Read MONEY Master the Game: 7 Simple Steps to Financial Freedom Online
Authors: Tony Robbins
BULL’S-EYE!
Now we have a chance to combine all we have learned! By now you have decided to set aside a percentage of your income, and that may very well be in your 401(k).
You want to make absolutely sure that your 401(k) has the lowest possible fees and low-cost index funds.
You can see how your company plan fares by using the Fee Checker on America’s Best 401k (
http://americasbest401k.com/401k-fee-checker
). Once again, if you are an employee,
you should make the company owner (or management) aware of their legal responsibility to provide the most efficient plan available and that they are at risk of getting into major hot water with the Department of Labor. If you are a business owner, you are legally required to get the plan benchmarked annually, and America’s Best will provide a complimentary benchmark; simply take two minutes to fill out this online form:
http://americasbest401k.com/request-a-proposal
. Here is the great news: the typical small plan will save $20,000 per year in fees alone. Bigger plans will save hundreds of thousands, even millions, over the life of the plan, all of which goes directly back to the employees and the owner’s personal retirement plan as well.
SEVEN FREQUENTLY ASKED QUESTIONS
Stick with me here. We’re about to start putting ideas into action. These are the seven most common questions that come up in the context of 401(k) plans and IRAs and how to best utilize them. Here we go!
1. SHOULD I PARTICIPATE IN MY 401(k)?
To the extent that your employer matches your contributions, you should certainly take advantage of your 401(k), as the company is essentially covering the taxes for you.
And if you think taxes are going up, checking the box so that your contributions receive Roth tax treatment is the way to go.
(A quick side note: the 401(k) plan itself might be insanely expensive and the investment options poor. If that is the case, you may not want to participate at all! To determine how your company’s plan stacks up, go to
http://americasbest401k.com/401k-fee-checker
and click on Fee Checker to assess your company’s plan.)
Just to be clear, if you check the box to make your contributions Roth-eligible, you will still be investing in the same investment options (or list of funds), with the only difference being that you will pay taxes on the income today. But your future nest egg will be completely tax free when you withdraw. Retirement expert Dr. Jeffrey Brown of the University of Illinois gave me his take on his own personal finances. “I’d take advantage of every Roth opportunity I can because . . . I’ve spent a lot of time looking at the long-term fiscal outlook for the United States, and you know I am a pretty
optimistic guy, on the whole. But I have to tell you that
I cannot envision any situation in which our need for tax revenue in the future is not going to be higher than it is today.”
Taking it one step further, Dr. Brown has personal guidance for his younger students: “Absolutely pour as much money as you can into that Roth because you’re going to be paying little or no taxes on it, and then someday you could have the greatest income ever.”
If you are one of the few that thinks taxes in future will be lower, you could be in for a huge surprise. “Conventional wisdom” says we
should
be in a lower tax bracket when it comes time to retire, as we won’t be earning as much. But in reality, our home is often paid off (so we don’t have any mortgage deductions), and the kids are long gone (so we don’t have any dependents).
Finally, you might be self-employed and think that all this 401(k) talk is irrelevant. Not so! You can start a Solo 401(k), which is a 401(k) for an individual business owner and his or her spouse.
2. WHAT IS A ROTH 401(k), AND HOW CAN I USE IT TO MY ADVANTAGE?
I said it before, but it’s worth repeating: most of today’s 401(k) plans allow you to simply “check a box,” and your contributions will receive the Roth tax treatment. This decision means you pay tax today, but you never pay tax again!
3. SHOULD I SET UP A ROTH IRA?
Yes!!
You can set up a Roth IRA account and contribute $5,500 per year ($6,500 if you’re 50 or older). You can even do so if you are already maxing out your 401(k) contributions. Opening a Roth IRA is as simple as opening a bank account. TD Ameritrade, Fidelity, and Schwab are three firms that make the process incredibly simple. You can do it online in less than ten minutes.
4. BUT WHAT IF I MAKE TOO MUCH MONEY FOR A ROTH IRA?
Sadly, you cannot contribute to a Roth IRA if your annual income is over $114,000 as an individual or more than $191,000 for a married couple (for 2014). But don’t fret, regardless of how much you make, you can still participate in a Roth 401(k). And if you have an IRA, you might want to consider converting your IRA into a Roth IRA, but know that you will have to pay tax today on all the gains.
5. SHOULD I CONVERT MY TRADITIONAL IRA TO A ROTH IRA?
Let’s say you have an IRA with $10,000. The government will allow you to pay the tax today (because it needs the money), and you will never have to pay tax again. This process is called a Roth conversion. So if you are in the 40% bracket, you would pay $4,000 today, and your remaining $6,000 will grow without tax, and all withdrawals will be tax free. Some people cringe at the idea of paying tax today because they view it as “their” money. It’s
not
! It’s the government’s. By paying the tax today, you are giving Uncle Sam his money back earlier. And by doing so, you are protecting yourself and your nest egg from taxes being higher in the future. If you don’t think taxes will be higher, you shouldn’t convert. You have to decide, but all evidence points to the hard fact that Washington will need more tax revenue, and the biggest well to dip into is the trillions in retirement accounts.
6. WHAT ABOUT MY OLD 401(k) PLAN(S) WITH PAST EMPLOYERS?
Older plans can either be left with a previous employer or “rolled over” into an IRA. One would leave it with an old employer only if the plan itself was low cost and had favorable investment options. By rolling over the plan into an IRA (it takes about ten minutes online to move the funds from your former plan to a third-party IRA custodian like TD Ameritrade, Schwab, or Fidelity), you will have greater control. You can invest in nearly any investment, not just a limited menu it offers. And with this great control, you will
be able to hire a fiduciary advisor and implement some exciting strategies and solutions we will review in section 3. With a fiduciary advisor, you don’t pay commissions. You pay for advice. And it’s typically 1% or less of your invested assets, and remember, you might be able to deduct it from your taxes.
Second, by rolling over your old 401(k) into an IRA, you will then have the option to convert an IRA into a Roth IRA.
7. WHAT ELSE CAN I DO IF I AM MAXING OUT MY PLANS AND WOULD LIKE ADDITIONAL OPTIONS TO SAVE?
Small business owners that are making a lot of money and want to reduce their taxes today can benefit greatly from the addition of a
cash-balance plan
on top of their 401(k) plan.
Cash-balance (CB) plans are the fastest growing of the defined benefit pension plans and could overtake 401(k) plans within the next few years, according to researchers at Sage Advisory Services, a registered investment advisory firm headquartered in Austin, Texas. In fact, over one third of Fortune 100 companies have adopted a cash-balance plan. So what is it? A cash-balance plan is basically a pension plan. In other words, the amounts deposited are earmarked to provide the business owner with future retirement income. So what’s the biggest draw? For a high-income business owner, not only can she max out her 401(k)
and
a profit-sharing plan, but she can also add a cash-balance plan, which creates some very large, fully deductible contributions. On
page 156
is a table showing the possible deductions.
Money Power Principle 2. One of the most important Money Power Principles is “You get what you tolerate.”
Don’t tolerate having your money in a plan that is siphoning off fees to the benefit of someone else. And we have to remember that the 401(k) is only as good as what’s inside it. Turn the page and discover the next myth. Because the most popular place for people to put their 401(k) money is one of the most misunderstood investments of our time.
6
. There are different rules for a Roth IRA and a Roth 401(k). According to the IRS: “If you were age 50 or older before 2014, and contributions on your behalf were made only to Roth IRAs, your contribution limit for 2013 will generally be the lesser of: $6,500, or your taxable compensation for the year.” See “Publication 590 (2013), Individual Retirement Arrangements (IRAs),” “Roth IRAs,”
www.irs.gov/publications/p590/ch02.html#en_US_2013_publink1000253532
.
CHAPTER 2.6
MYTH 6: TARGET-DATE FUNDS: “JUST SET IT AND FORGET IT”
I am increasingly nervous about target-date funds with each passing day.
—JACK BOGLE, founder of investor-owned Vanguard
When you are looking at your 401(k) investment options, do you ever wonder just how they came up with that list? Or why your spouse or best friend who works across town has an entirely different menu of choices?
As the saying goes, always follow the money.
YOU GOTTA PAY TO PLAY
In the world of mutual funds, the common practice of sharing in revenues is known as pay-to-play fees. According to the Watson Towers worldwide consulting firm, approximately 90% of 401(k) plans require pay-to-play fees in exchange for placing a mutual fund as an available option on your plan’s menu. These pay-to-play fees virtually guarantee that the client (you and me) gets a limited selection and will end up owning a fund that proves profitable for the distributors (the broker, the firm, and the mutual fund company). Said another way, the “choices” you have in your 401(k) plan are carefully crafted and selected to maximize profits for the vendors, brokers, and managers. If one has to pay to play, they are going to want to maximize their profits to recoup their cost. And target-date funds, sometimes called
lifecycle funds,
may just be the most expensive and widely marketed creation to make their way into your plan’s investment options (with the exception being Vanguard’s ultra-low-cost versions).
DO TARGET-DATE FUNDS MISS THE MARK?
Despite being the fastest-growing segment of the mutual fund industry, target-date funds (TDFs) may completely miss the mark.
The pitch goes like this: “Just pick the date/year in which you will retire, and we will allocate your portfolio accordingly [the Golden Years 2035 fund, for example]. The closer you get to retirement, the more conservative the portfolio will become.” I am sure you have seen these options in your 401(k), and statistics would say that you are likely invested in one.
Here is a bit more about how they
actually
work.
The fund manager decides upon a “glide path,” which is the fancy way of describing its schedule for decreasing the stock holdings (more risky) and ramping up the bond holdings (traditionally less risky) in an attempt to be more conservative as your retirement nears. Never mind that each manager can pick his own “glide path,” and there is no uniform standard. Sounds more like a “slippery slope” to me. Then again, this is all built on two giant presuppositions:
1. Bonds are safe.
2. Bonds move in the opposite direction of stocks, so that if stocks fall, your bonds will be there to protect you.
As Warren Buffett says, “Bonds should come with a warning label.” And since bond prices fall when interest rates go up, we could see bond prices plummet (and bond mutual fund prices, too) if or when interest rates go up. In addition, numerous independent studies show how bonds have strong “correlation” in bad times. Translation: stocks and bonds don’t always move in opposite directions. Just look at 2008, when bonds and stocks both fell hard!
The marketing message for target-date funds is seductive. Pick the date, and you don’t have to look at it ever again. “Set it and forget it.” Just trust us! We’ve got you covered. But do they?
ONE GIGANTIC MISUNDERSTANDING
A survey conducted by Behavioral Research Associates for the investment consulting firm Envestnet found that employees who invested in TDFs had some jaw-dropping misconceptions:
•
57% of those surveyed thought they wouldn’t lose money over a ten-year period.
There are no facts to support that perception!
•
30% thought a TDF provided a guaranteed rate of return.
TDFs do not give you any guarantee of anything, much less a rate of return!