The Boomer Rollover Conundrum

Boomers will be retiring en masse in the coming years. And with that retirement comes options. For the first time their lives, they will be outside the comfortable boundaries of their employer's retirement plans and on their own. The choices are many and often confusing. That is why I thought it would be informative to discuss over the last couple of days, an option you may have considered.

Today on the Financial Impact Factor Radio with Paul Petillo, Dave Kittredge and Dave Ng we continue the discussion we began yesterday about self-directed IRAs. While having control over your retirement is important, how much risk is too much and who can handle the increased potential of loss or gain.

To listen to yesterday's show, click here.

Here are some outtakes from this conversation:

Yesterday we discussed a different corner of the retirement investment world when we talked about self-directed IRA. I suggested that “If there is one thing we all seem to be seeking and at the same time, remains as elusive it is control. Our investments often seem to want us to master its fate, as if simply involving yourself is enough.” T.S.Eliot seemed to agree although we all know he wasn’t talking about your retirement plans when he wrote: "Only those who will risk going too far can possibly find out how far it is possible to go."

Jim Hitt of AmericanIRA.com to discuss the IRA that you control. There is a lot left to be discussed it seems and little clarification is needed in advance. Jim is a third party administrator or TPA. We have had a few professionals who ply their trade as a go-between, somewhat detached from the other two parties but necessary in the legal and tax compliant execution of a retirement plan. Sometimes we need to be reminded that all retirement investments, 401(k)s, 403(b)s, IRAs in all their incarnations are essentially parts of the tax code. And I’d be willing to wager that when taxes are mentioned, there is a certain fear, perhaps caution that moves to the forefront. Self-directed IRAs are no different.

On numerous occasions, we have, in advance of a guest appearing on the show prepped the listening audience, discussed what we knew about the next day’s topic and did so in almost every instance, without the guest’s knowledge. Today, we’re going to look back.

Most of us have had out retirement plans nestled safely – and I’ll describe what I mean by safely in a moment – inside a 401(k). The way these plans are constructed give us a sense that someone else is watching over us. They choose the investments. They made the match. They suggested that they had a fiduciary responsibility to us. I asked Jim if he had just such a responsibility and he simply replied: no.

So we began the discussion there as I asked Dave and Dave if they would like to tell us what fiduciary responsibility is?

Now we all know that risk is something we need and knowing how much of a risk you can take is key in the way you execute your goals. But this is no easy task when it comes to this type of IRA. "Trust your own instinct, “ as Billy Wilder once said: “Your mistakes might as well be your own, instead of someone else's."

As Baby Boomers begin this massive wave of retirement, many are for the first time going to get their life’s retirement account to control. I was caught by one thing Mr. Hitt suggested as to the people who come to him: they come in good times and bad.

The risk of self-directing your IRA is there. Jim discussed using this money for real estate investment purposes, business opportunities and other investments such as gold, commodities, etc. And it all boils down to coordination.

Listen to Financial Impact Factor Radio with your hosts: Paul Petillo of Target2025.com/BlueCollarDollar.com and Dave Kittredge and Dave Ng of FinancialFootprint.com

The show is broadcast daily, online at 6amPST/9amEST.

Paul Petillo is the managing editor of BlueCollarDollar.com/Target2025.com and a fellow Boomer.

When Your Retirement Plan Goes to Court

In 1970, Congress took to task the responsibility of mutual funds to offer a fair price for their services. This "fiduciary duty with respect to ... compensation for services" suggests that investors should know how much a fund is charging. But these fees are not always as transparent as we would like.

Buried inside many 401(k) plans are fees charged by the plan sponsor that are often in addition to what many would consider the transparent information available. These fees are not often known to the 401(k) investor at a glance.

Is Any Fee Fair?
On Monday the Supreme Court heard arguments in the case of Jones v. Harris Associates. Harris Associates was accused of charging higher fees for 401(k) investors than they charged for similar investments made by pensions. The trial was heard in the 7th District Court and the ruling suggested that the fees, while almost twice that charged for institutional investors was not out of line with what is considered the industry standard.

The question remains, what is fiduciary responsibility? The late Justice Benjamin Cardozo, writing in the widely cited case Meinhard v. Salmon, believed that "partners in a business have a fiduciary duty to inform one another of business opportunities that arise." He wrote: ""a fiduciary represents the punctilio of honor, and that is contrasted with the morals of the marketplace operating at arm's length."

This would suggest that the business partner relationship extends to the investor, who is essentially locked into the plan offered by their employer. They do not, as in other business dealings, have the ability to walk away from the investment and choose something else. This lack of portability, the old "money walks" notion of how free markets conduct themselves does not apply in this situation.

When Higher Fees are Noticed
These fees are particularly troublesome in light of the recent downturn. What would be considered reasonable fees when the stock market is outperforming become a glaring slap in the face when fund returns are down. The belief that fees whittle away the potential of greater returns is well founded.

As an example, consider the 45 year old, gender neutral investor who has a household income of $50,000. With an 8% contribution rate and an 8% return (after fees) over the remaining 20 years this person plans on working (a beginning balance of $100,000 and a potential of inflation, which is currently running in negative territory but historically runs around 3%). This person would have enough cash on hand, provided that the 8% return remained in place on the investments accumulated throughout their retirement, to not run out of money until they were 87 years old.

In the case heard before the Supreme Court, the additional half percentage point levied against the investor in the 401(k) would remove almost two years of income from the plan. The Court was asked to determine whether these fees were excessive in light of what other investors paid for similar products.

In an overview of the argument: "Open-end investment companies – more commonly known as mutual funds – are often created and managed by investment advisers. Although the funds and advisers are separate entities, the overlapping nature of their relationship can create conflicts of interest. The petitioners believed that Harris Associates did not "provide full and accurate disclosure of all material facts related to the transaction; and (2) ensure that the transaction is fair to the shareholders."

Does Your Plan take Responsibility?
The Investment Company Act of 1940 was designed to keep the role of advisor and client separated by a board, which would determine fees the advisor would like to charge. Prior to this, the relationship without the board made the practice of who paid what. But the advisor hires the board making the threat of firing the advisor much less of a possibility than if the board was independently elected. "Justice Scalia, for example, speculated that even if a board could not directly fire an advisor, it could set the advisor’s fee so low that the advisor would quit."

But the argument came down to an apples and oranges comparison of which fees were reasonable. The Court has numerous options including doing nothing. Yet, as long as investors focus on the fees charged, the argument should continue if only as an act of dissent voiced by the participants in the plan. Forcing the plan sponsor to shift to a more fee friendly environment, possibly with a new advisor would be a step in the right direction. But that could lead to a less focused fund manager who may not try as hard.

Fiduciary responsibility remains a difficult ideal to litigate. "Captive" investors may simply have to deal with higher fees in the short-term until there is some ruling supporting comparisons. Or, as many in the investment community hope, the markets will return and these concerned investors will simply forget how much they could have made with lower fees as higher return offset the losses.

Paul Petillo is the Managing Editor of BlueCollarDollar.com and a fellow Boomer

Shining a Light on Your 401(k)

It Should be Easier
There are numerous obstacles that keep us from building enough wealth in our 401(k) plans. The first is as simple as beginning to invest in your retirement future. This is stressed frequently and with good reason. The earlier you begin investing, the better situated you will be for retirement in the far-off future.

The second hurdle is how much to invest. I suggests that no matter how poorly a plan you have with your employer, setting at least 5% of your pre-tax income (a number that does not have much of an impact on your take-home pay) is better than not investing at all. For first time 401(k) investors, who may need as much of their paycheck as possible, this is a good start.

The third hurdle is the company match. This is used as an incentive to get you to put some money away for your future by offering to match the first couple of percentage points. Some companies do not do right by their employees when they match only with their own company's stock or if they have lowered or withdrawn the match due to the "economic downturn".

And the last hurdle to these beginners is where to put their money. Not all plans are created equal and not all investments in these plans are worthwhile. That doesn't mean you should ignore the opportunity to invest, it simply means that your choices are not as good as they could be. This is particularly troubling if you are an older investor who may have gotten a late start or if you have changed jobs and are now enrolled in a less than adequate plan.

The Role of the Investor
Often, 401(k) users simply sit back and allow these companies to make difficult choices without their input. There is a fiduciary responsibility that is assumed by your employer when they offer you a plan like this to provide not only viable investments but opportunities to grow your money.

Becoming more vocal, even if you are the lone voice in the crowd used to be difficult. Access to necessary information was largely outside your abilities and most of the information was held close to the vest by the employer. Since January 2009, that has changed.

BrightScope, the brain child of two investment managers and a former engineer at HP, allows you to look at your company's plan in a way that was not possible previously. Designed to help human resource departments make good choices about plans, BrightScope seeks to give these folks some sort of benchmark to judge how their plan is run and how their employees access it and use it. BrightScope realized that "because benefits data has been controlled by a small group of companies that are not incentivized or governed by the same fiduciary standards that a plan sponsor must honor" difficulties in determining which is the best plan to offer their employees was not possible.

This concept understands that transparency is not what it should be and even though regulation to improve these plans may be forthcoming, waiting to id not a better choice. BrightScope it should be noted works with these HR departments and those with the fiduciary responsibility to improve those plans now.

How does it Work?
The software it employs, according to the website, works like this:
"BrightScope obtains some of its data from public sources such as the Department of Labor, the Securities and Exchange Commission, the U.S. Census Bureau, the Equal Employment Opportunity Commission, and the Bureau of Labor Statistics. Mutual fund asset allocation and fee data are obtained from mutual fund prospectuses, statements of additional information (SAI) and Form N-SAR. Mutual fund return history data is obtained from Xignite, Inc. Data on 401k fees comes from company filings, and directly from plan sponsors who work with us to improve their plan. While all participant-level data is protected and confidential, we aggregate data across comparable companies to construct relevant benchmarks for fees, plan design and plan performance. BrightScope believes it possesses the most comprehensive database of 401k information in the country. The company leverages this database to provide plan sponsors, advisers and participants with accurate and high quality data to help them make more informed decisions."

It also realizes that the cost passed on to you in the form of fees is not readily available to you and therefore must be garnered from the overall return of the investment. This is also up for regulatory change.

The company also makes some assumptions when it applies its magic to your plan. It grabs an average employee, someone who is a "44-year-old, gender-neutral individual, earning an income of $44,000 a year, with a starting account balance of $40,000". From there, it acknowledges that each plan offers different company contributions, its own set of fees (generated by the large variety of plan sponsors, banks, mutual fund families , insurance companies, etc.), what is offered in the plan and whether the investment menu quality is adequate enough to provide growth opportunities, and how soon the employee may begin to use the plan (vesting schedules). These are, to say the least, unique to each company.

After determining what the company calls the "retirement goal line", a calculation that uses actuarial tables and assumptions of how long it will take the employee to get to retirement, BrightScope then runs a simulation, thousands of them. The better the plan, the quicker the plan participant gets to retirement, the higher the rating the plan gets on a scale of 1-100.

A Step in the Right Direction
It is no easy job being a plan fiduciary. BrightScope offers some much needed assistance with the task. Understanding that the responsibilities are many, including the need to act solely in the interest of plan participants and their beneficiaries, focusing their efforts towards the "exclusive purpose of providing benefits to them" is not as easy as it sounds. Not all companies have the personnel to achieve this sort of understanding.

Many times, the task of due prudence when overseeing these plans. the ability to follow all of the documents associated with the plan, being able to determine whether the underlying investments in the plan are diversified enough and cost effective (remember the fees are net of returns), is not always within the purview of the department responsible.

While you do have the right to request all of this information yourself and you can challenge the plan as being inadequate for your needs, BrightScope makes it easier to illustrate the problem. many companies believe they have done right for their employees. They may not know otherwise.

Check out your plan here.

Paul Petillo is the Managing Editor of BlueCollarDollar.com and a concerned Boomer.