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July, 2009:

Independent Advice – The “Secret” Secret of Successful Folks

Jul 30th, 2009
by jblankenship.
2 comments

secret by gotplaid.
In support of articles I’ve written here previously, the WSJ put out an article today that tells us “Investors Turn to Independent Advisers“.  Apparently, folks are beginning to understand that the “broker” isn’t working in their best interest.
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“The reality is that the brokerage firms are set up for the brokerage of products,” says Ms. Rosenband (a former Smith Barney rep). And even though brokers’ titles may have changed over the years to “financial advisers and consultants,” she says the culture at the firms hasn’t. As a result, clients were often confused about what they were getting, she says, adding that she brought over about 20% of her clients, mainly those who were primarily interested in a long-term approach.

I agree with the article, the average investor/saver/future retiree can definitely benefit by utilizing an independent fiduciary advisor over a brokerage sales rep.  I just hope this message is getting out to enough people to make a difference.

Photo by gotplaid?
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Roth IRA Eligibility

Jul 29th, 2009
by jblankenship.
1 comment

JDRothThe Roth IRA, as we’ve covered here many times, represents a very valuable retirement savings vehicle.  There are several reasons that the Roth IRA is so valuable, including:

  • qualified withdrawals are tax free
  • withdrawal of regular contributions is available at any time for any reason
  • there is never a Required Minimum Distribution for the original account owner

With all of these benefits, you can see why the Roth IRA has become a very popular option for retirement savings.  So the question now becomes: Am I eligible to contribute to a Roth IRA?

Roth IRA Eligibility

The eligibility requirements for a Roth IRA are as follows:

  1. You must have earned income.  This means you receive compensation in the form of wages, salaries, tips, professional fees, bonuses, commissions, self-employment income, nontaxable combat pay, and taxable alimony or maintenance.
  2. Your Modified Adjusted Gross Income (MAGI) must be less than:
    1. $169,000 (for 2009) if your filing status is Married Filing Jointly or Qualifying Widow(er); or
    2. 116,000 (for 2009) if your filing status is Single, Head of Household, or Married Filing Separately (and you did not live with your spouse at any time during the year); or
    3. $10,000 if your filing status is Married Filing Separately and you lived with your spouse at any time during the year.

And that’s it.  You are not limited by participation in an employer-sponsored plan as you are with deductibility of a traditional IRA.  There are a few limiting factors, though:

  1. You cannot contribute more than your earned income.
  2. A spousal contribution is allowed, as long as the total of contributions to personal and spousal IRAs doesn’t exceed the total of your personal and your spouse’s earned income.
  3. You are limited by an annual amount (for 2009 it’s $5,000 with an over age 50 “catch up” of $1,000).  This means that your total IRA contributions (traditional and Roth added together) cannot exceed that annual limit.
  4. When your MAGI reaches a certain amount, your contribution amount will begin to be limited.  You can visit this page for more details on the MAGI limits and how they are applied.

Note:  Yes, the gauntlet has been tossed out there… we’ve increased from a Roth Trifecta to a full-fledged Superfecta of Roths.  Incidentally, in the wild, I believe a group of Roths is known as a “proth”.

One million extra points for the first comment to name all four of our Roth IRA “hosts” so far.

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Medicaid and Retirement Accounts

Jul 24th, 2009
by jblankenship.
2 comments

Statistics are telling us that approximately 25% of us will need some sort of extended long-term nursing care during our lives – and as our life spans increase with improvements in medical care, this number is likely to go up.

Most of us have had situations with family or friends where we’ve witnessed this firsthand – and since Medicare doesn’t really provide much in the way of long-term care benefits, the individual is left with three possible sources to pay for long-term care:

  1. private payments from your savings and other sources
  2. long-term care insurance coverage (LTCI)
  3. Medicaid

old man and sheep by Kris HaamerGiven the tremendous costs for long-term care, many individuals are faced with the distinct possibility that any savings that they have amassed over their lifetimes (and that they hoped to pass along to their heirs) could be quickly wiped out or drastically reduced with a stint in a skilled-care facility.  Then who will take care of the sheep?

Medicaid

Briefly, Medicaid was originally introduced in 1965 as a “safety net” for healthcare, directed to poverty-stricken people.  Along in the late ’80′s, it became clear that this safety net could be quite beneficial to people of modest means, and so the laws were changed to allow for additional beneficiaries of the program through some simple planning.  Later during the early ’90′s, some of the eligibility requirements were tightened up a bit, but there is still benefits to be had for folks who need them.

Eligibility for Medicaid is based upon the amount of assets available – only about $2,000 is allowed to remain in savings vehicles.  Community (joint) accounts are subject to special rules, and depending upon how your state chooses to administer the program, half of these jointly-held accounts could be used as eligible assets.  Other assets, including primary residences, annuities, and life estates, receive special treatment under Medicaid eligibility rules as well.

Retirement Accounts and Medicaid Eligibility

So how are your IRA, 401(k), and other accounts viewed with regard to Medicaid eligibility?  As a general rule, retirement accounts are included as available assets when considering Medicaid eligibility – even if the individual is under age 59½ and otherwise ineligible for distributions without penalty.  This account must be liquidated before the individual would be eligible for Medicaid coverage.

One way to protect assets from liquidation is if the account is in periodic payment status – such as subject to Required Minimum Distribution (RMD) either due to age 70½ requirement or if the IRA is inherited and subject to RMD.  In some states the account in periodic payment status is considered an income source rather than an asset, and so the circumstances might help to protect the account’s assets from being included as a whole for Medicaid eligibility.

For example, if an individual was in RMD status due to being over age 70½, his account would be considered in payment status.  If the account was worth $200,000, this amount would not be counted against him for Medicaid eligility, but the periodic income stream would be.  If he were age 72, his annual required payment from the account would be roughly $7,812, which would be considered for his income budget, approximately $651 per month.  If this was his only income, that amount would be reduced by $60 for personal needs allowances, and the remainder would be paid to the nursing home – with the balance of the cost of the nursing care paid by Medicaid.

If the individual is married and the other spouse is not subject to long-term care, there are allowances made for monthly minimum maintenance needs as well (this varies by state – see the link below for additional information on a state-by-state basis).

What About a Roth IRA?

So, if you’re thinking ahead you’re wondering how this impacts a Roth IRA… since a Roth IRA is not subject to minimum distribution rules.  Rightly so – the Roth IRA is never in a payment status as long as the original owner is living, and as such, Roth IRA assets are counted toward Medicaid eligibility status.  These assets would have to be spent down before the individual could become eligible for Medicaid.

Bottom line…

So the bottom line is that you need to consider lots of things as you think about Medicaid eligibility.  If you have significant assets available, you could be better off to consider a Long-Term Care Insurance strategy, as otherwise your assets might have to be spent down and quite possibly depleted.  Unfortunately there isn’t a “rule of thumb” to use in determining whether LTCI makes sense – each individual’s situation will be a little different, taking into account medical history, family medical history, asset base, age, etc..  This is the sort of analysis that you should do as you near retirement age in order to consider whether or not LTCI or Medicaid could be a part of your future healthcare plans.

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Let It All Go – IRS gives you 11 years…

Jul 23rd, 2009
by jblankenship.
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octocostume by SappymoosetreeWhen you were a kid, did you ever dream of being able to just let it all go – not having to follow any rules, no penalties, no restrictions?  What if I told you that the IRS provides you with just such an environment – where you are free to literally do (or not do) anything you want with your IRA?  Including buying yourself that octopus costume you always wanted?

So just where is this nirvana?  Where you can just go willy-nilly and do whatever suits you with your IRA?  It’s not a where, but rather, when.

Between the ages of 59½ and 70½ there are no rules or restrictions regarding withdrawals from your IRA – including no required withdrawals.  How ’bout them apples??  That’s a full 132 months where you can take money out of your IRA at any time, for any reason, and there are no consequences!  Well, other than having to pay ordinary income tax on the tax-deferred withdrawals.  You’re also free to not take money out of your account, if you wish – a privilege that you might yearn for after you reach the end of this free-for-all time.

And it gets better if you have a 401(k) – you have from age 55 to age 70½ with no restrictions, the only additional requirement being that you have separated from service (left your employer) on or after age 55.  And many employers are stepping up and helping folks out with that lately – hardly a day goes by without hearing of someone “separating from service”.

So – when everything seems to be going against you, you can sit back and think about how the IRS has given you this wonderful span of time… eleven full years… with no restrictions.

Ahhhhh – feeling better now?

Photo by Sappymoosetree
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IRD from an IRA

Jul 22nd, 2009
by jblankenship.
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Aretha by ClevelandSGS

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The topic of Income in Respect of a Decedent (IRD) can be a particularly confusing aspect of the tax code – but it doesn’t need to be. Put simply, IRD is any income that a decedent would have received had death not occurred – that has NOT been included as income on the final return. In essence, this rule provides that certain items in the estate, specifically income items, do not receive a step-up in basis. This income has to be accounted for on one of three tax returns:

  • estate
  • beneficiary
  • other assignee (of right to income)

If you are the beneficiary of an IRA and are required to include some IRD on your tax return, you may be eligible for a special IRD deduction. This deduction is limited to any estate tax that has been paid on the income received in respect of the decedent. This would have to be a significant-sized estate, since the applicable exclusion amount for 2009 is $3.5MM – although this is set to change in 2010 with the sunset of the EGTRRA provisions (stay tuned to this channel for more news as it becomes available!).

It is important to note that the IRD deduction is only available for federal estate tax – your state estate tax may or may not be deductible, you’ll need to check that with your state authorities.

IRD from an IRA

From an IRA, IRD would include any income that you receive that was a portion of the gross estate. Any growth that occurs after the date of death of the original owner becomes income to the beneficiary, and therefore is not IRD. Any estate tax that can be attributed to that IRD is deductible as a miscellaneous deduction on Schedule A of Form 1040 – and this deduction is NOT limited by the 2% floor as are most other miscellaneous deductions. If the IRA had basis – that is, if the IRA included non-deductible contributions – then those contributions are not taxed to the beneficiary as IRD. Income tax has already been assessed on these amounts.

Roth IRA Nuances

For a Roth IRA, the IRD would only include income received via non-qualified distributions, and then only the portion that represents growth in the account. The main way that you could get caught by this one is if the IRA has not been established for the required five-year period prior to the death of the original owner. Any income (growth) in the account up to the date of death is IRD, the contributions are tax-free, and any growth after the date of death is income to the beneficiary.

IRD Deduction

To calculate the IRD deduction, you need to know the amount of the taxable estate, the amount of tax paid on the estate, and the value of the IRD item(s) in the estate. As an example, we’ll say we have an estate valued at $5MM, and an IRA worth $1MM. On the entire estate, we paid tax of $675,000.

Next, we calculate the estate tax on the value of the taxable estate without the value of the IRA – and we come up with $225,000. So the estate tax attributable to IRD is $450,000, or 45% of the IRA value. So, as we take distributions from the IRA, we are allowed to claim a deduction of 45% of each distribution until the entire $450,000 attributed estate tax is used up. This deduction offsets (in theory) the fact that you must include the distribution as ordinary taxable income.

Once again, this is not an activity for the faint of heart. I suggest working closely with your tax pro to make sure that you’re calculating things correctly – it can amount to some sizeable tax issues if you’ve fouled it up somehow.

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Linksharing 7/19/2009

Jul 19th, 2009
by jblankenship.
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Abraham Lincoln by cliff1066Linkin’, Linkin’, I’ve been thinkin’…*

Quite a list of articles in this week’s Linksharing, let’s get right to it:

On the Affine Financial Services blog, Helen provides us with an interesting perspective on Roth IRA conversion planning for non-traditional families, with her article No Aversion to Conversion.  I always find an interesting read when I get the feed from Helen, and this one is no exception.  And then, as if writing compelling blog articles wasn’t enough to get my attention, she gave me the honor of a mention in her weekly rundown of notable blog posts!  Thanks Helen.

Mike, over on the Oblivious Investor blog, wrote two articles I wanted to highlight this week.  The first is a diagram explaining Why We Invest In Actively Managed Funds, and I have to say, by jove I think he’s got it!  With a simple illustration he points out so much that’s working against the little guy in the financial services world.  The second article is compelling not only for the post itself, but also for the comments thread – take a look at How To Be A Successful Investor and you might learn a thing or two…

Dave, on his blog I Hope To Retire Someday, wrote an interesting perspective on how Fear Can Be Good And Bad For Financial Planning – I think it deserves a look, to see if you can recognize how fear has impacted your decisions… And then, later in the week he makes a move which causes me to call his judgment into question, by making note of one of my articles on his weekly review of blog posts.  Thank you for the honor, Dave.

Another blog that I try to read as often as possible is Frank Curmudgeon’s Bad Money Advice – and this week he had a gem of an article entitled Annuities and Baby Boomers – discussing the reasons that annuities aren’t more popular among retirees.

Lon, my colleague from the Net Worth Advisory Group, wrote a very good article, reviewing What Should I Look For In A Mutual Fund?, and then followed up with a good basic explanation in What is an IRA?

Fellow Garrett Planning Network member Diane Blackwelder of Charleston Financial Advisors wrote about our behavior as investors and what we might expect to do in resolution in her article Closing the Behavior Gap.

Last but not least, on the IRS Hitman blog, Richard Close provides us with some insights for Newlywed Tax Tips.

Hope you’ve gotten a few nuggets of financial goodness out of all these – I know I did.  Take care until next week!

* 1000 extra points to the first person who attributes that quote – even though I homonym’d Lincoln… 

Photo by cliff1066
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IRA Inheritance – Not Taking Timely Distributions

Jul 18th, 2009
by jblankenship.
1 comment

inheritance by Marco BellucciA commenter from my post on splitting an inherited IRA sparked this particular post – his question was “What are the consequences for not re-titling an inherited IRA as F/B/O?”  You can see my response to that specific question at the original article…

But that question sparked the idea of discussing what happens when a beneficiary doesn’t act in a timely fashion with regard to taking Required Minimum Distributions from the inherited IRA?  That’s our topic for today.

The Inheritance

So, let’s say you inherited an IRA from your mother – this was her own IRA that she had contributed to or rolled over funds from a qualified plan at some point, and had designated you as the sole primary beneficiary.  Things get really hectic and confusing after the death of a parent, and sometimes we don’t cover all of the bases properly… and in this example, you didn’t realize that you needed to begin taking Required Minimum Distributions (RMD) from your inherited IRA as of December 31 of the year following the year of your mother’s death.  As of now, for example’s sake, let’s say we’re in the fourth year after your mother’s passing. (see Notes below)

At this point you have two choices:  take the entire balance of the IRA as a distribution before the end of the fifth year; or “unwind” the mistake by taking your RMDs for the first four years, paying the 50% excess accumulations penalty on each distribution, and then continuing on with your lifetime RMDs.  In each case, of course, you would be required to pay ordinary income tax on the distributions.

Five Year Distribution

This one is the “default” distribution option – and the rules are that you must take the complete distribution (either a series of payments or a lump sum) within the five years following the year of the original owner’s death.  In the example we’ve started, this means that you have roughly a year to complete this distribution. 

Since ordinary income tax is owed on distributions from your inherited IRA, if the balance is significant this could represent a sizeable tax bill for you.  It might even put you into a higher (or much higher) tax bracket, causing lots of unnecessary additional tax – if you took the other route.

Unwinding the Mistake

In order to avoid the excess taxes described above in the Five Year Distribution, you would need to go back and take distributions for the three prior years that you missed, based upon your Table I factor.  For example, let’s say your inherited IRA was worth $100,000 at the end of the year in which your mother passed away, and your age in the following year was 28.  According to Table I, your life expectancy is 55.3 years.  Dividing the IRA balance by 55.3 gives us a RMD of $1,808.32.  That’s your first distribution.

Continuing the example, you’d use Table I again along with the balance of the IRA at the end of the first year (minus $1,808.32) to come up with the RMD for the second year.  For the sake of the example we’ll assume that the IRA is growing at a fixed rate of 5% per year, and so the balance at the end of the second year is $105,000, which you subtract $1,808.32 from to come up with your balance of $103,191.68.  Your Table I factor for this year (age 29) is 54.3, yielding an RMD of $1,900.40.

For the third year, your IRA has grown to $110,250.  Subtracting your two years’ worth of RMD leaves you with $106,541.28, and your Table I factor is 53.3, giving you an RMD for the year of $1,998.90.

Adding these three years’ worth of RMDs together equals $5,707.62, which you’d take out in a distribution for the prior years.  This amount is subject to ordinary income tax (just like your W2 wages), but is also subject to a special tax on “excess accumulation”.  This tax is for failure to take RMDs in a timely fashion, and amounts to 50% of the distribution that was required, or $2,853.81.  While you could take this amount out as an additional distribution, keep in mind that you’d have to pay ordinary income tax on that amount - but at least you wouldn’t have to pay the 50% penalty on it.  You’d probably be better off just paying in half of what you take out in the RMDs, since you hadn’t had that money in your hands anyhow…

For this year, you would also need to take a RMD – and continuing our example your IRA balance at the end of last year was $115,762.50 – from which you would subtract the RMDs of $5,707.62, leaving $110,054.88.  Your Table I factor is 52.4, which provides you with an RMD of $2,100.28, which you need to take as a distribution by the end of the year.  (For this particular year, 2009, you do not have to take an RMD at all since RMDs have been waived for this year, but you’ll need to continue this RMD calculation process for each year hereafter unless other waivers are put into place.)

Don’t Try This At Home, Kids

I know I’ve cautioned you about this before, and perhaps you see it as a little self-serving (tax guy recommends a tax guy, duh!) but you can really cause yourself some extra grief if you foul this one up.  It would be worth it to have a tax professional review your calculations at the very least – and to tell the truth, you’re probably just as well to have the tax guy do the calculations for you because the cost is likely about the same for him to review your work as to do it himself.  The tax pro can help you with the required filing of Form 5329 (to account for the excess accumulation tax) as well.  In addition to the tax, interest may be owed as well on the accumulation tax due in prior years.

Notes:

It should be noted that the fact that the decedent is your parent is not critical to the facts of this example – only that you are inheriting the IRA from someone other than your spouse.  A spousal inheritance is a different animal altogether.

A factor of this example that IS important is that the IRA belongs specifically to the decendent and is not an inherited IRA.  If you’ve inherited an IRA that was already an inheritance, if it was specifically directed to you as the designated beneficiary then the rules are the same – but if you received the IRA via the estate, you’ll have to follow the five-year distribution rule exclusively.

Lastly, it is also important to note that the example only identifies a single primary beneficiary – if there is more than one beneficiary, the process described would be complicated by the fact that the oldest of all the beneficiaries (with the smallest Table I factor) would be the one whose distribution period is used for all beneficiaries, since the IRA was not split by the end of the year following the year of the death of the original owner.

Photo by Marco Bellucci
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Splitting Inherited IRAs

Jul 16th, 2009
by jblankenship.
6 comments

These things can give you a splitting headache…

splits by cheetah100In the case of an IRA, often it is desirable to split an account into two (or more) accounts in order to better accommodate a distribution plan upon the death of the primary owner of the account.  This can be done prior to the death of the IRA owner, or it could be done after the death of the IRA owner, as long as it’s accomplished before the end of the year following the year of death.

Why is this important?

When an IRA is inherited by a non-spouse individual, that individual is required to begin taking distribution of that IRA, based either upon their own age or the age of the decedent.  In most cases when the beneficiary is younger than the decedent, it is advantageous to stretch those payments out over the longer period of time.

If there is more than one beneficiary, unless the IRA is split, the Required Minimum Distributions will be based upon the attained age of the “designated beneficiary” – who is the oldest beneficiary as of September 30 of the year following the year of death.

If you’ve split the IRA into separate IRAs for each beneficiary, each titled as “John Jones, deceased, FBO Jane Brown” (probably not exactly like that because the names will be different in almost all cases), then the individual IRAs can be distributed according to the age of each individual beneficiary.  The IRA must be split by December 31 of the year following the year of death.

Note: bear in mind that you don’t have to have the IRA split into separate IRAs for each beneficiary by September 30 of the year following the year of death – this is just the administrative date for determination of the designated beneficiary.  In the event that the IRA is split into separate inherited IRAs by December 31 of the year following the year of death, then administratively the designated beneficiary of each separate IRA as of September 30 would be the individual “FBO” owner of the account.

Photo by cheetah100
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Why We Use Commodities in Investment Portfolios

Jul 15th, 2009
by jblankenship.
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Continuing the theme we used last month, that of exploring the components of a properly-diversified portfolio, we now turn to Commodities.

What Are Commodities?

wheat corn and sky by smoorenburgFirst of all, let’s talk about the nuts and bolts of commodities as an investment.  These are among the oldest type of investments in our financial marketplace, and the trade of commodities grew out of the need by both producers and consumers of various goods to reduce price risk into the future.  It could be a farmer hoping to nail down a price for his crop in advance, or a convenience store chain locking in a price for gasoline… the idea is to reduce risk of volatility in prices when either the need to consume is ripe, or when the product is ready to be delivered.  This is accomplished at a cost to the producer and/or consumer – known as a risk premium – that allows the buyer (or seller) at the other end of the transaction a potential profit benefit for taking on the risk.

Put simply: if a farmer has a potential 10,000 bushels of grain that will be available for delivery in three months, he seeks to lock in a price for his grain that represents a profit against his expenses.  He sells his grain in the future (actually purchases an option to sell) at a specified price.  The seller of the option has taken on the risk that the price of grain will be lower at that point in time (when the contract matures), since he is in essence taking responsibility for that grain when it is delivered.  On the other hand, if the price of the grain at the time of the contract maturity is higher, the option seller stands to make a profit from the transaction.  (It should be noted that the seller of the contract makes a certain amount, the risk premium, either way – but if the current price of the commodity is considerably lower at maturity of the contract, he’d still lose money on the deal.)

It works similarly on the consumption end – continuing our example of the grain above:  if a bakery wants to lock in the cost of grain to make flour three months in advance, he might enter into a contract to buy grain at a certain price.  (Keep in mind, the price that the farmer sells the grain and the price that the bakery buys the grain will not be equal – hence the risk premium.) The seller of the grain (could be the same guy) takes on a risk that the price of the grain at delivery is higher than the contract price, while vice-versa, would stand to make a profit should the price of the grain come in lower than the contract price at delivery.

Of course, the real world isn’t as simple as my example – because that guy who sold the options to the farmer and the baker?  He’s likely to change his mind about how prudent those choices were when he made them, and look to find someone else to take on the contracts.  He might sell them for less than he got for them (if he believes that the end result would be worse!) or he might envision a higher value for his option contracts (and get it) if the market will bear his selling at a higher price.  And so it goes…

Note – I know that there is bound to be a commodities-trading guru out there who’ll look at my explanation and say “that’s pretty dadgum oversimplified” but the spirit of the concept is correct enough for this article, so calm down, would ya?

Why Do We Include Commodities In Our Portfolios?

Wait a second, we’re not quite ready to answer that question – first a word about correlation… no, wait – how about some examples of various commodities first, then correlation?

Examples of Various Commodities

There are lots of different commodities, but some of the major ones are:

  • Crude oil
  • Natural gas
  • Gold
  • Soybeans
  • Copper
  • Aluminum
  • Corn
  • Wheat
  • Live cattle
  • Pork bellies
  • Frozen Concentrated Orange Juice (FCOJ*)

Correlation

If you’ll recall from previous conversations, the reason that we have more than one type of asset class in our portfolio in the first place is to diversify.  And in order to be diversified, our various asset classes must not mirror rises and falls in the values of the other asset classes in our portfolio.  This “not mirroring” is known as non-correlation – in other words, if two investments (or asset classes) always go up and down in similar proportions at the same time they are said to be correlated.  If, however, when one investment or asset class goes up the other asset class either stays the same, goes down, or goes up but not at the same ratio, the two classes are exhibiting non-correlated behavior.

Of course by sheer happenstance there will be times when both assets move up in the same ratio as one another, but if we studied them over long periods of time we’d see the degree of correlation that they have to one another.  If the two asset classes always move the same way in the same amounts they would have a correlation ratio of 1.  If they always move in opposite directions in the same amounts, the correlation ratio is -1.  Anything in between those two would be represented by a decimal (either positive or negative), expressing the degree to which the two asset classes were correlated.  If the two show no relationship whatsover to one another, correlation is said to be zero.

Are We Ready to Answer the Question Now?

Yes, now we’re ready.  In case you forgot, the question was “Why do we include commodities in our portfolio?”  The answer is that commodities have, over significant periods of time (and shorter-terms in case you’re wondering) displayed a negative correlation to the stock market – both US domestic and foriegn – while at the same time maintaining a positive correlation to inflation.

What this means is that when we have investments in both equity (stock) and commodities, we can expect to have a portion of our portfolio on the increase any time the other portion of our portfolio is decreasing.  Sounds like the best of both worlds, right?  This is the benefit of diversification in action.  We can add commodities to a portfolio quite simply, by using a mutual fund or exchange-traded fund (ETF) that follows a commodity index.

Now, obviously we wouldn’t just have the two asset classes in a portfolio, although you could do much worse, I suppose.  No, in general our portfolio should include both domestic and global equities, including emerging markets, plus a portion of fixed income (generally domestic, government and global), along with commodities, real estate (domestic and foreign) and timber.  Varying the proportions of these asset classes is how we increase our risk and therefore our potential for reward.  We’ll talk about Timber as an asset class next month.

Photo by smoorenburg

* one thousand extra points to the first person who leaves a comment with the title of the movie in which FCOJ played a major role.

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You’re Not (necessarily) In Control

Jul 14th, 2009
by jblankenship.
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So you’ve set up your 401(k) with your employer’s administrator, made your allocation choices, and everything is set to go.  You’ve got this retirement saving thing by the tail, right?

control by faramarzNot so, Mona Me. (or is that mon ami?) Or at least not completely so.  You see, way back in the bad old 2006′s (before all the hope and change), Congress passed the Pension Protection Act, which had a provision in it that allows employers to automatically enroll employees in retirement plans, and even make default investment choices for them.

Doesn’t apply to me, right?  Since I enrolled on my own and made my own choices for allocation of my investments… right? Once again, Mona, you’re not completely correct.

The Most Common Change

The plan sponsor (your employer) can make changes to the funds available for investment choices at any time.  So, instead of that no-load broad market fund that you originally chose, now you have a loaded (yes I know they’re usually waived loads in 401(k)’s) high expense ratio fund that doesn’t really accurately represent the total domestic equity market very well.

And your employer can make this change any time they want – maybe it’s to get their son-in-law an additional commission since he sold the plan.  But then again, maybe it’s just because the bossman read an article that said A shares were superior to all other investments, or something equally idiotic.

The Other Kind

Another possible way that your employer could change your allocation plan in your 401(k) account is if it was determined that your account wasn’t diversified enough.  Seems pretty big-brotherish, but it’s still a possibility – although according to this article in the WSJ, “So far, plan sponsors aren’t re-enrolling just because they think a participant isn’t properly diversified…”.

Default investments can be changed on a whim as well – from a basic money market account to, perhaps, a costly stable-value insurance product.  And when these choices are changed, your money is automatically moved.

The Bottom Line

So – the watchword you should take away from this is that you need to pay close attention to communications that you company sends you regarding your retirement plan.  None of these changes can be made without communicating the change to you in advance – but if you are like most folks when you get that pack of paper and the book written on recycled cigarette paper, the last thing you want to do is sit down and study it over, right Mona?

Particularly pay close attention when your company sends you a letter explaining any changes to the plan.  These are supposed to be concise and easy-to read, so watch for them.  Usually when funds are going to be automatically moved you’ll get some notice in advance so that you can choose something different from the default.  This may be helpful, or it may not – but you’ll be in a position to have better control over your fund.

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