SEPs; The Good, the Bad and the Ugly

Last month we talked about how a SIMPLE was like flying from coast to coast sitting in a middle seat instead of first class. After thinking about it I realized I was completely wrong. Both first class and coach arrive at the final destination with the same success rate and this is absolutely not true of The Cambridge Plan and the SIMPLE and certainly not true of this month’s topic the SEP. There are too many problems with a SEP for most of the employees to arrive successfully at their final destination (Retirement with Dignity). Let’s start with only an employer contribution; that’s right no employee contributions. No Roth option or profit sharing option, and no catch-up if you’re behind. Forget about automatic salary deferrals and escalating contribution levels over time. Probably not using Institutional funds or any type of model portfolios. Most of the time invested in “Retail” loaded funds. With all these deficiencies’ there’s no wonder why we can’t safely get to our destination. As you can see it would be a much better analogy to compare a first class flight “The Cambridge Plan” with attempting to fly across the United States in a glider. Statistics I’ve read indicate that less than 7% will successfully navigate the retirement dilemma with a standard 401(k) where they can contribute; I would love to see the statistics on SEPs.

As many of you are aware; we have discontinued the monthly training sessions on “The Cambridge Plan” but we are still available to help and support on any individual cases you may run into throughout your year. We have found that both CPAs and accountants are very receptive to the idea of discussing and upgrading their clients SIMPLE, SEPs and Profit Sharing Plans. This is a big win for the CPAs in front of their clients but in most cases need to be educated on what a MEP is and how it can help their clients. Take a CPA to lunch and have the talk. It works.

“American Workers Short on Retirement”

The Wall Street Journal published an excellent article last Saturday focusing on the shortage in retirement savings for the age group between ages 60 and 62. These are the pre-retirees that hope to retire within the next 5 years. Their findings are that this group is about 75% short of their needed amount within their 401(k) s. The typical household was earning $87,700 and the assumption was they could retire on 85% of this amount for a total retirement need of $74,545. I find this to be a false assumption since most households can’t or won’t accept a 25% drop in income and expenses unless it is forced on them through job loss or disability. The article goes on to explain the average employee in this situation has under $150,000 in their 401(k) when in fact they would need $636,000 to bridge this gap. Remember the gap already assumes a 25% drop in income and expenses and confirms that the average employee has accumulated approximately 3 years of income when they typically need a minimum of 8-10 years of income.

We have a crisis on our hands that we are not yet addressing with the level of urgency that’s needed to create viable solutions. Our current retired population is much different than our next retired generation. My parent’s generation retired with monthly pensions, paid off homes and very little consumer debt; if any. The baby boomers are a whole new dilemma. Most don’t have a pension and many carry large mortgages well into retirement. Many have most of their money in their 401(k) s and all of this money will be taxed when withdrawn.


There is plenty of blame to go around about who is responsible for this future financial crisis. Just imagine 100 million retiree’s running out of money and dignity; well this isn’t totally true because 8% are estimated to be on track. An 8% success rate tells me that it can be accomplished even within the current less than perfect system, after all, what one man can do another can do. We must learn about the behaviors and attitudes of the most successful savers and incorporate these characteristics into our retirement system while drastically improving the quality of the investment experience by creating low cost and efficient plans. Many of these traits and behaviors can be automatically built into the plan to nudge us in the right direction using technology. In my travels I view this as a joint effort between the companies and the employees. In almost all cases I see inferior, high cost and inefficient plans that are run by employers and HR Departments that are not trained in result based retirement plans. They tend to be complacent and thrilled to have a plan no matter how bad it might be and once they own it they tend to defend it for years. On the other hand, we have employees that must figure out how to mirror the 8% that have successfully funded their retirement plans. These behaviors are things like; signing up early and regularly increasing their savings amount. They choose low cost, diversified portfolios within their plan; they don’t spend their accounts when they change employers and rarely use loans. The best state of the art plans have automatic sign-up at certain percent of income with annual increases of 1 -2 % per year until you reach a maximum savings rate. They also provide professionally managed accounts so the employees can choose risk adjusted portfolios instead of trying to assemble and manage a portfolio using expensive and normally high turnover funds. I hope we begin to take these warnings to heart and start to ask; “What can I or my company do to improve our Retirement Outcomes?” Just Ask!

A Retirement Fix for Almost Everyone

By Mark Folgmann

Just about everyone can enjoy a successful retirement with three upgrades. Upgrade number one; increase your savings rate by 3% within your 401(k) or retirement plan. Make sure this is 3% of your total household income. You can accomplish this without pain by bumping your savings rate 1% each and every birthday till you reach 10%. The average person is saving about 7% into their retirement plan and this will get you to 10% plus any company matching. Upgrade number two; increase your expected returns on your portfolio by 3% per year. You can accomplish this by paying attention to cost and creating portfolios that have an expected rate of return 8-9% per year. About half of the 3% increase could be driven by cost reduction in most plans we see in the marketplace. The other half comes from the elimination of bad investment behavior. If you have done your homework and feel comfortable managing your own portfolios make sure you also rebalance on your birthday each year when you increase your savings rate. Most employees we talk to aren’t confident managing their portfolios so this is a service we provide on the 401(k) s we provide oversight. Statistics show that the average employee averages less than 5% per year after fees and expenses on their account. These first two upgrades will fix over sixty percent of the retirement scenarios. Remember these changes should be made on all household income; if you have two people employed you must figure out how to implement these suggestions on both incomes even if you only have one retirement plan available through your employers. If this is the case you may need to fund an IRA or Roth IRA on the side or fund the available 401(k) at twice the rate. If you are still coming up short in retirement income after you make the above changes you must consider upgrade number three which is work 3-5 years longer than planned. This really should not be a tough call since retirement was never intended to last 25 plus years. The clients I have worked with over the years that have stayed productive well into their late 60s or even 70s have been the ones I’ve enjoyed being around the most. Since they are productive and active both mentally and physically they energize the people around them with stimulating conversations about the new and exciting things they are accomplishing. If your profession does not allow for an extra 3-5 years of employment you must start preparing for this transition at least 5 years prior to leaving your current employment. You might turn a hobby into an income or become a consultant in an area where you have specialized knowledge. Either way the extra years working will enhance your retirement years by saving more and spending less while you continue to work. These three upgrades will not solve the problem for everyone but will get over eighty percent of American workers into a position where they can retire with dignity and independence.

“Going Forward” What Should I Do Now

By Mark Folgmann

A new client recently asked me what he should focus on during this uncertain economy and what I thought to be the keys to success over the next five years. It seems that on a daily basis I hear people say that recovery is right around the corner, from my office landlord claiming that the commercial market will recover within three years to the financial news media insisting that we are coming out of this recession. In my personal viewpoint, I’m not even sure if we have started the commercial market downturn nor do I know if the economy is rebounding. What if everyone is wrong? I believe the only things that matter are the things within your control. I have laid out a list of things that one can control over the next 5 years that I believe will leave you better off in the year 2015 than you are in the year 2010 simply by implementing these into your life.
Buy the right size home and use standard financing. The maximum home value should be no more than 2.5 times your household income with a minimum of 20% down payment on a fixed 15 or 30 year mortgage. If you can’t satisfy these three requirements; rent until you can.
Live within your means. Simply; spend less than you make. Save 10% of your total household income into your retirement program (IRA, Roth or 401k). This should be implemented until the day you die.
Develop a plan to eliminate all other debt by the end of 2015. Operate off of cash going forward. Build cash reserves with eliminated debt payments.
Implement a diversified investment strategy with your existing investments. Hopefully you learned last time that a balance approach works much better. I have many simple reads to help you accomplish this. One of my favorites is “The Coffeehouse Investor” by Bill Schultheis. This is a book that you can read in a couple of hours and be better qualified to handle your portfolio than most financial advisors.
Cost matter. Make sure you understand every dollar you pay in fees and cost. Remember each and every dollar you pay in fees is one less dollar you will have to support your retirement. Vanguard is always a great place to start here. Not only will they help with your cost but will also help structure your portfolios. Jack Bogel is one of my favorite authors and I would suggest reading anything he has written. His most recent book “Enough” is a great read.
Of course most of these suggestions are common sense to many but all will put you in a much stronger position. Just imagine if our leaders in Washington implemented the same list.

“Fee-Based or Fee-Only” They Are Not the Same

By Mark Folgmann

The underlying difference between fee-based advising and fee-only advising is often disguised through many shades of grey. Advisors today use all kinds of smoke and mirrors to confuse investors and blur the lines between services offered in each form. Fee-based advisors would like clients to believe they are the same as fee-only advisors when in reality these are two completely different practices of investing which may result in substantially different financial futures for the client. It is the commissioned salespeople that find it to be a much better business model if they can produce predictable ongoing revenue from their clients when they can. When I see fee-based accounts created by broker-dealers and distributed by their sales force, they typically contain expensive, actively managed retail mutual funds that would have been offered in the past with sales loads. The fee-based account typically waives the loads (front end or back end) and allows the advisor to tack on a 1-2% fee each year to generate ongoing revenue. The average actively managed mutual fund charges about 1.25% in expense ratio and has about the same in trading cost (brokerage commissions, bid/ask spreads, market impact and cancelled trades) for a total cost of approximately 2.50% per year. Of course trading cost will vary depending on the percent of portfolio turnover and the asset class of the fund. After the advisor adds on their fee-based amount of 1-2%, the total cost amounts to 3.5-4.5% of the account balance each and every year. If you do the math and use the rule of 72 which states money doubles every ten years at 7.2%; it doesn’t take long to figure out why they would rather take their commissions each and every year on a growing pot of money. Keep in mind that a well diversified portfolio may return 8-9% each year before cost and if you lose 3.5 - 4.5% in fees, your ending value will be 40-60% less due to fees alone.
The National Association of Personal Financial Advisors (www.napfa.org) is a great place to find a fee-only advisor. To comply with full disclosure I should mention that I am a full member of NAPFA and we have a great group of NAPFA members in Traverse City. There are many advantages to using a fee-only advisor but in context of this article the difference is substantial. When a fee-only advisor creates your portfolio they will not use high priced retail funds with high annual turnover when they create your portfolio. They will either use low cost institutional funds, index/passive funds or individual securities. All of these options will significantly reduce fees and friction on your portfolio which in turn should increase your net return. Most of the fee-only advisors I know will create portfolios that have an all in cost of 1.25% or less which includes the advisor fees. Obviously it's impossible to completely eliminate all fees but it is important to understand the difference in pricing models. A long term annual fee of only 1.25% compared to 3.5% or 4.5% with the same expected returns on your portfolio will increase your monthly retirement income by a substantial amount over the long haul making this a notable difference.

Improve Your Sleep

By Mark Folgmann

I was recently reminded how troublesome it is to get financial advice. Over the last several months we have had numerous calls from individuals looking for second opinions regarding their financial future. People are looking for someone to advise them on a fiduciary basis with full disclosure and without any conflicts of interest. Most of these potential clients decided to look for a new advisor because they did not feel they were well represented over the last two years as we watched the market collapse and recover. After deciding to work with us, one of our new clients arrived for his appointment and shared with me a dream he had a few nights earlier. He said that he woke up in a cold sweat because he had arrived for his scheduled appointment and the office was empty; no furniture, no phones, no people; just an empty space. For a moment we laughed and joked about it but then I started to think about this concern; it was in fact a legitimate concern.
Every day I read in trade publications about advisors all over the country going to jail for stealing client’s money and spending it on their own lifestyles. How does the average person ensure their money is safeguarded and not in a position to be used by their advisors? There are distinct advantages to working with a truly independent advisor who does not sell products and acts in the client's best interest but regardless you also must know how to safeguard your money. The top 5 tips for safeguarding your money when selecting and using an independent advisor are:
#1. Use an advisor that will accept fiduciary responsibility in writing. This alone will not protect you but will be a good first step... remember criminals still carry guns even though it may be illegal. At the very least this will eliminate the salespeople who will not agree to act in your best interest before their own.
#2. Review their ADV Part II which will introduce you to their firm and the services they provide. Get a service contract that explains the scope of services provided. All fees should be fully disclosed in writing.
#3. Always make sure you know where your money is deposited. Typically this would be at a custodian or brokerage that is responsible for safeguarding your money. These are names like Charles Schwab, TD Ameritrade, Fidelity or Vanguard. Never make a check out to your advisor or your advisor's firm unless you are paying them directly for advice on a retainer or hourly basis. Your investment checks should be made out to the place they are being invested or deposited with. Don’t abbreviate names on your checks and follow the money. Check and double check the deposit through a third party source. Call Ameritrade direct or log into your account over the internet to confirm the money has arrived and has been properly allocated.
#4. Many times an advisor will create personalized statements when they are misusing client’s assets. This allows advisors to hide transactions; you must receive your statements directly from the place your money is being held. Once again this would be from places like Schwab, Ameritrade or Fidelity. If you receive customized statements from your advisor they must be accompanied by custodian statements.
#5 Typically someone that will separate you from your money illegally will use their likeability and their personality to make you trust them. You must not be afraid to ask the tough questions and do not accept their answers without checking. The more you like your advisor the easier it is to take advantage of you. When things don’t feel right; many times they are not.

A Government Bailout - You Decide

By Mark Folgmann

This year there has been an awful lot of hype over converting all or part of your pre-tax IRA to a tax- free Roth. Due to the unique tax rules in place this year, if you convert all or part of your regular IRA to a Roth IRA you will have the option of paying your tax based on this year’s income or spreading the tax over two years based on your 2011 and 2012 income. Clearly this provides for specialized tax planning based on your individual circumstances and may present you an opportunity to benefit from the tax code. The typical $100,000 income ceiling for conversions is also lifted this year which allows for an individual or family to convert part or all of their IRA. In all honesty, we have selectively been converting regular IRAs to Roth IRAs for clients over the last five years. We typically capitalize on low income years to convert assets so we end up paying very little tax on the conversion. We also proactively plan income streams to control our tax bracket by distributing income from various asset locations to reduce our overall tax obligations. Usually within the first ten years of retirement we have numerous opportunities to control our tax burden. However, this becomes a little more difficult after a client reaches the age of required minimum distributions from their retirement plans. Overall I’m a believer of strategic planning which would allow for the reduction of taxes for both you and your family. It is my personal belief that you have far more control over how much you will pay in taxes and when you will pay these than you think. We have multiple clients that have very high six and even seven figure portfolios that have a 10% or less effective tax rate.
This massive marketing campaign by the financial service industry makes me wonder who really benefits from this great opportunity. First of all, we know the financial service industry will benefit tremendously. They make money when transactions are completed and as long as we believe this is in our best interest, they will continue promoting change. Second is the government who appears to be the biggest winner. It continues to pile up large deficits and is now promoting the collection of taxes in advance. Doesn’t it seem a little strange to you that the whole benefit of funding an IRA was a tax deduction while we were still working and compounded deferral of all the money that would have been paid in taxes? Why did that change? Not only does the government receive large amounts of prepaid taxes but they promote it as if they are doing us a favor. Remember, I am in support of tax planning but most people will not know in advance if they will be better off by converting and paying taxes now or deferring and paying taxes later in life. Far too many things change and the calculations require so many assumptions that the end result becomes an unknown. My personal belief is that most investors will not end up better off converting their IRA to a Roth. Make sure you check with your tax advisor prior to completing any conversions. Ultimately you get to be the judge on who benefits from this once in a lifetime opportunity. My money says the investor will finish third.