Making Your 401(k) More Useful

Geoffrey Stiff, in On Wall Street, offers these options for making your 401(k) more useful after the devastation of the past two years:

The first is to purchase an annuity with the 401(k).

A second option is to start buying today increments of an in-plan annuity that guarantees income at retirement.

A third option is for the person to personally retain the risk of longevity by keeping full access to account value in place and manage a reasonable withdrawal rate, generally considered 4% to 5%. By using an advisory service available at many plan sponsors, a reasonable withdrawal rate can be determined based on a participant's risk level and required confidence level.

The best way to compare the three options is to use a specific example and look at the outcomes with different growth assumptions.

The Arkansas Teacher Retirement System

The executive director of the Arkansas Teacher Retirement System has assured state lawmakers that he would ask them to increase its charge to school districts and other entities that employ its members only after he has explored all other options, this after he distributed a 22-page report to the Joint Committee on Public Retirement and Social Security Programs.

The report had indicated that increasing the Retirement System payroll charge from 14 percent to 15 percent would cost the employers about $27 million a year from $380 million to $407 million.

The Madoff Investor’s Tax Bill of Rights

The following information has been released by New York Senator Charles Schumer:

Joined by middle class New York City residents who lost everything they had at the hands of convicted scam artist Bernie Madoff, U.S. Senator Charles E. Schumer today unveiled the Madoff Investors’ Bill of Rights that would dramatically expand federal tax benefits aimed at helping devastated smaller investors recoup some of their losses. Many of Madoff’s victims were older and retired and don’t have a monthly income to rely on day to day. The largest Ponzi scheme, run by disgraced financier Bernie Madoff, cost thousands of investors more than $60 billion. Schumer’s new legislation would expand theft-loss benefits already available to larger investors who lose money due to scams, allow for accelerated and increased contributions to tax-free retirement accounts to make up for losses, and allow for penalty-free early withdrawals from retirement accounts for investors in dire need of cash to get by.

“The fact that Bernie Madoff swindled so many investors is outrageous, but the fact that so many of the smaller investors, who may not have even known they were investing with Madoff, are not receiving the same assistance as direct investors from is simply unfair,” Schumer said. “This proposal would finally give those smaller investors, many of whom lost everything, the tax relief they need and deserve.”

Schumer said that while many famous names lost hundreds of millions and even billions in the Madoff ponzi scheme, thousands of smaller investors were also left with nothing. These indirect investors typically invested through feeder funds or other brokers and tended to have lower net worth. Typically, these smaller investors gave money to an investment advisor and many didn’t even know that their money was with Madoff.

The IRS originally issued rules this past April under which a direct investor could take a theft loss deduction for their Madoff losses, by saying that theft losses could be treated as net operating losses (NOLs), as if the individual investors were small businesses. Direct investors were allowed to “carry back” their losses for 5 years instead of 3, and carry forward any remaining losses for up to 20 years. A longer carryback is important because it puts cash in your pocket by providing refunds for taxes paid in past year.

As a result, the IRS guidance was of help only to the direct investors, because the “feeder funds” that had the money of thousands of smaller investors were worth more than $15 million. By statute, the small business test is done at the level of the business, not the level of the individual partners. Under the law, the smaller, indirect investors are also not eligible for the $500,000 of relief from the Securities Investor Protection Corporation (SIPC), so they were shut out of both government insurance and the expanded carryback on the theft losses.

In the Senate’s unemployment bill, Schumer’s provision ensured that relief under the tax code would not be limited only to corporations and would include these smaller indirect investors; prevents having a “haircut” apply to all losses in all years and ensures that at a very minimum, the indirect investors would be eligible for a 4-year carryback at 100 percent and a fifth year at 50 percent, so they would get what amounts to an additional year and a half of loss carryback compared to current law.

In order to expand relief available to Madoff’s smaller investors, Schumer today announced he is introducing new legislation that would increase the amount an victimized smaller investor can carryback on their income taxes, raise the limit on tax-free contributions to retirement accounts so an investor can replenish losses quicker, and waive penalties for withdrawing from retirement accounts to increase daily cash flow. Many of Madoff’s victims were older and retired and don’t have a monthly income to rely on day to day.

Specifically, Schumer’s Madoff Investor Tax Bill of Rights includes the following provisions:

• Expanded Income Tax Relief for Smaller, Indirect Investors -- The bill will fix the NOL carryback issue for indirect investors in the 5th year, and allow both direct and indirect investors with losses from a qualified fraudulent investment scheme to carry back their losses for up to 6 years (7 years, in the case of someone who turned 65 by 12/31/08), essentially doubling the period that existed prior to April 2009. Both direct and indirect investors will receive identical treatment.
• Allow Victims to Carryback Losses a Retirement Account -- Under current law, no tax relief is available for theft losses from a retirement account that invested in a Ponzi scheme, directly or indirectly. Many victims, particularly a number of the smaller investors, had assets in a retirement vehicle, such as an IRA or a 401(k), and now these retirement savings are totally gone.
• Waiver for Early Withdrawls from Retirement Accounts -- The bill will allow a waiver of the 10 percent tax penalty for hardship withdrawals from retirement plans for people below age 59½ who need the money to survive. People would still have to pay the taxes; the bill will simply waive the 10 percent penalty on early withdrawals in these circumstances.
• Benefits for Widows -- The bill will fix a problem related to widowers and the carryback of losses. Under current law, a surviving spouse may not be able to fully utilize the loss carryback if the dead spouse was the breadwinner and all of the assets were in his or her name. Under the Schumer bill, when there has been a change of marital status due to death, the surviving spouse will be able to carry back a theft loss from a fraudulent investment scheme to a prior joint return year (up to 7 years, in the case of someone who turned 65 by 12/31/08) and be able to offset all of the joint income, rather than just the income of the surviving spouse.
• Increased Contributions to Retirement Accounts -- For people whose retirement losses as a result of Madoff’s fraud exceeded 50 percent of their savings in qualified retirement accounts, the Schumer bill will include a special “catch-up” contribution rule allowing them to contribute 50 percent more to such accounts than they are allowed to under current law, for a period of up to 10 years (or until one’s losses have been restored), in order to help restore their retirement assets.
• Other Provisions -- The bill will also allow a period of time to file amended estate and gift tax returns, because many victims have filed estate or gift tax returns in the past that reported Madoff income which has been found to be fictitious. The effect of the proposal will be to permit estate or gift taxes paid on fictitious amounts, or lifetime gift tax or generation skipping tax exemptions that have been utilized, to be appropriately refunded or restored. The Schumer bill will allow returns filed in the 6 years prior to the discovery of the theft to be amended. In arriving at the total loss eligible for the 6-year carryback (both regular and retirement accounts), the amount of the loss shall be reduced by any expected recovery, via the Securities Investor Protection Corporation, legal action, or other sources.

Your Virginia Pension

The state government of Virginia has repeatedly expanded retirees' benefits over the years while making sure employees paid nothing toward their retirement. Now some state and city officials worry that the pension system's largess cannot be sustained. The investment losses during the recession might compel the state to inject nearly $400 million more into the system over the next two years.

Many states typically contribute about 9 percent of a worker's salary into a retirement fund and the employee kicks in an additional 5 percent. But in Virginia, the state kicks in 11 percent of a worker's pay and contributes 25 percent of a State Police officer's salary and 39 percent of a judge's pay.

Employees with 30 years of service can expect a retirement benefit equal to about 51 percent of their average final salaries. Typically, however, state workers retire after about 24 years of service and earn a benefit of about 41 percent of their pre-retirement salaries. In 2009, the average benefit was $16,601 per year for retired state workers and $20,708 per year for retired teachers.

Save More without Spending Less

Charles Schwab recently released a survey measuring attitudes of various generations toward retirement. A central finding showed 95 percent of Americans unwilling to spend less in retirement. They would rather save more and work later.

Among other trends:

• Taking Charge: More than half of all investors (52 percent) are getting more involved in retirement planning. Self-reliance increased after hearing about experiences of a friend or loved one going through a personal financial crisis.
• More Time, More Money: Younger investors are saving more money now, taking advantage of their longer time horizon. Approximately half of Gen Y (48 percent) and Gen X (53 percent) have increased their retirement contributions.
• Postponing Retirement: Among Older Boomers and Gen Y, 40 percent of both groups plan to postpone their retirement date. Compared to the previous survey, postponement declined among older generations (previously 61 percent) but rose for Gen Y (previously 28 percent).
• Working During Retirement: Nearly half (47 percent) of workers aged 65 and older are prepared to work during retirement. That compares to 10 and 11 percent among Gen X and Gen Y, respectively, and 20 percent of Baby Boomers.

Lifetime Income Disclosure Act

The office of Sen. Johnny Isakson, R-Ga., has issued the following news release:

U.S. Senators Jeff Bingaman, D-N.M., Johnny Isakson, R-Ga., and Herb Kohl, D-Wi., today introduced legislation to help Americans ensure they do not outlive their retirement savings.

With the shift to 401(k) plans, American workers have become increasingly responsible for saving for and managing their retirement investments.

However, many Americans are not saving enough, and they are unsure how quickly to draw down their savings in their retirement years.

The Senators' Lifetime Income Disclosure Act would require 401(k) plan sponsors to inform participating workers of the projected monthly income they could expect at retirement based on their current account balance. The measure is patterned on the Social Security Administration's annual statements, which are mailed annually to working Americans to inform them of estimated monthly benefits based on their current earnings. Congress mandated annual Social Security statements in 1989, and they have proven to be very useful to workers in preparing for retirement.

By providing similar information for 401(k) plans, the Lifetime Income Disclosure Act would give American workers a more complete snapshot of their projected income in retirement.

"It is estimated that half of American households will lack sufficient retirement income to maintain their pre-retirement standard of living. Yet many Americans are unaware of their financial vulnerability. Our bill is a common-sense approach to empowering Americans, and helping them determine whether they are on a path to a secure retirement," said Bingaman, a long-time Senate leader on retirement issues.

"Defined contribution plans such as 401(k)s are the retirement plans of the present and future," Isakson said. "This bill will enable participants to receive additional, helpful information so they can better plan for their retirement."

"In our 401(k) system, it is not enough that participants make the choice to save. Then they have to decide how much to save, where to invest their savings, and how to make the best use of it when they retire. This bill will help millions of Americans make the best choices for a secure retirement," said Kohl, Chairman of the Special Committee on Aging.

Leading retirement policy advocates agree that this approach will strengthen Americans' retirement preparedness. "Preparing for retirement can be a daunting process," said Nancy LeaMond, Executive Vice President at AARP.

"AARP believes the Lifetime Income Disclosure Act will improve an individual's understanding of the retirement income produced from their 401(k) accounts, leading to more informed decision making about retirement needs. AARP commends the bipartisan leadership on this critical initiative."

"We applaud Senators Bingaman, Isakson, and Kohl for addressing the most significant risk women face in retirement - that they will run out of money," said Cindy Hounsell, President of the Women's Institute for a Secure Retirement. "Planning for the long-term and recognizing the importance of income for life is key for all women. The sooner women can take steps to prepare for their income needs in retirement, the better off they will be."

Said David John, Senior Research Fellow at the Heritage Foundation and Principal of the Retirement Security Project: "Sometimes a simple common sense change has the biggest effect. Including a disclosure of how much monthly income a worker can expect from 401(k) savings will encourage younger workers to save more for retirement, and older ones to convert their savings into annuity-like products so that they won't outlive their savings. The Act will build greater retirement security for everyone at virtually no cost to the taxpayers, employers, or workers."

Specifically, under the Act, defined contribution plans subject to ERISA - including 401(k) plans - would be required annually to inform participants of how the account balance would translate into guaranteed monthly payments - a "retirement paycheck for life" - based on age at retirement and other factors.

To ensure there is no material burden or potential liability on employers who voluntarily sponsor 401 (k) plans, the legislation directs the Department of Labor issue tables that employers may use in calculating an annuity equivalent, as well as a model disclosure. Employers and service providers using the model disclosure and following the prescribed assumptions and DOL rules would be insulated from liability.

South Dakota Limits

The South Dakota Retirement System Board of Trustees has recommended limiting annual increases in benefits to improve the system's financial condition after a more than 20 percent fall in assets in the last fiscal year caused by the recession.

The board voted 15-1 to endorse a bill that would reduce annual cost-of-living adjustments in benefits at least temporarily. The proposal will be submitted to the 2010 South Dakota Legislature, which will have the final say on the changes in the retirement system that covers public employees in the state.

Optimism

The Hartford’s research found people who had created a financial plan for retirement were decidedly more confident and optimistic about the future:

• Those who planned for retirement were three times more likely to be confident that they will have sufficient income in retirement as compared to those who have not planned. Nearly one-third (31.5 percent) of those who had planned (planners) said they were “very” or “extremely” confident of having sufficient income for retirement as compared to 10 percent for those who had not planned (non-planners).
• Nearly three in five planners (57.7 percent) said they were on target to retire as planned compared with 38.7 percent of those who did not take planning steps. Forty-four percent of those who did not plan said they had no idea as to when they might retire and 17.3 percent said they would have to delay retirement up to two years or more.
• Overwhelmingly, those who did not plan were uncertain as to where to obtain financial advice. Of those who had not created a financial plan, 42.5 percent said they did not know where to turn as compared to 9.6 percent for planners.
• Those who described themselves as planners were three times more likely to rely on an independent financial expert for credible financial advice than those who said they did no planning (39.9 percent vs. 13.4 percent); were more likely to rely on a bank representative (19 percent vs. 12. 5 percent) or securities firm (16.5 percent vs. 5.7 percent) or insurance agent (10.2 percent vs. 4.4 percent) for planning advice.
• Few people are confident in their financial planning capabilities. In 2009, 82.7 percent of survey respondents said they were less than confident in their financial planning knowledge and abilities, with 34.2 percent indicating they were “not too” or “not at all” confident.
• Retirement and/or financial planning are viewed as too complex or too difficult by one in two Americans (50 percent). The number of people who have taken steps to plan for retirement remains relatively unchanged from 2008.
• Nearly one in five (18.4 percent) planners said their investment earnings had increased as compared to 4.8 percent of non-planners. Planners were twice as likely as non-planners to have increased their net worth (12.2 percent vs. 5.3 percent) and 32.7 percent of planners said they save more while 22.4 percent of non-planners could say the same.
• Insecurity Over Security
• The Hartford’s research identified growing concerns about financial security and the ability to find the path to financial security in retirement:
• The correction of the financial markets, despite a pronounced rebound during the summer and early fall, has created uncertainty over the future. Nearly a third of all respondents (31.6 percent) said they have no idea as to when they will be able to retire and 19.3 percent indicated they will have to postpone retirement for up to two years or more in the aftermath of market meltdown.
• Confidence about having enough money for retirement remains low. Nearly four in five people (78.3 percent) are less than confident that all of their sources for retirement income, including employer-sponsored pension plans, government-sponsored pension plans and personal savings and assets, will be adequate to maintain their standard of living in retirement. That compares to 74.6 percent in 2008, 78.5 percent in 2007 and 69.2 percent in 2006, indicating a longer-term decline in confidence.
• The prospect of enjoying life in retirement appears to have grown ever more elusive for many people. The goal of enjoyment declined to 14.4 percent in 2009 from 26.2 percent in 2008 and 43.2 percent in 2007.
• Confidence in employer-sponsored pension plans plummeted. More than one-third of all survey respondents (34.4 percent) said they were “not at all confident” that the income from their employer-sponsored pension plan would be guaranteed for as long as they lived in retirement. Fully 45.4 percent were either “not too confident” or “not at all confident.” In the previous three years, the highest response rate for “not at all confident” was 5 percent and the highest total for “not too confident” and “not at all confident” combined was 15.1 percent in 2008.

Retirement’s Primary Financial Concern

A Five-Step Plan for Reworking Retirement Savings

Robert Powell of MarketWatch offers a five-step plan for reworking your retirement-savings strategy:

1. Think about you: You need to focus first on the life and lifestyle you want and then the money needed to fund it.

2. Your household balance sheet: Get a handle on what you own and what you owe. Look at your entire household's assets and liabilities, not just your personal balance sheet.

3. Your cash flows: Determine what your fixed and discretionary expenses, plus your income sources, will be in retirement. Try to use your fixed sources of income (annuities, Social Security, interest income from bonds and CDs) to pay for your fixed expenses or better yet your minimum standard of living, "your floor," according to the Retirement Income Industry Association. And then you would use what some call your "risky" assets to pay for discretionary expenses. In an ideal world, you want a financial capital-to-consumption ratio -- say 30:1 -- that makes it less likely that you'll run out of money.

4. Assess and manage retirement risks: Factor retirement risks into your retirement plan, including but not limited to inflation, health care, and longevity.

5. Choose the right financial products to produce a minimum standard of living.