Employees Can Now Sue Over 401(k) Accounts – Is This a Good Thing?

From Financial Planning Magazine’s website comes this little news story:

Employees can now sue over mismanagement of their 401(k) accounts to recover their losses after the Supreme Court reversed a ruling on Feb. 21 the lower courts made more than 20 years ago.

In the unanimous opinion, Justice John Paul Stevens wrote that the landscape of retirement investing has changed since the earlier ruling and that this decision should give employees the right to sue over administrative problems with their accounts. “Fiduciary misconduct need not threaten the solvency of the entire plan to reduce benefits below the amount that participants would otherwise receive,” Stevens said.

Employment law experts say the ruling, which states that the Employment Retirement Income Security Act allows individual account holders to sue plan administrators for violating their fiduciary duties, leaves important questions unanswered. The court’s opinion did not disclose steps that must be taken prior to taking employers into court, such as appealing to the plan administrator.

I have a feeling that this going to cause lots of problems. For one, I can see it scaring employers away from offering a 401(k) plan in the first place. Second, I can see employee’s choices of funds being limited due to the employer’s fear that the employee may pick the wrong fund or put too much m0ney in one particular fund and end up suing the employer if things don’t work out. I can just hear all the future lawyer advertisments!

Of course there are times when pure neglect on the employer’s part should be addressed. For instance, there was an example in a recent Wall Street Journal article ($) of a guy who sued his employer because they didn’t make the changes that he requested to his account, which he says led to a $150,000 loss. What’s confusing about this is that the employee says he made requests for changes in 2001 and 2002 and the company didn’t follow through. I wonder why the employee didn’t follow up?

Anyway, I agree that companies should offer solid 401(k) plans to their employees and that any and all fees should be transparent so that the employee can see what’s going on with their money. These 401(k) plans should offer low-cost investment choices across all the major asset classes and employees should be required to take an asset allocation class and should also be required to sign an investment policy statement.

So, now it’s your turn to weigh in. What are your thoughts? I bet Jeremy has something to say about this!

Retirement Planning & Taxes: New Questions

Tax diversity has become a more common discussion among personal finance experts in recent years. This is due not only to the plethora of tax-free, tax-advantaged, and taxable investment options that people have today, but also to the uncertainty of our future tax system.

This is a topic I haven’t thought much about, because the answer has always seemed obvious. I am young and in a low tax bracket; I also intend for my income to rise over the course of my life, even through retirement. I also happen to believe Congress will eventually be forced to increase tax brackets accross the board if we’re going to keep piling on the entitlement promises(which it seems inevitable that we will). Because of all this I really don’t think my tax bracket will ever be lower than it currently is.

So because I qualify for a Roth IRA contribution and am offered a Roth 401k at work, my simple retirement solution has been to take advantage of as much tax-free savings as I can. Seems like the right call, no?

Well, I just read an article that has made me think seriously about other options for the first time. Protecting Your Retirement No Matter Who’s President. It’s short and to the point; I recommend checking it out.

The author advises taking a “three-pronged” approach to maximizing your investments (i.e. minimizing taxes).

“First, stash at least enough in your 401(k) to get the full employer match. Use the account to hold your portfolio’s bonds. The interest will be taxed as ordinary income anyway — and the 401(k) will allow you to defer the bill.

“Next, if you’re eligible, fund a Roth IRA. The Roth won’t give you an initial tax deduction, but all withdrawals should be tax-free.

“Finally, if you have additional money to save, buy stock-index funds or tax-managed stock funds in your taxable account. These funds should generate modest annual tax bills, and when you sell, the realized gain will be dunned at the capital-gains rate.

This advice is far from new, except for the last bit. Rather than going back and fully funding a 401k, the suggestion is to invest in regular old taxable accounts (albiet with tax-friendly index funds). I’d never considered that being taxed later at the capital gains rate might be more favorable than being taxed later at your future ordinary income rate.

But I have a Roth 401k, not a Traditional one. So I guess the question for me is, do I think being taxed later at the future capital gains rate will be better than being taxed now at my current income tax rate? The answer should tell me whether to continue to invest in my Roth 401k (after getting the match) or choose taxable index funds.

I think that for young people like me the decades of tax free growth combined with not being taxed at all on the withdrawals in retirement is a situation hard to beat. Then again, it’s also kind of reassuring to be able to justify having accessible, if taxable, investments in case I encounter a serious emergency or other investing opportunity before I hit 60.

Consider the author’s final quote:

What’s the advantage of all this? If income-tax rates rise, that could cut into the value of your 401(k) withdrawals. If capital-gains rates climb, it will hurt your taxable account. And if the income-tax system is ever replaced with a national sales tax, the Roth will lose its luster. In other words, you’ve spread your tax risk — and thus you should be in good shape, no matter what Congress does.

Geez. I hadn’t even though of that…

More from Meg at The World of Wealth

New Retirement Income Solutions

Good morning. I’ll be out most of the morning but I wanted to go ahead and give you something interesting to read (emphasis mine):

The financial services industry has recently introduced new mutual funds that create income streams for retirees. While they’re not intended to be the sole solution for any given retiree, the funds aim to take some uncertainty out of the decumulation process. The timing is hardly a coincidence: The oldest among the nation’s 78 million baby boomers turn 62 this year, the first wave of what the Social Security Administration calls a “silver tsunami” to become eligible for Social Security benefits. Contrary to the popular conceit that boomers will reinvent retirement and never stop working completely, these older boomers are eager to retire, according to a recent study by the MetLife Mature Market Institute. Respondents were asked to describe the best aspects of being 62, and “retirement” and “not having to work” topped the list.

A big attraction of the new retirement-income mutual funds is that they offer the flexibility and liquidity that annuities lack. You can cash out of them or add new shares at any time. “In some ways a plain-vanilla, inflation-adjusted immediate annuity may be the best thing for people, but they don’t like it, so how do you respond?” Munnell asks. The financial services industry has responded with funds that offer regular income with varying payouts and strategies. Some aim to preserve principal while others liquidate it over a fixed horizon. Most are funds of funds.

That quote comes from an article in the February 2008 issue of Financial Planning. The article is about some of the new retirement income solutions that being created by financial service firms and mutual funds. From what I have read, I like this idea because it gives annuity providers some competition and with competition comes better products and hopefully lower fees.

Anyway, to get a handle on what I’m talking about read the article. I’ll write more on this topic later today.

UPDATE: If you’re interested, here is Money Magazine’s Walter Updegrave’s thoughts on managed payout funds.

Kiplinger’s Simple Long-Term Portfolio

I was thumbing through Kiplinger’s Mutual Funds 2008 and saw their model portfolio for long-term investors. They define long-term as 10 or more years away. This is an all-stock portfolio:

Kiplinger’s Long-Term Portfolio
(Using Vanguard Funds)
35% Large-Cap Domestic Stocks Vanguard 500 Index (VFINX)
25% Small-Cap Domestic Stocks Vanguard Small-Cap (NAESX)
25% Large-Cap International Stocks Vanguard Total International Stock Fund (VGTSX)
10% Real Estate Investment Trust Vanguard REIT (VGSIX)
5% International Emerging Markets Vanguard Emerging Market Stock Fund (VEIEX)

I think this looks like a pretty good portfolio assuming you can meet Vanguard’s minimums, which as I understand them, would require a minimum of $60,000 if you wanted to purchase all five funds at the above allocations as Vanguard has a minimum of $3,000 per fund. You could always start out with a smaller number of funds and diversify as your account grows. Or, you could start off with Vanguard’s Star Fund (VGSTX), which has a $1,000 minimum and offers a conservative (VERY conservative) allocation among different Vanguard funds (click here to find out more).

Humor: Some “Expert” Advice

I received the following email from a PR person for a personal finance expert I had never heard of before. Here’s the email (I’m leaving off the “expert’s” name because I don’t want to embarrass him):

Personal finance expert A. K. suggests putting as much as you can into your retirement plan. K., who is also the founder of SomeWebsite.com advises to put everything you can into these plans, whether an IRA, 401(k), 403(b) or other tax-advantaged retirement vehicle.

Here are some of the benefits:

  • You get a tax deduction today, which means an instant rate of return at your effective tax rate. So taxed at rate of 20% for example, you actually get a 20% return just for investing in your future.
  • Your money grows tax-advantaged. Whether you use a Traditional IRA or a Roth IRA, your money is growing and you are not paying taxes. So every dollar earned you get your effective rate REINVESTED and it compounds instead of paying that money to Uncle Sam.
  • If you are in a retirement plan with a match (like a 401k) then every “matched” dollar equals 100% return, before you invest.
  • Many of these plans are automatic and are not high maintenance on your part, K. explains. Just make sure you rebalance your portfolio and review your investment strategy at least once a year.

    “Who is the ideal candidate? Anyone with earned income,” K. says.

    I don’t know about you but I found this kind of humorous. I don’t know a PF blogger out there who doesn’t already know this stuff. If I were A. K., I think I would have a talk with his PR person to see if they couldn’t come up with a little more intriguing PR campaign.

    The Ten Worst Days in S&P History

    The other day when I was working on my posts about investing on the wrong day, I looked for information on the 10 worst days in the S&P’s history. I couldn’t find the information I was looking for so I sent an email to Standard & Poor’s and asked them. They were very helpful and sent me the 15 worst days in the S&P Index’s history:

    Notice that with exception of 1946, all of the bad days are clustered in the 20s, 30’s and 1987. It’s also important to note that the S&P 500 Index didn’t become the S&P 500 Index until 1957 when it went from 90 stocks to 500 stocks. I wonder if the numbers from the 20s and 30s would have been any different had the index consisted of 500 stocks.

    Anyway, by far the worst day was October 19, 1987, which I talked about earlier this week. All the other worst days pale in comparison to the 20.47% loss on October 19, 1987.

    What is “Stagflation?”

    Today’s Wall Street Journal featured a front-page article about stagflation fears ($). From the article:

    The U.S. faces an unwelcome combination of looming recession and persistent inflation that is reviving angst about stagflation, a condition not seen since the 1970s.

    Inflation is rising. Yesterday the Labor Department said consumer prices in the U.S. jumped 0.4% in January and are up 4.3% over the past 12 months, near a 16-year high. Even stripping out sharply rising food and energy costs, prices rose 0.3% in January, driven by education, medical care, clothing and hotels. They are up by 2.5% from the previous year, a 10-month high.

    What’s stagflation?

    Here’s the definition of stagflation according the Barron’s Finance & Investment Handbook – Fourth Edition (Affiliate Link):

    STAGFLATION term coined by economists in the 1970s to describe the previously unprecedented combination of slow economic growth and high unemployment (stagnation) with rising prices (inflation). The principal factor was the fourfold increase in oil prices imposed by the Organization of Petroleum Experting Countries (OPEC) cartel in 1973-74, which raised price levels throughout the economy while further slowing economic growth. As is characteristic of stagflation, fiscal and monetary policies aimed at stimulating the economy and reducing unemployement only exacerbated the inflationary effects.

    I found that last sentence interesting:

    “As is characteristic of stagflation, fiscal and monetary policies aimed at stimulating the economy and reducing unemployement only exacerbated the inflationary effects.

    It seems to me that the Fed’s rate cuts are only going to add to the inflationary pressures and do more harm than good. I think there are times when we just have to face the music and allow things to play out like they are supposed to and quit trying to change fate.