Thursday, May 28, 2009

Retirement Planning: Your Business Plan for Retirement, part two

As I explained in part one of this series, more than just a great business idea makes a business successful. More than simply wanting to strike out on your own, make money as your own boss and create a reality out of a vision, a business, now matter how big or small must have an exit strategy for its creator. It might be a legacy, a business that you would like to see passed on to your heirs. It might be a stepping stone to bigger and better opportunities down the road. But what it should be, all things dreams of success aside, is a bridge to the day when you are no longer working.

To consider retirement at the onset of your company's creation is paramount to that goal. We may say we are working for the glory and the independence, the profits and the satisfaction but in truth, we are working for the payoff.

While the solo 401(k) is designed for the business of one, often times that business will grow to include other people. Product lines expand as your success grows. Contracting out work can be a temporary stopgap yet if you would like to see your business grow to entice more customers and control the quality of your projects, you may need to hire people to work with you in those goals, folks who share your ideals and passions, the same people who, because of their dedication will also be deserving of a piece of the profits generated.

A SEP-IRA can fill those needs nicely. But like all taxable events, the rules need to be followed. SEP-IRA or self-employed pension individual retirement account allows you, the employer of one or more, to share in the profits of your business by making contributions to this type of plan.

It acts just like a traditional IRA would with added feature of shifting contributions. In good years, the plan can allow contributions of up to $49,000 per employee. This contribution is tax deductible for the business and the growth of those funds is tax deferred. In years when the business profits falter or are simply subject to cyclical changes, the contribution can be lowered or eliminated completely.

SEP IRA is a retirement plan designed to benefit self employed individuals and small business owners. Sole proprietorships, S and C corporations, partnerships and LLCs qualify. In those circumstances, the company pays the business owner (you) a W-2 salary. In this situation, the annual SEP IRA contribution can be between 0% to 25% of the owner's W-2 salary up to the SEP IRA contribution limit. The caveat: you must also contribute to your employees the same percentage as was contributed to yours.

The contribution limits are slightly lower for an unincorporated business such as a sole proprietorship, unincorporated partnership or a LLC electing to be taxed as a sole proprietorship. In this instance, annual contributions are made into your SEP IRA account between 0 to 20% of your net adjusted self employment income. Either way, these are hefty savings allowances compared to the limits placed on other types of retirement plans.

One important thing to consider though: having a solo 401(k) as well. because a SEP-IRA is dependent on profits and if you have employees, sharing those profits with them, a solo 401(k), allowable as well alongside the SEP-IRA, gives you another opportunity to put away money for retirement from your income, which may not be reliant on the profits of the business.

Eligible employees must be at least 21 years of age and have worked for you for at least three years of the last five years. SEP-IRAs are easy to set up and cost effective, may have little or no paperwork to file with government and could net you a tax deduction of up to $500 for the first three years of the plan. Plans are administered by the employer through a mutual fund company. generally offering a simple basket of funds from which to choose.

While plan participants cannot borrow against their SEP-IRAs, they may roll them over to another qualified plan. And like all IRAs, are subject to the same withdrawal penalties and restrictions on age.

Next up: The simple IRA and the solo defined benefit plan.

Tuesday, May 26, 2009

Retirement Planning: Your Business Plan for Retirement part one

Those of us who write about personal finance will, almost by default attempt to explain your personal finances, even your marital finances, as a business endeavor. And as truthful as those analogies might be, it still doesn't prepare you for your own business. If the entrepreneurial spirit is truly alive, then chances are you have given some thought to opening your own business.

More than the business plan is needed. More than just that great idea; the one that you know is just what some consumer somewhere cannot live without. More than just that spirit of being your own boss. More than the freedom to call the shots, be the builder of your own destiny. Being in business for yourself is a huge risk against your retirement.

Your reliance on your skills will sap the very lifeblood out of you, leaving you thrillingly exhausted at the end of each day. It will be great and terrifying, all at the same time. And many of us will fund that venture with money that may not come directly from your previous employer's 401(k) - at least I hope not - but from money you could have put away for that future.

There is a way to not lose out on that future as long as you apply some of the principles that guided your retirement plan before you struck out on your own. And if you tapped those funds, there are ways to recoup those lost dollars quickly.

But you have got to act fast. Right from the beginning. Without a doubt, you will need a salary from your business. And just like when you had that other job, the one with the 401(k), you should account for a pre-tax retirement contribution.

There are several ways to get going. First, we will discuss the easiest one to set up. In the next post, we will talk about other plans to think about as your business grows.

The solo 401(k) is for a sole proprietor, a business of one. It was created for people with great ideas, folks like you Your business can have a spouse for an employee but generally, the self-employed, the entrepreneur, the small business owner must go it alone. The good thing about solo 401(k): simplicity.

Simple to use and easy to maintain, you may contribute up to $13,000 of tax-deferred income with a bonus incentive thrown in for good measure in allowing you to add up to 25% of profit from your business as well. You might be living on tuna and crackers, but this type of plan can allow the start-up business owner the advantage of playing 401(k) catch-up in a relatively short time. The contribution limit is $41,000.

The relaxed rules that come with a solo 401(k) offer you the ability to decrease your contribution or suspend it altogether. By try not to. Because other rules in the plan might come in handy during some rough spots in your business's future. Known as hardship withdrawals, these loans against your solo 401(k) often have more favorable terms than those plans administered by larger enterprises. You might, at some point in time consider rolling over your previous 401(k) into your new plan.

Yet, like everything that seems too good to be true, there are a few drawbacks to the to the solo 401(k).

First, you need to find a plan administrator. Typically, these might be mutual fund managers but not always. The fund families are generally less expensive (trust and equity companies can charge anywhere from $400 upward to set up the account, and an additional percentage or fixed fee on the balance of the account) costing about ten dollars to set-up the account and 0.25% against the account balance, it may on the surface seem like a no-brainer to chose these folks. But the funds they offer you may add additional costs to the account in the way of fees and some fund families, like Fidelity want $10,000 upfront to begin with any fund.

Here is a list of plan administrators (a downloadable pdf.).

You should also consider your business's growth potential. If its quick, and you anticipate hiring employees, setting this kind of plan up may be a waste of time. Once your solo 401(k) is set up and your business grows, you will need to transition to a traditional 401(k) sooner than you would have liked to - or had the time to.

If you do anything, keep this in mind: this is a taxable event and should have the stamp of approval on it from someone who is a professional. Find a good one through references or very good friends.

Next up, the SEP-IRA.

Thursday, May 21, 2009

Retirement Planning: Do You See What I See (in your 401K)?

Last year, Rep. George Miller, a California Democrat and chairman of the House Education and Labor Committee was not sure that folks understood how much their 401K plans were costing them over the lifetime of investing. He introduced a bill to the committee, interviewed mutual fund heavyweights like John Bogle of Vanguard Group, and eventually tried to get the legislation through Congress. He failed.

Now he is taking the same bill and trying again. Rep. Miller believes that it is what you don't know about that retirement account that could harm you more than the possibility of a market downturn. He acknowledges that the downturn stripped a great deal of wealth from many retirement portfolios. But he feels as though the hidden costs in these plans took them down further than they needed to go and, even as they fell, these fees continued to cost the investor.

Your 401K may be paying fees not only for the administration of the plan but also for the funds in the plan. This can often be hidden from investors when the markets are doing well. The problem for employers is much the same for the individual investor: although much of the language has become easier to read, it still has a long way to go to achieve full transparency.

Over a 20-30 year working career, these costs can deeply impact a retirement plan. Trading fees, investment fees, advisory fees or stewardship fees according to John Bogle's testimony last year can strip up to 75% of the plan's balance if unchecked.

Fixing this problem is not as easy at it sounds. Mutual funds continue to be less than forthright when discussing fees, shifting them to administer plans while declaring that their overall expenses are lower. Turnover rates within the fund, the presence of other funds with in the fund (often the case with life style or target-dated funds) hide other fees within fees, and the fact that what is often considered value funds may in fact be something much more risky all give the investor a veil of cost-effectiveness that might not be there.

Mr. Miller is shooting for disclosure first but openly shows his disgust for what is happening to these accounts, good markets or bad. In his opinion, and this blogs as well, the fees come after the average investor dutifully invests their money.

Some of the options on the table include the index fund and its availability in the average 401K plan. But as we have found out, this is not always as clear an option fee-wise as some would believe. And with SEC investigating the target dated funds, the offering that has caught fire recently as investors sought to protect their money by moving into a fund that promises to adjsut risk over time, shooting for disclosure is the right first step.

In the meantime, here's what you can do. Stick to only a handful of funds, spreading your investment among three to four sectors such as large-cap, mid-cap and small-cap funds with a fixed income (preferably something encompassing as much of the bond market as possible. Keep your index fund investment on the outside of your 401K plan - better to pay those taxes now rather than later. And until target-dated funds fess up and disclose what they really are, stay away from them. A little time and diligence can provide you with the same type of investment at a far lower cost.

Monday, May 18, 2009

Retirement Planning: What the Financial Planners are Thinking

We have a multi-dimensional problem when it comes to retirement thinking. We want to pinpoint numerous factors in our retirement plan, when in fact, the effort might be wasted. Much like the physicist who wants to measure a particle, quantum mechanics explains that it cannot be done, in part because it would change the particle by trying to stop it. Making a retirement plan pause gives you no measurable assurance that where you are right now is going to be the right move somewhere down the road.

These financial planners, their opinion which many will still turn to even if their advice led us down this road in the first place, are still called upon to give direction. I have neighbors who fret over the fate of their retirement accounts yet as soon as a son or daughter wants to make a financial decision, the first step is to set up an appointment with a financial planner.

Now these planners are looking for a way to regain your trust - many still have your business but largely feel uncomfortable with the disappointed looks on your faces. To address this, they have begun offering some suggestions, which although not new, they are a shift from too much risk to finding a way to eliminate what they see as unnecessary risk.

In a recent article to financial planners, The Investment News offers some suggestions that will no doubt be taken by their lobby group to Washington. They think that Social Security will remain a part of a retirement plan. They do concede that fixing this program will require not only a cut in benefits but an increase in taxes. Not very imaginative but keep in mind, this group is not likely to waste too many braincells on a program that produces no profits.

Instead, they are focusing on readjusting their client's portfolio from (age-appropriate) risk to vanilla risk (read that as a long-term relationship with folks who seek a way to get ahead by taking a much slower vehicle). This could add as many as ten years to your working life.

The net effect of working longer - besides working longer - is a more fully funded plan. But that funding will not have realized its full potential without a certain amount of risk. Many planners, as they restructure your plan for you will move your money into more costly types of investments that, on the surface, offer less risk.

Not all index funds are created equally and the shift into target dated funds does not come cheap and in some cases, are not a proven way to soften risk. Index funds can suffer from what is known as style drift, a way to enhance the return of the index by taking on an actively managed methodology.

Target dated funds are still suspect. There is no proof they do what they promise and do it for less cost. I have had problems with fund companies selling these funds as the risk free, cost effective ways to save the retirement community. And planners have become one of the forward sales makers for this product.

Adding to the list of products this group is looking to sell to lawmakers is the right to annuitize retirement income at age fifty. The thinking here is so simple, it is almost backward thinking. They are suggesting that the investor in a defined contribution plan take their money and essentially take it off the table, guaranteeing it will be there when they retire. This would allow folks who were unsure about the future to "buy" an annuity, with its high fees and suspect growth aspect instead of switching to a lower risk platform.

The suggestion that employers begin a retirement plan for all employees that have failed to do so and docking pay to fund it, seems, at least on the surface, to be a good idea. A bit Orwellian but the strategy is worth looking at for all workers before something like this becomes law. After that, the employer may pick the plan and in doing so, may not fully understand their fiduciary responsibility. But then, they would probably hire a planner.

Thursday, May 14, 2009

The Social Security Solution

Its nothing new. I mean, the solution. I've been an advocate for it for years and have taken my lumps from plenty of conservatives for that stance. On the other side of the aisle, there has been a muted acknowledgment that it might work but they fear, as most rich folks do, that they will be basically paying and not receiving back. I like to call it the boomerang effect. What you put in they believe you should get back out, eventually.

Nobody who makes a lot of money, taps their ability to invest and believes in the markets will really much like the idea. Conservatives call it socialism but its more like social security. Not the name of the program but the net effect.

We all know about the impending doom of Social Security (and the other two often mislabeled as entitlement programs for the poor, Medicare and Medicaid). We have seen it coming for years as economist and actuaries have been tapped for their expertise and foresight at seeing the future. Sure they crunch numbers and look at folks who earn this or that and they can make a pretty good determination of how much will be paid out compared to how much will be going in. But is this mostly an exercise in futility? Some would call it politics? Others might even see it as polarizing.

It is one of the few government programs that needs to be balanced and rebalanced in order to work. The accompanying suspicions that this will burden future generations unfairly and unnecessarily are always announced as someone pointed out, at the same time there is a huge get-together of the nations health insurance providers.

But what makes it so prone to future bankruptcy? Too many people withdrawing from the fund and no one replacing the missing benefits? To much borrowing? Too much debt?

When solutions are bandied about, the always seem to point to a payroll tax increase, a retirement age increase or a benefit decrease. Some even think a combination of the three might be even more beneficial. A payroll tax of just under two percent would fund the program for 75 years. Increasing the retirement age, as is currently happening, and less people can collect benefits leaving more in the fund longer. A benefit decrease is self-explanatory and might just be economically devastating to a large group of retirees.

A means test would solve everything. The current program is fair to everyone. But any changes in benefits does not distribute evenly or fairly. A means test would place the right amount of benefits where they are needed most.

Here's how it would (might) work:

We could shoot for a $15,000 a year retirement income as the threshold for full benefits; after that it would be reduced incrementally. Will this keep folks from investing for their future? Not really. If anything, it would allow people to draw on their retirement savings only as needed for longer. Add that to that threshold sum to the $15,700 estimated benefits thatand you have just enough to keep the retired person a consumer (which is really what we want them to be) and with enough cash to pay for their lifestyle. Retiring with more would only increase the quality of your retirement years and for those that focus on just such goals, they would not take their eye off of that target because they thought it might jeopardize the size of their SS check..

To make it fair, you could re-run the test every couple of years. That way, if a person with a reduced benefit (because they have so much that Social Security simply pays for pool maintenance) were to have a change in financial circumstances, they could be reconsidered.

If you consider the self-directed invested for retirement rates among all workers, most would not even come close to that mark, despite access to the markets. But many will and they will do it exactly the way they are now. But those that are not using the markets, and they number in the millions, will not be left as burden on the society you want to retire in.

The system was designed to keep the poorest from a poverty existence. We should restore it to its original purpose. It would have the net effect of keeping the economy moving and not burdening it (and their families) with poor retirees.

Sunday, May 10, 2009

Happy Mother's Day: Do You Know Where Your Retirement Plan Is?

We all have mothers in common. And on this day, besides remembering her with flowers, candy or breakfast in bed, there is no better time to begin planning for her future. I mention in my book "Retirement Planning for the Utterly Confused" that women often play a very diverse role throughout their working career. The roles they play, the numerous hats they don, are often the reason Mom doesn't have the financial strength when her working years are done.

She often leaves work to have children (not always and if your are a stay-at-home Dad, you would be wise to pay attention as well) and this is first instance of retirement interruptus. Her efforts at saving for the future, at a time when every financial advice giver agrees, are the best years for saving for that far off distant future, are put on hold. That one move can have long-term damaging effects.

She may hit other bumps in the road as well. Later in life, statistics show that it is often the woman who leaves work to take care of a parent in their golden years. This creates a cycle of disaster as the lack of preparation of the parent leads to a continuance of the problem that must be avoided. Adding another work stoppage seems to make the previous break for children even worse.

There is also the issue of being single. They may wait longer to get married, but no one problem for s secure financial future looms larger than the possibility they they will face their retirement years without a spouse. While this independence might seem attractive at first glance, your Mom may be under severe financial stress, shortening her lifespan in the process.

Sons and Daughters need to unite. Today (and the next day and the next) are the best times to take all of this into account.

Sons should not only be looking at their own mothers and mothers-in-law but their wives and daughters as well. In many instances, these women default to your experience with money. In many instances this is a grave mistake. Men, as it has been shown, are more emotional about money, willing to take bigger risks, and are often not focused on the big picture.

Sons, you need to begin the conversation. Is your wife saving as much as you are? Is she adequately insured for potential disability or even long-term care? Is she assuming enough risk to make her retirement investment grow?

Is your mother's finances in the best place to ensure it will not outlast her time with you? Are you financially prepared to deal with a health problem (has she named an executor, made a will, or otherwise let her intentions be known) or a loss of property? Have you made a plan to determine all of the possible scenarios that might play out, as difficult as something like that might be to do?

Is your wife (and daughters, if they are at least twelve years old) involved in how your financial house is structured? Are you guilty of financial infidelity, an act of risky behavior that you hide from the family's finances and fail to admit? Have you saved enough for a rainy day?

These are all tough problems to deal with. But ignoring only puts off until tomorrow what you should have planned for today.

Today is the day that Sons need to help your mother, your wife and your daughters have a better future. Daughters: Today is the day you need to get involved, open the conversation and make a plan for your future.

Oh, and Happy Mother's Day!

Monday, May 4, 2009

Retirement Planning: Close but Not Quite Close Enough

More folks are looking at the past year with notable regret. They are looking at the fate of their investment strategy and wishing they had listened to the few who were warning of the coming investment storm or, promising to change their thinking in favor of a once-bitten-twice-shy approach moving forward.

Those closer to retirement are concerned that their current portfolio balance may not be enough to get them to retirement or, they feel comfortable with the current balance and want to protect whats left just in case. To those who have suffered losses, moving the whole of what you previously owned can be fraught with perils.

Your old portfolio was probably more open to risk and was not forward looking as much as it was now looking. You would check your portfolio and congratulate yourself for your investment savvy, even if the gains were due to market forces you knew little about as long as they trickled into your portfolio. But now we realize that this was not a very prudent approach. And as human nature dictates, we recoil from doing the same harmful thing again. (Although that same human nature is also responsible for our short-term memory, a hindsight look at risk that argues it was probably worth it; I'll try again.)

Leaving well-enough alone, even if it is not as well as you would have liked it to be, is actually the most prudent method for recovering those losses. Selling at the bottom, especially in a mutual fund, does not allow you the time to recoup and, if you you still have a long-term approach, shuns the idea that any recovery will take place. (In a previous post, I suggested that this could take as little as four to six years.)

But what do you do to change the habit of chasing market fads? First, leave the funds you currently own right where they are. This doesn't mean that you should ignore them completely. What it does suggest is no longer funding them if you are within five years of retirement.

Instead, use new money to take a new approach. Fixed income has become much more attractive post-meltdown and for good reason. There are some guarantees that your money will still be there when you retire. Building on your stock allocation with bond funds is not only wise, it has been highly suggested by many planners. (What those planners will also suggest is moving from one fund to another. Not wise.)

Municipal bond funds have become increasingly attractive. The reason I suggest buying munis through a bond fund is the relative inability of the average investor at determining the risk in these bonds. (Yes, there is risk. Some municipalities may be facing dire straights as a result of the current economy and will offer too high a return to attract investors.) But right now, munis have a sizable spread over Treasury offerings of similar duration meaning that, to attract investors, the yield is higher over the same period of time.

To fully appreciate what a bond can do for your portfolio, but a total bond fund that encompasses a broad swath of fixed income debt. Because there is risk and fees, don't think you can simply buy in and forget about it.

Inflation could create problems in the future diminishing the expected returns and making your invested dollar worth less even as the face value of it remains the same. Interest rates could fall as well and investors who purchase bonds outside of a bond fund are more vulnerable - provided they are aware of these two key elements: If you hold a security until maturity, interest rate risk is not a factor. You’ll get back the entire principal upon maturity. But if you buy a bond that is considered a zero-coupon investment, you might face some interest rate concerns. Zero-coupon bonds make all their interest payments when the bond matures and because of that, they are the most vulnerable to interest rate swings.

Credit agencies rate bonds based on numerous factors. The higher the rating, the lesser the chance you will face a default risk. In other words, the higher the rating on the bond, the greater the likelihood you will get your principal back in tact. But on the flip side, the yield for this degree of safety is much lower than on a riskier bond.

Another good reason for using a bond fund is liquidity. Suppose you had one to sell and no one wanted it? And the last big risk factor is reinvestment. A bond you may be holding may be called back, a move that essentially allows the issuer to pay off the bond, return your principal and leave you looking for a similar bond with comparable yield.

Even those these risks persist, a bond fund helps alleviate them. I'm not so sure a Target-dated fund could do as well. In my mind, it would be like fighting a war on two fronts.