Will you self-direct your retirement?

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.

Retirement Planning: Companies are Still Trying

Such is the conundrum of the 401(k). Your retirement planning tool is showing signs of increased balances even as some of the experiments to get people to invest more - via auto-enrollment - is as Aon Hewitt suggests, somewhat sub-optimal.

Auto-enrollment was supposed to get all boats to rise. New workers who knew little about this sort of plan to help them save for retirement were automatically enrolled in their new employer's defined contribution plan. But these new investors did not respond as the industry thought they would. Pamela Hess, director of retirement research at Aon Hewitt suggested in a January 26th press release from the company: "Auto-enrollment is a relatively simple and effective way for companies to help workers plan for retirement—especially younger workers who may not feel the immediate pressure to save for retirement." And yet, once in the plan, these new workers, often referred to as the Gen Y investor, failed to follow through on the effort with interest of their own.


Companies are still trying
It is not as if the companies aren't trying. Designed to simplify the investment decision process, more than half of the companies surveyed attempted to educate these new workers, appealing to this younger investor with the offer of online investment guidance coupled with online investment advice and managed accounts. Compared to 2010, when just 28 percent of employers offered managed accounts, this is a noticeable increase in what is often considered the most basic of fiduciary responsibilities.

Plan sponsors are undaunted by the lackluster use of these plans and continue to offer additional levels of services which include investment modeling and even attempts at profiling how what you have accumulated will be spent down once their employees do retire. Younger employees seem to accept the target date fund, the primary choice for the auto-enrollment effort despite the questions surrounding the viability and transparency of these funds.

Reinstating the matching contribution has helped some of these plans. By the end of 2010, in the wake of the Great Recession, 23% of the companies had stopped or lowered the amount of money the plans contributed. Over half have decided to add these matching contributions back to the plan in 2011 with about 18% of the 23% who stopped toying with the idea of bringing the matching contribution back.

Other incentives to get these workers to contribute more to their 401(k) plans are not so much incentives as elimination of other benefits that future retirees once banked on for their retirement. Fewer companies offer medical benefits to their employees and some have even raised the current cost of health insurance to employees to offset the cost of helping with retirement, a trade-off that seems counterproductive. Others have simply frozen their pension plans pushing workers to seek the alternative self-directed method of ensuring a secure retirement.

Some of these moves have actually forced the employee to invest more and the latest numbers published by Fidelity point to an increase in the average balance in these plans. yet the average balances, now estimated at the 2010 year end were still far below where they actually needed to be. If you had invested steadily over the last decade, your balance, according to Fidelity is around $180,000. If you are within fifteen years of retirement, you are still hundreds of thousands of dollars away from what is often considered the optimal balance.


The 14, 16, 18 Rule
For most investors - I prefer this term to overused "saving for retirement" - the accumulated balance in these plans should equal 14 times your last year's salary. Aon Hewitt points to a need for 16% of the salary of the 31 to 45 year old group as the goal, which includes the total amount of available benefits such as Social Security and any pension plans they might have. Because the youngest workers can count less on these additional sources of income for retirement, they will need 18% of their salary to make retirement comfortable.

If plan participants at Fidelity are any indication, these plans are moving in the right direction. Over a million people involved with the Fidelity offerings have accessed their online tools or simply called for advice. According to Beth McHugh, vice president of market insights at Fidelity, the answer to how much you will need still depends on the worker taking control of the plans. She suggests "At the end of the day saving at appropriate levels, saving continuously and ensuring that you have the appropriate asset allocation are the most critical components to help ensure that you have sufficient savings for retirement."

But contribution levels still remain lower than they should be. The average participant has increased their contribution, but from a paltry 4% to a better 7%. Yet this increase is still far from what the investment and retirement community would like to see workers contribute. Add to that the lack of portfolio diversification once they are in the plan, little effort by the participants to rebalance on a regular basis and for older workers, adequately defining the risks they are taking with those investments all increase the chances that these plans are not doing as well as they could.

Some of the uncertainty of retirement needs may be the problem. Not knowing the impact of taxes (although there has been an increase in the amount of Roth 401(k) options in many plans) and the negative effect of inflation. workers are underestimating what they might need and if they are making educated guesses on that number, taking too many risks too close to retirement to try an offset those issues.


The Selfish Approach
Perhaps the worker should instead frame the plan in a more realistic way. Most advice offered on how these plans should be spent down once you retire involve a suggestion that returns on the plan in a post-employment environment should be all that the retiree tap. This avoidance of using capital - in other words protecting the balance in the plan at all costs, may have created a greater worker angst than is needed.

Focusing on preserving wealth as an heirloom is not how these plans should be calculated. In a era of less, the retirement planning employee should be focusing on what they will need first and not so much on what they might leave to their heirs. While prudent lifestyles are still a great help - both prior to and after they retire - being selfish in your projections is not necessarily a bad thing.

Retirement Planning: The Annuity Answer is a Question

You can't escape it.  You are having your choices about retirement and your plan diced and splayed and discussed in any number of forums.  None of the outcomes from these conversations are suggesting what you want to hear. So here's a flash: you're worried.

Insured Retirement Institute President and CEO Cathy Weatherford recently wrote "Unfortunately, as the promise of Social Security continues to be on unsure footing, working Americans are coming to realize that they will need more than just that paycheck to sustain them throughout their retirement." Even when the Employee Benefits Research Institute released its most recent report, concerns about retirement were, as they could only be expected to be, were the top concern.

And with that comes the numbers.  Now I tend to agree with Steven Strogatz, professor of applied mathematics at Cornell and the author of "The Calculus of Friendship when he suggests that although we are easily duped by words, numbers "brook no argument," he writes suggesting that they "are the best kind of facts."  he describes them as cold, hard, and objective. So when the EBRI reports that 69% of those recently surveyed believed that retirement accounts were extremely important, most of us agreed. Three out five the EBRI concludes from their question don't believe in Social Security and almost two-thirds say they lack confidence in the program enough to begin saving more.

Now to Ms. Weatherford's defense, she sells annuities.  So when she adds that "Increasingly, they [the working folks] are looking for ways of securing their retirement income through annuities, retirement savings accounts and other insured retirement strategies. Employers can play an important role in helping to connect employees with available benefits that can lead to a financially sound future."  I am left to ask the question: wasn't it the employers who got us to this point?

Although as the report, which was commissioned by Project 2010 suggests that 94% of the employers offer a plan of some sort, the less than surprising number is the actual participation.  With three-quarters of the employees that have access us them, it is the fourth that don't is the more troublesome number. And tucked inside these numbers is the fiduciary fib that these employers have done everything they could do to get their employees involved.

Employers are directly responsible for encouraging their employees to invest for their own futures.  Some incentivize their plans with matching contributions. Matching contributions do not have to be high in order to get their workers to participate in the plan.  In fact, studies have shown that a more modest matching contribution might actually spur the employee to put additional funds into their accounts. In the latest economic downturn, companies dropped or greatly reduced their matching contributions and are slow in returning to them.

The matching contribution does a great deal in getting the employee to do right by their own future.  But more important is the period of time between initially beginning the job and the actual beginning of their participation in the plan.  Some employers hold their matching contributions for a longer (than is necessary or even in some cases, realistic) vesting period giving the employee less incentive to invest if they feel as though they don't expect to remain at the job that long.

Some employers do offer plans that are both robust but well-supported with information and educational materials. But no plan is the be-a;;-to-end-all offering that would create the perfect scenario for everyone: employers, employees or the plan administrators. And also included in the report was the fact that 17% of the plans now offered annuities. Is this just an attempt at getting to that perfect "everything" plan?

This lack of what the investment industry refers to as a holistic approach, or decumulation, has professionals practically drooling in anticipation of of what these products can hold for their industry.  I don't really worry that my opinion about annuities will alter simply because this product has begun to emerge as the next big element in your retirement plan.  An annuity will always be an annuity and because of that, will always have more unanswered questions that concrete evidence that it is a better product as a whole instead of its parts.

Annuities are hybrids, born in the insurance industry as part insurance and part investment.  They are costly and unwieldy, ripe with fees and special ta situations for your heirs, hard to get rid of if you change your mind and don't necessarily do for women the way they provide for men.  That last part about women versus men is an actuarial adjustment for the longer lives women have. No other "investment" makes such a distinction.

Then there are the idea of guarantees. Annuities make certain promises, the largest of which is that they will never go out of business. Never is a really long time. And depending on the potential you might have for living longer than you anticipated, it would be nice to think that a company could never falter, never be affected from some unforetold expectation and never consider closing its doors for good. But it happens. It doesn't happen with your equity mutual funds and some bonds might default in your bond funds, but insurers are not forever. This is risk that is grossly understated.

What makes people so fearful about Social Security is the very thing that makes it work.  Whenever you can pool risk, you eliminate more than you create.  The fixes to Social Security are rather simple and even if you are decades from retirement, the program has the legs to continue on even in the face of the Boome onslaught (a wave that may effectively be not much more than swell in this post-recession economy). Annuities can't do what Social Security does and for good reason: there is no money to made.

In the name of fiduciary responsibility, plan sponsors will be begin to offer this sort of product with questions on cost, viability and suitability all left unanswered.  Even a simple CD could do the same sort of thing an annuity would, come with FDIC insurance and promise to never lose a penny.  A well paid CD tucked inside a retirement portfolio but outside the tax-deferred plan would help ease those fears just as well.

But the biggest fear is that when they do become available in your 401(k), they won't be one annuity, but a succession of small, mini-products, each with differing contracts. So far, no retirement plan has been able to answer the question of liquidity and security. Until those can be answered with any certainty the annuity will languish as an option, even with government support.

Paul Petillo is the Managing Editor of Target2025.com

A Fiduciary Duty with Respect: Retiring with a Plan

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.

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's full article on fiduciary responsibility can be found here.

Can You see What They See?

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.

Finish reading this post here.