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Retirement: News, Appraisals, Information, Research, Advice – Everything Life Settlements
The Cost of Your 401k Plan After Retirement
There can be no question that saving for your own retirement is a financially sound and important thing for you to do, and one of the most common and popular methods of doing this is by investing in a 401K plan at your place of work. But what you may not know is that not all 401K plans are the same.
If you are like many people in the United States, the chances are that you have had several jobs over your working life and, as a result, still have a number of 401K plans with different former employers. Or perhaps you have recently retired, but are not yet ready to cash in your 401K plan(s). Whatever your individual circumstances may be, you should be aware that your 401K plans could actually be costing you money.
Under the current laws, not only are the companies administering your 401K allowed to charge maintenance and service fees, but they are also not required to inform you what those maintenance and services fees are. Some insurance companies and stock brokerage houses are charging as much as 4% or 5% per year off the top for the plans they administer, which can significantly decrease the annual yield and value of your plan. (There are also fees and charges associated with maintaining IRA accounts, and generally there will be management or transaction fees associated with most products.)
Specific fees that are considered to be “hidden” are:
Trading costs, commissions between fund managers and brokerage firms
Soft dollar “excess commissions” paid to brokerages pursuant to Securities
Exchange Commission (“SEC”) rule 28(e)
Sub-shareholder (participant) servicing fees – called “sub-transfer agent fees”
(“Sub-TA”)
Account distribution (sales) based 12(b)-1 fees
Account servicing based 12(b)-1 fees
Unitized variable annuity wrap fees
Variable annuity mortality costs
“On-the-fly” pass through fees
Retail versions of institutional funds (i.e. funds that could be purchased at a lower price but are not, due to fiduciary ignorance)
Unfortunately, managers at many companies have signed on with 401k sponsors and simply do not understand the fees involved. Since the fees are not paid by the company, bu rather by you and the other participants, they have small motivation to look hard at the fees. In fact, a study by Spectrem Group showed that most plan sponsors don’t know what they pay.
So unless you ask and thoroughly read the prospectus and make sure onerous fees are not being levied against your account, it’s best to do an IRA rollover and not leave your funds in a high priced qualified plan.
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Retirement Investing During Deflation
If a recession becomes severe, dollars may suffer from deflation rather than inflation. This would change the rules you have for retirement investing over the past 30 years. What should retirees consider doing if deflation sets in?
We’re familiar with the effects of inflation. Our dollars just don’t buy as much as they used to. Too much ‘easy money’ from too much credit puts more dollars into everyone’s hands so each dollar is worth less than before. So too many dollars are chasing too few goods and the prices of goods are bid up. In this typical inflationary environment, retirement investing rules are to get rid of cash and hold hard assets like real estate.
But when recession occurs, everyone becomes afraid of consuming. Businesses feel the pinch and people lose jobs. Government may try to ‘prime the pump’ by offering and instigating low interest rates. That reduces the cost of credit and hopefully to get people to begin borrowing and ‘consuming more’.
But if the turn down is too severe, very few people will be enticed to spend money. The money supply actually contracts. The results in a low demand to buy most things and can force prices down. And deflation is the general decrease in the prices of goods. Your dollars are worth more! Rather than get rid of dollars, you want to own them and convert them selectively to assets that have fallen in value (real estate, stocks, etc).
Most retirees have no job to lose. They’re living off Social Security, pensions and their investment earnings. Most of this retirement income may be fixed income. Those in such a circumstance can actually benefit from deflation – mostly from the benefit of lower prices for things.
But under deflation, dollars become more valuable and debt – i.e. owing a fixed amount of dollars – becomes more of a burden. So retirees should reduce the cost of their debt by reducing payments or restructuring.
As deflation sets in you’re paying off debt in more expensive dollars. So any way to reduce the dollars you must commit to debt payments is beneficial.
Restructure your debt payments. With recessions comes falling interest rates. Take advantage of lower interest rates to restructure debt payments you can’t pay off quickly.
Refinance your home. If you have a mortgage, refinance at lower interest rate to cut your monthly costs – or to pay it off over a reduced time period.
Since the value of cash is increasing, holding it will increase your wealth – but only during deflation. Aside from preserving your emergency funds, you’ll want to hold dollars for retirement investment opportunities at low prices.
If you do have extra cash, stay aware of overly depressed investment prices and commodity prices (oil and gold)that will recover after the recession ends and present low risk retirement investing opportunities. Real estate investments – especially condos – are a typical case. It may even be worth a small remortgage of your paid off house for some investments (this strategy is not suitable for everyone as any borrowing will incur a fixed payment commitment while the return on investments is not assured).
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What’s Not Taxable of your IRA and 401(k) Distributions?
Generally, your IRA and or company 401(k) distributions are taxed as ordinary income. That’s because you funded them with tax-deductible contributions and all the earnings of these contributions have been tax-deferred. So nothing has been taxed. Taking a distribution before turning 59½ will add a 10% penalty tax to the income tax.
Nevertheless, you may have made some ‘after-tax’ contributions to them, and those – not their earnings – will come out tax free. So let’s see how this to handle these.
Taxable and non taxable distributions for company-administered plans such as a 401(k)
This is pretty easy because it’s your employer who is responsible for tracking both your tax deductible and after-tax contributions to the plan. They’ll report those amounts to you, either on your statements or on a 1099-R when you take a distribution from the plan.
IRA distribution
You’re the administrator of your IRA. So keeping track of after-tax contributions is your job. That’s done on IRS Form 8606 each year you make an after-tax contribution and each year you take an IRA distribution.
This form – each time it’s filed – carries forward the total of prior year after-tax contributions and adds them to any current year contribution. It also formulates the non-taxable portion of any distribution you take in the year. And, of course subtracts out that amount from the total after-tax contributions among your IRAs. Normally, form 8606 is attached to your tax return.
The non-taxable portion of your IRA distributionsduring the year is the ratio of all your after-tax contributions (from your latest Form 8606) divided by the total value of your IRAs. No, you don’t get to take out just the ‘tax-free’ part! Each time you take an IRA distribution, part is taxable, part is return of after tax money (not taxable).
What if you forgot to file your Form 8606 over the years? Just get the form and its instructions; it’ll give you some suggestions on documentation you can use to substantiate your prior after-tax contribution amounts. If you think the amount of after tax contributions you have forgot to document is significant, then get help form a tax professional so that you don’t need to pay tax twice when you take distributions.
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Retirement Distributions–How to Cut Senior Taxes
How you Use or Spend Your Savings Determines how much Retirement Tax You Pay
When it comes time to tap your savings and investment accounts, investors often ignore which source should come first for retirement distributions. In general, many experts often advise investors to draw from their taxable accounts first, then tap qualified accounts such as IRAs and 401(k)s further down the road.
There is a logical reason for this – prolonging withdrawals from your qualified accounts or tax sheletered accounts gives these assets additional time to grow with the benefit of tax-deferral. There are other reasons why this strategy for retirement distributions could be efficient from a federal income tax perspective.
Let’s say that you have three sources of investment funds: a regular taxable account (which could hold individual stocks, bonds, or mutual funds,) and two qualified accounts: a traditional IRA and a Roth IRA. What happens if you tap your traditional IRA? First, all retirement distreibutions from a traditional IRA are taxed at your current ordinary income tax rate. Second, a 10% federal income tax penalty will usually apply to traditional IRA withdrawals taken prior to age 59½ (subject to a few limited exceptions explained in IRS Publication 590, among the exceptions include but are not limited to withdrawals for qualified higher education expenses, first-time home buyer, and medical insurance premiums for certain unemployed taxpayers, and withdrawals taken by disabled taxpayers).
What about retirement distributions from a Roth IRA? First, your principal contributions from the Roth can be withdrawn without occurring any tax. Additionally, any withdrawals from your Roth are first treated as being taken from your principal. Should you have to tap into your earnings, these withdrawals are subject to ordinary income taxes at your respective tax rate. And if you are less than 59 ½ years of age “or” you do not hold the Roth for more than five years, the distribution could also be subject to the 10% federal income tax penalty.
However, by leaving the money in the Traditional and Roth IRAs, you have the opportunity to accumulate tax-deferred investment growth over the life of both the owner and the beneficiaries. Assuming the age and holding period requirements are met, all Roth retirement distributions also come out free of future federal income taxes to the account owner as well as the beneficiaries.
What if you tap your taxable account first? First, you will owe taxes on any capital gains you realize from the sale of investments in this portfolio. Assuming you have held the asset for more than one-year, your rate will be lower than your current income tax rate (0% for taxpayers in 10-15% brackets; 15% for all tax brackets exceeding 15%). You might also be able to offset any capital gains with capital losses, which can soften the blow of your annual tax bill.
As you gradually tap your taxable account, the distributions you receive from these investments will slowly recede as well, thus lowering your tax burden from dividends and capital gains paid to you. Moreover, your qualified accounts could potentially have longer time to grow with the power of tax-deferral, which could enhance the value of your qualified retirement funds.
Eventually, you will have to take required minimum distributions from your traditional IRA, once you reach age 70½. Although these retirement distributions will be taxed at your ordinary income tax rate, you could be in a lower tax bracket by then. As previously mentioned, these distributions are taken, in many cases, over the life expectancies of the owner and the beneficiaries. On the other hand, traditional IRAs do not receive a step-up in income-tax basis when they are transferred to younger beneficiaries at the owner’s death. Although there is something to be said about the power of deferring taxes, one should also consider future income tax consequences to younger family members before making a decision.
Assuming you have assets in Roth IRAs, you should know that minimum distributions are not required. In view of this and the fact that retirement distriubutions will come out free of federal income taxes (assuming the age and holding period rules are met), you may want to consider your Roth assets as your source of last resort.
Deciding which account to tap first depends on your financial and tax situation now and during your retirement years. In general, leave your IRA and qualified accounts to grow but don’t proceed with this advice until you have had a tax consultant or retirement advisor confirm.
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