By Mark Folgmann
“A Crack in the Wall”
Is this the start of Small 401(k) Lawsuits? We have been talking with small business owners for the last two years about the potential lawsuits that may be lingering over the horizon. A small business 401(k) is not an investment product but rather a delicate income generating machine that will fund our eventual retirement years. Since this is classified as a “real” retirement plan there is a fiduciary requirement that must be met by the people in charge of the plan. Here is where the problem begins, the plan fiduciaries are not taking their responsibilities serious and therefore run the risk of lawsuits by their employees. Until last month the only companies involved in litigation over fees, conflicts of interest or lack of disclosure were large Fortune 500 companies and most thought the small employer ran very little risk. We have now learned that the first small 401(k) with less than 30 employees in Kansas has filed a lawsuit on a plan with under $2 million in assets. This Wichita-based Orthopedic and Sports Medicine office has filed litigation against their advisor, the record keeper and the custodian of the plan claiming that the trio of plan providers caused participants to pay “secret” and “excessive” fees.
Unfortunately this appears to be the one and only way to get employers to pay attention to their plans. We still have the opportunity to save the existing 401(k) but it will take our undivided attention. The excess fees and lack of disclosure are costing Americans between 30% and 50% of their cash flow in retirement. Matt Hutcheson who is the nations best know Independent Fiduciary estimates that the average retiree would increase their eventual income by over $500 per month in retirement if they had a competent Investment Fiduciary overseeing their 401(k). This means the typical employee will have to work an extra 6yrs to make up the high cost of fees within the plan If some of these changes would have happened 25 years ago we would not have anywhere near the amount of senior going back to work and taking service jobs from our young people. This means the typical employee will have to work an extra 6yrs to make up the high cost of fees within the plan If some of these changes would have happened 25 years ago we would not have anywhere near the amount of senior going back to work and taking service jobs from our young people.
By Mark Folgmann
The New Retirement – Solutions Last time we started the discussion about how the old retirement paradigm is dead and why we need to think and prepare for our last stage of life in a new way. We can no longer depend on company pensions and social security to provide our economic base so that we can sit back and relax. The new retirement will depend on the greatest generation in American history making multiple adjustments in order to create ongoing streams of income to supplement their 401(k) s. There are numerous small adjustments that can enhance and create a very proactive and productive lifestyle in our later years.
These are my top six. 1. Save 10% of total household gross income till the day you die, notice I did not say till you retire but till the day you die. The main reason I suggest this strategy is because it will automatically cause you to live within your means and accumulate more money each year of your life. I’ve known people that retired broke but lived long enough to become millionaires. 2. Plan to eliminate your mortgage around the time you start collecting social security. Anyone can get their hands on a mortgage calculator and determine how much extra you need to pay each and every month in order to accomplish this. This will provide tremendous relief and peace of mind throughout your later years. 3. Maintain a well balanced portfolio with maximum diversification. You should start shifting to a higher Allocation of fixed assets 5-10 years prior to retirement and can use your age as a general guide to determine the percent invested in fixed assets. Most people take far too many risks and don’t really understand what it feels like to lose half your portfolio in a rough year. Don’t let this happen to you; maintain your fixed positions in your portfolio. 4. Pay attention to cost. Almost all financial decisions carry heavy cost and you must know what and to whom you are paying this cost. Everything from your checking account, car loan, investment portfolio and insurance program generates fees and commissions for someone other than you. Do your homework and work diligently to reduce your cost over your lifetime. We usually find that when we take on a new client we reduce fees over their lifetime by hundreds of thousand of dollars. Jack Bogle the founder of the Vanguard group refers to this as the tyranny of compounding fees. 5. Manage taxes throughout your retirement because we find that today many retirees pay taxes than when they worked. There are two main reasons for this which are distributions from 401(k) s or IRAs and the loss of deductions because children are grown and hopefully no mortgage expense. Many are also taxed on their social security up to 85% and before you know it your quarterly tax bill is quite daunting. We find with proper tax planning we can keep most retirees in an effective tax rate of 5% or less. 6. This one is my favorite because it allows you to stay productive and active till the day you die. Streams of income using your unique skills and abilities you have developed over your lifetime of learning. Don’t wait till you want to leave your employer to add additional income streams, these should be learned and established by the time you want to slow down and live life on your own terms.
My personal goal is to create and establish between 6 and 12 ongoing income streams that will last forever and allow me to spend time on things I love like helping the people around me achieve the impossible. Colonel Sanders didn’t get started cooking chicken till he was 65 years old and look how long that lasted. Most of these things are common sense and certainly something our grandparents would teach us. I believe if you will take these lessons to heart and follow through you will create a lifetime of financial peace and well being. Many will want you to believe that this stuff is rocket science but I’ll bet you would agree most if not all these strategies can be accomplished on your own with very little outside help. Good luck and enjoy your “New Retirement”
By Mark Folgmann
“Preparing for the future” Americans have historically depended on the “Three Legged Stool Theory” for their retirement security driven by a monthly pension, social security and their retirement savings. I believe this strategy is dead and gone and for most will never return. If I’m right we must change our paradigm and step outside the traditional retirement box. The past will not repeat itself and most of us will grow old without the benefit of a pension and some may not even see any benefit from social security. A mobile workforce with the average employee changing employers 7-10 times in a career will force us to think differently about our retirement years. Somewhere along the line we decided that we had the right to sit back and enjoy life somewhere around the age of 62. This was a great strategy when we had three sources of income, a paid off home and typically only lived another 10-12 years. Now with pensions all but obsolete, social security at great risk and a national savings rate at -2% we are kidding ourselves if we think we can retire under this obsolete system. On top of all that most are still carrying debt at retirement and may live another 30 plus years. Even with all that against us we can still thoroughly enjoy our later years with a few slight adjustments.
First of all the Financial Service Industry will not save you with all their fear tactics, hot investment tips and their efforts to make you believe their on your side. Their Not. I believe that most people are far worse off with a financial planner or advisor than they would be on their own. After 25 years of observing the tactics of this industry I firmly believe that almost all advisors destroy more value than they create. Remember the financial service industry is a zero-sum game. Every dollar in fees or cost has to come out of your accounts. Don’t get me wrong, there are some people that reach a point where they are uncomfortable handling their affairs and it makes sense for these people to get some advice but for the most part it’s a loosing game. The advisor will win, his mother ship will win but in the long run you will suffer. An extra 1-2% in fees over a lifetime could eat 30-50% of your profits and all that loss goes to the industry.
The future solutions revolve around multiple streams of income and common sense. Part of the preparation for the “New Retirement” involves thinking about what you love to do and what specific skills you have. We were downtown last weekend with my grandson Mark and ran into a retired clown making balloon animals for kids for $1 each. I thought wow, if he did this 6 days per month at different locations and passed out 100 per day he is generating about $600/month. Do you realize he would have to save about $150,000 to generate the same income? What if he also repaired small engines one day per week in his garage and generated another $800/month and owned a rental house that paid him another $750/month. Of course I’m only giving you a hypothetical illustration but you probably get the picture. It would take over $750,000 in his 401(k) to generate that kind of income. Every single person has different interest and skills so the hard part is to determine what you really love to do and figure how to create lifetime incomes from it. Over our working career we must continue to refine and develop new skills so that we can create multiple streams of income while enjoying the work. The butterfly effect tells us that minor changes create major results and it’s my feeling that we need Americans to be productive and not sitting on the sidelines for the next 30 years. Next time we’ll discuss other things you can do to prepare for the “New Retirement”.
Tess Vigeland: The average 401k plan costs its participants 3 to 3.5 percent in fees and other hidden charges. For a closer look we're joined by pension consultant Matthew Hutcheson:
Tess Vigeland: Thanks for coming on the show today.
Matthew Hutcheson: Thank you. It's wonderful to be here.
Vigeland: Is it possible to estimate just how much we're all losing because of these hidden fees?
Hutcheson: Over a 20-25 year period, if you are being charged a total of 1 percent in your retirement account, the ultimate benefits that you will receive when you retire -- let's say age 65 -- will be reduced by approximately 20 percent.
Vigeland: So we're talking thousands of dollars?
Hutcheson: Over a regular working lifetime, we're talking about $80,000, and to make that shortfall up, a person would have to work three or four additional years just to break even, based on an excess 1 percent fee.
Vigeland: How high do some of these costs go? Are we talking 3 percent? 5 percent?
Hutcheson: The average plan, which is really 90 percent or more of all of the 401k plans in the United States, is paying approximately 3-3.5 percent. However, there are some plans, especially those that are associated with insurance companies, that have additional layers of fees added on; I've seen as high as 5 percent.
Vigeland: Is it possible to figure out how much money you are losing in fees?
Hutcheson: It is possible. There is a rigorous way, a scientific way that's based on some rigorous mathematical application, where you can determine what you're paying over a long period of time, but a normal participant wouldn't know where to look.
Vigeland: There are some mutual fund companies that have publicly argued "look, if we give people who are investing -- employees -- more information about fees, they're going to get so confused that they stop investing." What do you say to that?
Hutcheson: It seems odd to me that they would require a participant to take on the most difficult aspect of investing, which is selecting the investments themselves and constructing a proper portfolio. That is far more complicated then just having fees presented to them. When the FDA required food companies to disclose nutritional information on the back of food packages, soup cans, bags of potato chips, whatever, did you stop eating? Did you become overwhelmed and stop eating? Look, participants are going to invest; it's just that we need to give them the right information so that they can construct a portfolio that is not fast food, but is a healthy well-balanced meal.
Vigeland: What is necessary and what's not in terms of mutual funds charging for their services. They do have to make money somehow -- obviously it's a business. How do you know what's a good, justified fee and what's a ridiculous one?
Hutcheson: That is a very good question and there's some relativity to that. The relativity comes in the presumption that a mutual fund company can, over time, outperform ordinary market returns.
Vigeland: In other words, the whole reason we hire these companies is because we assume these professionals will get us a better than market return?
Hutcheson: That is correct, and, what we know is that a simple portfolio of 60 percent equities -- that would be stocks -- and 40 percent bonds outperforms 90 percent of the best and brightest portfolio managers in the country over the long term. So any dollars spent trying to chase returns when you do not have a guarantee that they will actually yield the results you are seeking are excessive. Now, some people may say, "well, those fees are reasonable because the fund manager is actually doing the work to try to get the better returns." I understand that. Are those expenses justified when we know that they're probably not going to be able to outperform the market over the long haul?
Vigeland: If I'm contributing to a 401k, a 403b plan, is it possible to say potentially how many people have their fingers in my money?
Hutcheson: Yeah, I estimate it's 14 or 15 potential individuals or companies who could be payed from your account for a variety of services. You've got the fund company, you have, potentially, an independent investment adviser who is directing that company, you have salespeople who could be selling for a commission, record keepers, fund custodians, you have accountants, actuaries, lawyers, outside consultants and the list goes on, and most of those things I mentioned are not stated in the prospectus.
Vigeland: Is it possible that any one 401k participant -- an employee -- could be paying an expense ratio, revenue sharing commissions, 12b-1, Sub-transfer agent, contract fees, early redemption fees, brokerage commissions, custodial fees, wrap fees, investment advisor fees and soft dollar revenue?
Hutcheson: Absolutely, I have seen that and I have seen accounts that pay well over 4 percent when you add all those up.
Vigeland: Why aren't more people angry about this and what's the most important thing that can be done to fix this?
Hutcheson: Good question. Most people aren't angry because they don't really understand what's happening. They presume that in our society today, everything's disclosed -- why wouldn't it be? What to do about it is, regulators and legislators need to understand that we can't have our society paying for services they don't use and we need to make sure that where the risk is, full disclosure exists also. So, if we have a system that is placing the investment decisions on the shoulders of novices(i.e.: participants: regular workers), then we need to honor them by providing them all of the relevant information, even if they don't understand it at first -- they're smart, they'll have the capability to learn and understand over time -- but we can't withhold it from them under the guise that it will overwhelm them. Don't dishonor us by withholding important elements that are going to reduce our ability to have a dignified retirement in the future. That's not OK and that's what's got to stop right now.
By Mark Folgmann Everybody is trying to predict when this economy will turn. Has real estate hit bottom? When will the bear market turn back into the roaring bull and what about jobs? Sure the real estate agents tell you it’s over and the brokers want you to believe we have hit bottom but the reality is “nobody knows”. I’m not a pessimist but even I can see this thing could go on for some time. When you really study world history not American history you will find that an economy can hit the skids for a very long time. Just because it hasn’t happen recently (last 100 years) doesn’t mean it can’t.
With my clients I have to prepare for the worst case scenario even if it never happens. What if we have another 9/11 before we see recovery? Many of my clients are already retired and can’t afford to loose another 10-20 years due to the economy. Have you ever thought about what it might be like if it took the country 8 more years to recover and Michigan 15 years? What would you do different? Would you save a little more while your family was still employed? What about reducing your debt by 50% over the next 2-3 years or maybe build up additional cash reserves? Should your 401k be allocated different and what about finally paying attention to investment cost? Can we really afford to pay 2-3% on our investments when we are only earning 2-5%? With over 90% of our country still working we still have plenty of time to shore up the ship and these minor changes can have a huge impact on our financial lives.
Hopefully we don’t see another decade of trouble ahead but if we do, you will be much better prepared. Today is the end of this years Cherry Festival and my wife and I have spent most of the week downtown either serving beer or enjoying the festival and can’t help but notice that many of the downtown stores close early during the festival or don’t open at all. This I don’t get, can’t we keep our town open till 9 or 10 pm for one week each year while hundreds of thousands of people come to spend money. We heard countless comments about stores being closed and would encourage everyone to stay open because the overall shopping experience is a big part of the festival. Even with Michigan tough economy it appears we have had another successful Cherry Festival, great job Traverse City.
By Mark Folgmann
“The Free Lunch Seminar” I work with an elderly widow downstate and meet with both her and her grown children at least three times per year. A little over a year ago her husband of 50 years passed and she lives pretty much on her own since her daughter is about two hours away. While completing her taxes for 2008 we noticed multiple transactions that we were not familiar with that generated excess taxes for my client. I immediately called a family meeting with the intent of taking an updated inventory and bring everyone up to speed. We got the children involved about 3 years ago because we were becoming more and more aware of my clients aging process and her memory loss and believed they needed their family to help in the decision making process. We set up trust and put the daughter in charge of most of her assets but like any independent individual she was not willing to give full control of her assets to her family.
Anyway, as we completed an inventory of assets and changes made for the year my client mentioned the name of the individual that she had been working with for about 3 months whom she met when she attended a “Free Lunch Seminar”. As we worked our way through the transactions we learned that IRAs were cashed with no regard for taxes and CDs were surrendered with multiple surrender charges. Annuities were liquidated and transferred again without attention to taxes or surrender charges. All told this individual sold my client 4 annuities, LTC policy, life insurance and a prepaid funeral policy. Now remember this was all going on while her daughter and I was meeting with her on a regular basis and when we asked if she wrote any checks to this individual or his company she said “I don’t remember”. After reviewing her check register we discovered checks written for hundreds of thousands of dollars and many checks were written within days of our meetings. All told we estimated the insurance agent made over $30,000 in commissions and tied her money up to age 95 with surrender charges. Have you ever wondered how they can afford to buy lunch for a room full of senior citizens? After this episode my client’s daughter took a full day off work and they visited all the banks where money was left and moved everything into the trust for safekeeping. The lesson I learned from this episode is we must have open communication with professional oversight. Your family’s professionals should communicate with each other as a form of checks and balance for the safety and security of your family.
By Mark Folgmann This is the 12th and last in a series of articles on 401ks. We have spent the past 6 months attempting to educate both the employers and employees about their retirement plans. These plans have the potential of becoming great and funding our retirements but we must spend time educating ourselves and understanding how to keep our 401(k) current. I have found that there are many outstanding resources that can help us do that and most of us can be highly informed with as little as 8 - 10 hours of concentrated study. Just imagine, we spend somewhere around 80,000 hrs working so that we can retire and most don’t have the time for 10 hours of preparation on how to assure retirement becomes a reality. I see more and more people who will never be able to retire and that is a real sad situation.
For employees that are two excellent books available at your local bookstore. The first is “The Smartest 401(k) Book You’ll Ever Read” by Daniel Solin. This is a really easy read broken down into 4-5 page chapters on key points that affect your plan. Dan also does an excellent job of covering how your behavior can destroy your retirement plan. The second book I would recommend is “Stop the Retirement Rip-Off, How to Avoid Hidden Fees and Keep More of Your Money” by David Loeper. David will teach you how to uncover all you plan fees and what to do if your fees are too high. These 2 books will put you in a position to make great decisions about your 401(k) and I would add “The Successful Investor Today” by Larry Swedroe who will show you how to experience a successful outcome with regard to your investment choices within your plan. For employers I would recommend “Fixing the 401(k) by Josh Itzoe. This book focuses on the problems of the plan sponsor and will lead you to a great plan.
We will be continuing this article next time with information that you need to make informed financial decisions and empower you to deal with the financial service industry. Remember Wall Street is not your friend and it’s main objective is to make profits off your money.
