administratively feasible time period to stop payroll contributions.  Remember though that you will not be able to start back until the next enrollment period.  When that is, is determined by your company’s plan.

Once a new retirement plan participant determines how much they want to save in their 401(k) plan, it’s time to consider how to invest.  Investing is a very individual topic.  Don’t run into paralysis from analysis!  If you don’t have enough time to determine how to invest your contributions, put them into your plan’s money market until you determine what is right for you.

Here are a few important tips on 401(k) money markets.  Most money markets are paying little to nothing in today’s economic environment.  Solely investing in a money market is usually not a core investment strategy for any long term retirement plan.  An exception to this would be if the investor did not want the volatility of variable investments and the money market was the only stable value option available.  FYI, if you are investing in a mutual fund money market, it DOES NOT have a guaranteed value.   Don’t be surprised if the money market option for your 401(k) has a negative return.  Some money market funds in 401(k)s are paying so low of a return that there is not enough interest to give a positive return after the plan’s fees.  The concept is that the money market has a relatively stable value (not guaranteed) that will give you time to determine what type of investments you would like to choose for the long term.   If you do not want the volatility of variable investments, consider any guaranteed options offered by your plan.   Note that guaranteed options may have different exchange rules so look carefully before making this selection.

In my next blog entry, I’ll look at the three types of investment strategies: do-it-yourself, having someone do it for you and self-help options.

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Often new regulations have unintended results.  With the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, businesses have a litany of new requirements to maintain their company’s 401(k), profit sharing or other qualified retirement plan.  Just like the song goes, “you got to know when to hold ‘em know when to fold ‘em”.  Law makers may not have intended this, but for some, maybe it’s time to fold.  Are you one of these employers?

The intent behind the reform that drove passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act had several motivators concerning company retirement plans.  Law makers were attempting to create clarity of all fees being charged to participants, clarity of fiduciary responsibilities and clarity of underlying investment products.  Noble as these efforts are, these new regulations that mandate more disclosure and responsibility will burden employers and that translates into more time and expense. 

So who needs to consider folding?  The new retirement plan regulations do favor and protect employees, and for the most part employers will tolerate the change and move on.  However, there are some 401(k)’s, profit sharing plans and other qualified retirement plans that are employee only plans.   Primarily these are retirement plans where the employer makes little or no contribution to the plan.  Employers can be reluctant to terminate non-contributory plans because they do offer employees a way to save on their own and can be a recruiting tool.  No retirement plan available at all can be a disincentive to prospective employees. 

But there is an alternative that may be a better fit for some. . . . such as a payroll deducted IRA.  I am not recommending a particular type of investment.  A payroll deducted IRA is a traditional IRA.  It has the same contribution and deduction limits.  The only difference is that the employer deducts the contributions from the employee’s income and forwards the money to the respective IRA plan. 

Payroll deducted IRA’s are not ERISA plans.  That means that the employer does not have the same fiduciary responsibilities of a regular ERISA retirement plan like a 401(k).   However it would be in the best interest of the employer to have a selection process that justifies the merit of the plan and the provider selected.    It would be advisable to select a vendor that has a payroll process in place.  If a vendor does not have business processing systems in place to accommodate payroll deducted IRA’s, it could end up being more of an administrative burden than the regular qualified plan.

There are pros and cons to payroll deducted IRA’s versus regular qualified plans.  For example qualified plans can allow loans where IRA’s cannot.  However payroll deducted IRA’s have no discrimination testing requirements.  That means less administration and cost.  This short blog is to let you know that there are alternatives and to encourage you to NOT just stop saving for retirement.  Remember that in today’s society fewer and fewer employers provide a complete retirement pension.  It’s up to the employees to plan for their futures.  Employers that can help employees save for their future will create favored places to work.   The payroll deducted IRA is a low cost alternative to help employers help their employees.

Paying off a mortgage early and saving later? 

Or paying minimum payments and saving now?

At times planning for retirement means finding ways to better spend your money rather than spending more money.  This week I was asked which would be better, putting more money into a retirement account or paying down a mortgage faster?  This is a good question that deserves elaboration.  Here is the set up:

From an original 15 year mortgage, the remaining balance is $110,000 at 5% with about 13 years left and the current principal and interest payment is $870 per month. ¹ Over the next 13 years $139,200 will be paid for this $110,000 loan.  If you doubled the payment, you could cut 7 years and 6 months off of the mortgage payment period and save $21,631 in interest.

But here is where the matter gets complex.  The interest is tax deductible but payments toward the principal are not.  For example over the next year the total mortgage payments will be $10,438.44.  But only the interest of $4,854.97 will be tax deductible.  The interest portion will decrease every year until the final year of scheduled payments the interest will be only $277.33.

FAST FACTS:

So how much money do you have to earn to pay the annual mortgage payment?  The amount of money a home owner has to earn to pay their mortgage goes up every year.  That is because the monthly payments remain constant.  The tax deductible interest goes down, how much a home owner has to pay in taxable income goes up.  To make the example simpler, let’s say the homeowner pays a flat 20% to income taxes.  Over the next year to pay that $10,438.44 mortgage payment, the home owner will have to earn $ 11,834.31.  In the last year of the loan when the interest goes down to $277.33, the homeowner will have to earn $ 12,979.22.

Knowing this puts us a step closer to understanding which is better: paying off the mortgage early and saving more later or paying the regular mortgage payment and saving more now.

If you click on the image below you can see the details of my findings.  But here is the bottom line.  Paying regular payments and saving now at that hypothetical 4% rate of return would require $184,079.62 of taxable income.  Paying off the mortgage early would only cost $162,449.12.  So that is a savings of $21,630.50.  That is pretty good so far for the paying off early column.

But what happened to the hypothetical savings account? In the savings now column the result was $180,030.37.  In the pay off early and save later column the result was less at $158,538.32 that is $21,492.05 less.

MORE FAST FACTS:

• Save Now & Pay Regular Payments
• $184,079.62 – $162,449.12 = $21,630.50
• Pay Off Early & Save Later
• $180,030.37 – $158,538.32 = $21,492.05

I would have to call this comparison a draw.  The Save Now & Pay Regular Payments scenario actually put $138.45 more in the homeowner’s pocket.  That is an amount so small that it’s not worth the effort.

This is the point where individual outside factors come into consideration.  For example if you are considering paying off a mortgage early to increase savings, a very important consideration is cash flow.  How readily available is the account you are putting money into?  Plus how will the value of the home you are paying for come into consideration?

If you are looking for ways to save more for retirement, the best recommendation here is cut your expenditures and save more.  Plus, if you have an older interest rate that is considerably higher than current rates consider refinancing at a lower rate and saving the difference.     

¹

Here is a good example.  I have a Section 529 education account that I started years ago for my now 18 year old son.  It’s May and he will be heading off to college in a few months.  That change brings the anticipation of some pretty big expenses.  I have a major portion of his 529 invested in domestic stocks.  So is it time to sell?  For what I am using in the next year, the answer is yes.

If you understand the logic I am using perhaps you can make better decision on when to sell your investments.    Let’s keep it simple.  I have invested in mainly U.S. stocks so I’ll compare my investment to a market index called the Standard & Poors 500.  Remember this is a list of the 500 largest companies in the United States.  The index is an unmanaged weighted average of their stock prices.  About a year ago on May 11, 2010 that index was at 1155.79.  On Friday, May 6, 2010 the S&P 500 Index was at 1340.20.  That is a 15.96% increase in about a year.  That is a respectable increase.  If you want to do the same analysis for a fund that you own, you need to see what market index most closely resembles your fund. 

In my case, I need a large portion of the value of my account within three months.  I have had a nice increase and I remember a saying I learned when I first got started in the investment business, “hogs get fat and pigs get slaughtered”.  If you are investing for a goal, and you have gotten close to that goal, you should sell.  I’ve had a nice increase in the past year, my goal is within sight.  Might I miss some increase in value?  Perhaps, but I could just as easily have a substantial decrease.  I have to remember that stocks and stock mutual funds are long term investments.  Look what happened in about a three month time period from April 23, 2010 to July 1, 2010.  The S&P 500 went from 1217.28 down to 1027.37.  That is a 15.60% drop. 

That is a good lesson to remember no matter what your time frame is.  Look at the worst returns for the market you are investing in as well as the best returns.  Risk is always a part of investing.  How you manage your risk will determine your success or failure.  You’ve heard this before, but it needs said again.  The past performance of an investment is no guarantee of its future performance.  You should be sure to read your investment prospectus to be aware of all fees and charges on your accounts before buying or selling.  And as always your comments and questions are welcome.

A great deal has recently been written about what a fiduciary is and their duties.  In a March 23rd webinar, Department of Labor, Senior Benefits Law Specialist, Mark Lurie stated “In general (a fiduciary is a)–position of trust, acting for the benefit of others with a high duty of care and loyalty.  (Under) ERISA – (it is) any person who exercises discretionary authority or control over plan assets or administration, or gives investment advice.”

Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act directed the Securities and Exchange Commission (SEC) to do a study of a universal fiduciary standard of care.  You can read the report of this study here: http://www.sec.gov/news/speech/2011/spch012211klctap.htm

This study was to analyze the standard of care the 1934 Securities Act (that dealt mainly with brokers) and the 1940 Registered Advisors Act (that dealt mainly with Registered Investment Advisors) was having on investors.  The focus was to see if a universal fiduciary standard of care would be beneficial to the public.  This next statement  may not do the entire debate justice, remember this is just a brief look.  But the question is boiling down to do the sales practices of a broker need to be done with the same standards of care that an Investment Advisor.  I will not take either side, but just say that the report really indicated that more study was needed.  It stated that “any rulemaking without such consideration would be ill-conceived at best and harmful at worst”.

 So where does that leave you with your company’s retirement plan?  Even though the SEC has not completed their study, the Department of Labor appears to be on track for implementation of their fiduciary standard of care rules on January 1, 2012. 

What should retirement plan sponsors do?  Contact your retirement plan service providers and ask when they will be providing disclosures mandated under ERISA 408(b)(2)?  Most plan vendors and service providers are still in the analysis phase of what to do.  But since the burden of information is upon the plan sponsor, that is you the employer, you should inquire to find out what is the timetable for reporting.  Since the rules are to go into effect at the beginning of the coming year, plan providers and service providers should have an idea of a time table for reporting by at least the beginning of the fourth quarter. 

This is an excellent time to really look at your retirement plan.  That is the entire idea behind these disclosures.  For the first time you may be looking at detail of the services you are paying for, the compensation you are paying, who is responsible for investment decisions and detail on record keeping fees and responsibilities. 

This will not be the last you will hear about fiduciary standards of care, it’s just the beginning and hopefully the consumer is the winner in the end.

408(b)(2) is issued by the Department of Labor and set to become effective January 1, 2012.  It’s possible that it may change somewhat before being effective, but it’s already been delayed once.  Planning for implementation within 2012 would be prudent.  Here are the highlights. 

 The regulation   requires employers that maintain retirement plans, such as 401(k)’s, provide written disclosures of investment and administrative cost related to their participant accounts.  This information must be provided prior to enrollment and on a continuing quarterly basis.

1. This is an employer responsibility not a vendor responsibility however employers must rely upon vendors to provide information. 
2. The fee disclosure must be provided to employees on each investment option available in a uniform comparative chart.  The DOL has provided a model chart.  You can see that chart at: www.dol.gov/ebsa/participantfeerulemodelchart.doc

 There is a lot more specific information that is required for the fee disclosure.  You can see the details in the model chart referenced above.

 Compensation disclosure is only one part of the new regulations coming.  Two other significant changes are services disclosure and fiduciary status.  The service disclosure is a good thing.  Employers will have in writing what they should expect from their service provider along with how much they are paying for those services.