If you employer matches your 401k contributions:

1. Invest in your 401k up to the amount to get the maximum match
2. Then invest in a Roth IRA if you are eligible
3. Then invest in your 401k again (no match)

If you employer does not match

1. Invest in a Roth IRA if you are eligible
2. Invest in your 401k

The situation is more complex if you are not eligible to contribute to a Roth IRA  with many contingencies that are best handled on a case by case basis.  Also, if your employer has a high cost 401k plan you may actually be better off investing some of your funds outside of your 401k in a regular taxable account once you have invested enough to receive the maximum 401k match.

The reason why Roth IRA contributions are a better bet for most people vs. a regular 401k contribution include:

1. Tax rates are likely to be higher than they are today in the future when you withdraw your 401k contributions.
2. You will have Required Minimum Distributions from a 401k plan at age 70-1/2.
3. Your heirs will required to take distributions from your 401k plan and pay taxes on them.  There are no required distributions from a Roth IRA and any distributions are tax free.

Does this mean that you should use active managers for poorly performing asset classes?   No.  The problem with this conclusion is not that actively managers are picking better stocks in their primary asset class but they are moving outside their designated asset class to try and improve performance.  When they do this they change your overall asset allocation and risk/return profile without telling you.  If you wanted to you could do the same thing with index funds but at least you would be aware of the changes you were making.

The article also did not address if they active managers’ performance was after all fees and expenses.  Actively managed funds have management fees that average 6x higher a low cost index funds.   In addition if you buy an actively managed fund through a broker you load fees in addition.  There is also the issue of taxes.    An actively managed fund turns its stock portofilio over about 3x/year which could generate signficiant short-term capital gains on which the mutual funds shareholders are taxed on lowering their overall retrun.  An index fund may only turn over 20% or less of its portfolio generating much lower taxable gains.

My advice:  Stick with low-cost index funds, for superior long-term performance.

They would rather have the guaranteed lower cost of an index fund vs. the unfulfilled promise of better performance through an actively managed fund.

This is the strategy that I use with my clients.  Although some actively managed funds will out perform an index fund the percentage that do is actually less than chance would predict.  It is also difficult to predict which managers will outperform and index fund year after year.  This is especially true for bond funds.  According to Morningstar the Vanguard Total Bond Market Index Fund has outperformed 83% of its peers over the last 10-years.

Index funds charge substantially less than their actively managed peers.  A low cost index fund costs about 1% per year less than its actively managed peer.  That means that the actively managed fund would have to outperform the index fund by 1% per year just to be equal.  That is very difficult to do for almost all managers.

Check the http://www.napfafoundation.org/ website for updates on when the bus will be coming to you.

For joint filers the rebate begins to get phased out when you Adjusted Gross Income (AGI) is greater than $150,000. After that you lose $50 for every $1,000 your income is over the threshold.  For example, if you AGI is $160,000 you rebate is reduced by $500.

For those filing as single the threshold for a reduced rebate begins at $75,000.  Your $600 rebate would be reduced to $0 once your AGI reaches $87,000.

For those of you getting a rebate below are 5 great things to do with it:

1. Increase your contribution to your employer’s 401k/403b to get the full match. For an employer that matches $.50 for every $1 you contribute your $600 rebate is instantly worth $900.

1. Contribute to a Roth IRA.  With a Roth IRA your earnings grow tax free. In 25 years that $600 could be worth $4800 with no tax due when you withdraw it!

1. Pay off high interest credit card debt.  If you are paying 24% interest on a credit card paying it off is like getting a 24% return on your investment.  Paying $600 would save you $144/year in interest payments

1. Start an emergency fund.  This is the money you use when the car breaks down etc. instead of running up a credit card debt.  Open a high yield internet savings account at www.ingdirect.com, www.emigrantdirect.com or check www.bankrate.com for the latest savings rates.
2. Open a 529 account for college savings.  The Bright Start Illinois Plan was ranked as one of the best in the nation by the Wall Street Journal.  Plus Illinois residents get a state tax deduction for any money they contribute. See www.brightstartsavings.com

]]> http://longfinancialplanning.com/blog/2008/05/01/why-you-may-not-get-a-rebate-check/feed/ 0 http://longfinancialplanning.com/blog/2008/02/08/more-attention-focused-on-401k-fees/ http://longfinancialplanning.com/blog/2008/02/08/more-attention-focused-on-401k-fees/#comments Fri, 08 Feb 2008 17:22:50 +0000 Chris Long http://longfinancialplanning.com/blog/2008/02/08/more-attention-focused-on-401k-fees/ The Marketplace radio show on National Public Radio recently ran a two part segment on 401k fees. They focused on how small employers and their employees don’t understand these fees and how much they can reduce retirement savings.

Of course, the banks,brokers, and insurance companies think the present system is pretty good. After all, if people don’t know what they are paying they are willing to pay a lot!

Listen to Part 1 of the show

Listen to Part 2 of the show

If you are responsible for your small organization’s 401k plan and want to find out how to get a low cost plan with full fee disclosure that’s easy to understand, check out my website for employer plans at http://www.longfinancialplanning.com/for-business-and-non-profits

• 403(b) plans will have a fiduciary responsibility to their participants like 401(k) plans.
• They will have to have a Plan Document and Investment Policy Statement like 401(k) plans.

How does that affect you?

If you are a plan sponsor you will be required to:

• Ensure that your plan’s costs are reasonable (some high cost annuity plans have expenses in excess of 2% per year that is really high!)
• Have a written Investment Policy Statement that outlines how the investment choices in the plan are made and how you ensure your costs are reasonable.
• Take fiduciary responsibility for the plan. That means that you are on the hook!  One way you can show you are taking fiduciary responsibility is to contract with a Registered Investment Advisor to advise you on the plan’s investment choices, and provide education to your employees.  If you choose to work with an adviser make sure that your advisor is independent does not receive compensation from any investments that he or she recommends.  You can find one at www.napfa.org

If you are a plan participant:

• You will be able to hold your employers accountable if you have a bad plan.  I define a bad plan is one with ongoing asset based expenses in excess of 1.5% per year. A really bad plan would be one with ongoing asset based expenses in excess of 2% per year.  These expenses include mutual fund expenses, wrap fees, annuity fees, commissions and any other fees that are based on the assets in the plan.  If enough people complain your employer may change the investment choices and fee structure of your plan to lower cost options.
• You will be able to complain to the Department of Labor if you feel that your employer is not meeting it’[s fiduciary duty to keep plan costs reasonable.
• You will still have the right to choose a mutual fund company outside of the choices provided by your employer but that mutual fund company will have to be approved by your employer.

What can you do now?

• If you are a sponsor read the IRS model plan language at http://www.403bwise.com/pdf/model_plan_irs.pdf
• Find out the cost of your current plan.  You can request a list of Questions to Ask about 403(b) Plan Costs by contacting me through the Contact page of the Long & Associates LLC website.
• Start planning for the changes now. You may want to engage the services of an advisor and record keeper who works with 403(b) plans to review your current investment options, and begin drafting a new plan document and Investment Policy Statement.
• Keep up on the changes as the regulations are written at www.403bwise.com

Main Advantages to Rolling Over Your 401k Plan to an IRA:

• Consolidates all of your retirement assets in one place (especially if you have several jobs all with 401k plans)
• You control your investments especially important if your old employer had poor investment choices in their plan

Now for some higher income earners you may be better off keeping the money in your old plan or rolling directly to your new employers plan.

Here’s why:

• Beginning in 2010 the $100,000 income limit to convert a Traditional IRA to a Roth IRA is lifted.
• But if you do convert your Traditional IRA to a Roth all of your Traditional IRAs are treated as one IRA for the purposes of conversion. If you have a large Rollover IRA with no basis, and a smaller Traditional IRA that no made non-deductible contributions to they will be treated as one IRA and you will have to pay tax on most of the conversion.
• If you don’t rollover your 401k to a IRA the only Traditional IRA you would have is the one you made non-deductible contributions to.  When you convert to a Roth IRA you would only pay taxes on the earnings of your Traditional IRA.

Example 1:

Jane has a 401k worth $200,000 and a Traditional IRA that she made non-deductible contributions to of $20,000.  She rolls the 401k into a Traditional IRA so now she has:

Rollover IRA $200,000 (Basis = 0) All of her 401k contributions were tax deductible

Traditional IRA $20,000 (Basis = $18,000) Non-deductible contributions =$18,000, earnings = $2,000

She decides to convert $20,000 to a Roth IRA in 2010.

Since all of her IRAs are added together for the purpose of conversions $18,000 of the conversion will come from her Rollover IRA and $2,000 will come from her Traditional IRA.

Assume Jane is in the 25% tax bracket.

Taxes = $18,000 X 25% (Rollover IRA) + $2,000 X 10% (portion of Traditional IRA that is taxable) X 25% = $4,500+50 or $4,550

Example 2:

Jane does not rollover her 401k into a Rollover IRA but either leaves it in her old employer plan or rolls it into her new employer plan.  Therefore she only has her Traditional IRA

She decides to convert her $20,000 Traditional IRA to a Roth IRA

Taxes = $20,000 X 10% (Portion of Traditional IRA that is taxable) X 25% =

$500

By not rolling over her 401k into an IRA Jane would save over $4,000 in taxes.