More on 401(k) Choices

Posted on October 27, 2014 by Dr. David Edward Marcinko MBA MEd CMP™

Join Our Mailing List 

Studies, Research, Experiments and Experience

By Rick Kahler MS CFP® http://www.KahlerFinancial.com

Rick Kahler MS CFPHere is a conversation I’ve had too many times: An acquaintance says proudly that he invests the maximum into his 401(k). I ask what allocation he’s made between equities and bonds.

He says he just divides his contributions equally among the four investment choices the plan offers. I cringe.

The Book

While it’s wise to put the maximum into your 401(k), it’s also important to choose the right investment options. This is difficult for most people, as shown in the 2004 book, Pension Design and Structure, by Olivia Mitchell and Stephen Utkus.

The Study

In one study, participants were asked to allocate their 401(k) contributions between two investment funds. The first group was given a choice of a bond fund and a stock fund. A second group was given the choice of a bond fund and a balanced fund (50% in stocks and 50% in bonds). A third group was given the choice of a stock fund and a balanced fund.

In all three cases, a common strategy was for participants to split their contributions equally between the two funds offered. Yet because of the difference in the funds, the asset allocations of each group differed radically. The average allocation to stocks was 54% for the first group, 35% for the second, and 73% for the third.

The Experiment

In another experiment, participants were asked to select investments from three different menus offering options with varying degrees of risk. Most made their choices simply by avoiding both the high-risk and the low-risk extremes. They didn’t select a portfolio from the available options based on the appropriateness of the risk each presented.

Investing your retirement funds in such a haphazard manner is almost the same as playing the roulette wheel. A portfolio with 35% in stocks will perform very differently than one with 73%. Especially if you’re young, holding the portfolio with the 35% stock allocation or the 73% may mean a significant difference in your retirement lifestyle.

Another Study

In another study, when employees were given a choice between holding their own portfolio or that of the average participant in the plan, about 80% chose the average portfolio. That’s like going into a clothing store and telling the sales clerk, “Just give me a suit in whatever size you sell the most.

Implications

These studies suggest ways employers can help employees make better investment decisions. One strategy is to reduce their investment choices to a small number of funds that offer portfolios with an asset allocation based on various target retirement dates. Another is to offer employees a variety of investment choices, along with guidance and education so they could make intelligent choices.

My Experiences

In my 30 years of investment experience, the strategy I’ve seen work the best is having a wide variety of asset classes (global stocks, global bonds, treasury inflation protected securities, real estate investment trusts, and commodities) that do well in a variety of economic scenarios. A study reported on by Peng Chen in Financial Planning in 2010 found that from 1970 to 2009, a portfolio with a minimum of 10% to a maximum of 30% in each of these asset classes out-performed portfolios that did not have commodity exposure. Splitting 401(k) contributions equally among these asset classes would provide a greater chance of having an appropriately well-balanced portfolio.

***

Spreadsheet

***

Assessment

Once you’ve chosen a variety of asset classes, then keep your hands off except for periodic rebalancing. True, this strategy means that in any given year your portfolio will always have winners and losers. Yet with a broad range of assets, the losers and winners tend to balance out. Over the long run the odds are good that you will do fine.

Note: Ditto for 403(b) plans.

More:

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

OUR OTHER PRINT BOOKS AND RELATED INFORMATION SOURCES:

Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants

Filed under: Interviews, Retirement and Benefits | Tagged: , , , | 1 Comment »

Are Employees Opting Out of 401(k) or 403(b) Plans?

Posted on January 20, 2014 by Dr. David Edward Marcinko MBA MEd CMP™

Join Our Mailing List 

New Retirement Thoughts for all Employees

By Rick Kahler CFP® http://www.KahlerFinancial.com

Rick Kahler CFPHow hard is it to do things we know are good for us – like exercising more – or saving for retirement?

New Year’s Resolutions

This time of year, with broken New Year’s resolutions piling up like snow-banks, it’s clear that the answer is “very hard.” Most of us have good intentions, but we aren’t so good at taking consistent action to turn those intentions into reality.

Retirement Pans

One of the areas where many people don’t do what’s best for them-selves is participating in company retirement plans. If your employer offers a 401(k) or 403(b) plan, it’s ridiculous not to participate in it. For one thing, it’s an easy way to put money away for retirement before you see it—and before you pay taxes on it. Even better, the employer’s matching contributions give an extra boost to your savings that’s almost like found money.

Yet studies have shown that only 67% of eligible employees participate in these plans if they have to choose to sign up. When employees are automatically enrolled in the plans, and have to actively choose to opt out; however, the level of participation increases to 77%.

For this reason, the US government in recent years is encouraging large employers to offer automatic-enrollment retirement plans.

US News Report

Yet a recent article in US News points out a downside to this well-intentioned attempt to save procrastinating non-savers from themselves. Plans with automatic enrollment may have higher participation, but that doesn’t necessarily mean greater benefits for employees.

Why no Better?

When more employees participate in a 401(k) plan, the employer has higher costs in the form of increased matching contributions.

A study last fall by the Center for Retirement Research at Boston College found that companies with automatic enrollment tend to compensate for those higher costs with smaller matches. The average amount—3.2%, compared with 3.5% for plans that don’t have automatic enrollment—may seem insignificant. Yet over time it can make a big difference in the amount of money an employee has available at retirement.

Default Rates

More importantly, the study also found that the default contribution rate (the amount invested out of each paycheck) in some automatic-enrollment plans resulted in employees saving less than had they chosen that amount themselves. The default contribution rates are likely to be less than the rate required to receive the employer’s maximum matching contribution. The default investment options also tend to have underperforming investment choices compared to those chosen independently by participants.

Report Synopsis

One rather obvious conclusion of the study is that automatic enrollment means more retirement savings for employees who otherwise would not have signed up for a 401(k). At the same time, because of the lower employer matches, employees who would have chosen to sign up anyway are likely to end up with less retirement savings than they would have in a non-automatic plan.

MD Retirement planning

Questions

Does this mean automatic-enrollment 401(k) plans are not a good option for retirement saving? Not at all! If you passively participate in an automatic plan and leave your contributions at the default contribution rates and investment choices, you’ll still be better off than if you don’t participate at all.

Research

Yet the research suggests that settling for the employer defaults, a one-size-fits-most option, is probably not your best choice. You can choose instead to educate yourself about the investment choices in a plan, contribute the maximum amount you can, and take full advantage of the employer match. The more you learn about the available options, the better choices you’ll be able to make.

Assessment

Ultimately, no employer or plan manager will ever care more about your investments than you do. The most successful retirement savers are still those who take responsibility for their own future.

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

Link: http://feeds.feedburner.com/HealthcareFinancialsthePostForcxos

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

OUR OTHER PRINT BOOKS AND RELATED INFORMATION SOURCES:

DICTIONARIES: http://www.springerpub.com/Search/marcinko
PHYSICIANS: www.MedicalBusinessAdvisors.com
PRACTICES: www.BusinessofMedicalPractice.com
HOSPITALS: http://www.crcpress.com/product/isbn/9781466558731
CLINICS: http://www.crcpress.com/product/isbn/9781439879900
BLOG: www.MedicalExecutivePost.com
FINANCE: Financial Planning for Physicians and Advisors
INSURANCE: Risk Management and Insurance Strategies for Physicians and Advisors

Product Details  Product Details

Filed under: Retirement and Benefits | Tagged: , , , | 2 Comments »

Doctors – Are You Ready to Retire?

Posted on March 4, 2010 by Dr. David Edward Marcinko MBA MEd CMP™

Moneywise?

By Somnath Basu; PhD, MBA

For those of us between the ages of 45 to 54, the thought of retirement should be popping up a few times these days. And, for doctors between ages 55 and 64, the thought may be taking on urgent tones. Many of us are reconciling to the idea that it may be a fact that we have to either postpone our retirements or live a much simpler life during retirement. Whatever the thoughts may be, what’s driving them is our preparedness to retire.

Preparedness Components

So, we will now examine what the component (dos and don’ts) may be for physicians, and others, to assess whether they are on the right path in their preparations to retire. It is somewhat easier if we consider the preparedness issues of the expectant retirees along the two age groups we tagged earlier. It is possible that we may find that the proper components of our retirement plans may already exist for us and we need to give them a good and disciplined effort to carry us through in the retirement years. It is also important to note, in this vein, that as a nation, our savings rate has gone from -0.6% in 2006 to about 5% today. While most of the increase in savings is the result of people building back an emergency nest egg, we can also take heart in the fact that the savings habit has not become obsolete or even rusty, and given the proper motivation (e.g. a sub-standard retired lifestyle), we can alter our destinies by riding on the same savings wave.

The Possibilities

Let us begin by describing the possibilities for the younger group (ages 45-54) doctors and employees pondering their retirement moves. There are two aspects of retirement that needs consideration. First is the contemplation of the needs associated with retirement lifestyles and the corresponding financial requirements required to sustain such lifestyles.

The second is to consider our current lifestyles, living standards (consumption), our income and savings and to assess whether we are set to achieve our retirement lifestyle targets. To understand the many possibilities, we will examine some typical scenarios using data from the Employee Benefits Research Institute (EBRI). Note that all calculations are only approximations for a typical individual.

Join Our Mailing List 

Example:

If you are about 50 years of age, have worked and saved for about 20 years [401(k), or 403(b)] or other pension plan) and earn about $100,000 a year, you should have about $200,000 in your retirement account today. Assuming that Social Security (if the organization remains viable and makes its required payouts), covers about 27% of your needed retirement expenses. You could expect a Social Security payment of about $30,000 per year at age 65. This would mean that in about 15 years, you would need to generate an additional $80,000 per year from your own savings. While you may think that you are not consuming $110,000 worth of lifestyle today, it is useful to note that this estimate is in future (and inflated) dollar terms.

This brings us back to the second question of how much you may be consuming today. If you are paying about 25% as taxes and saving another 5%, then you are currently spending about $70,000 today. At a 3% inflation rate, in 15 years this amounts to a spending of $110,000 on an income of approximately $160,000.

Thus, if your 403(b) balance does not change from now till retirement and you estimate to plan for a 25 year retirement phase, then your 403(b) account will be equivalent to about an additional $8,000 per year, which itself will grow every year minimally at the inflation rate.

If you assume the 403(b) plan will itself grow at about 7% a year over the next 40 years (from ages 50 to 90) then at retirement (age 65) you’ll have about $550,000 and be able to withdraw about $50,000 per year. This will leave you with a shortfall of $30,000 per year. To be able to afford retirement to its fullest, you’ll need to save an additional $15,000 per year for the next 15 years. Before you begin thinking that is a doable task and start assessing which parts of current lifestyle to pare, note that many of the assumptions above may not hold true.

Average Rates of Return

For example, earning a 7% average rate of return over 40 years is no simple task; Social Security may not be able to deliver on its promise. Physician income and job security is a political issue. Paring current lifestyle is a bigger issue. Healthcare and leisure types of costs during retirement may increase by more than 3%, even as you consume more of these retirement lifestyle services.

Therefore, you may want to continue enjoying your current medical practice lifestyle and consider worrying about retirement about 10 years (or more) later or you may take stock of your current situation. If your situation is worse than the average portrayed above, a big issue for you is to keep your physical and mental health well balanced and not depressed and medicated; plan to postpone retirement and practice or work longer, albeit in good health.

Assessment

If you are about 60 years of age, have worked for about 25-30 years, earn $100,00 per year and have about $350,000 in your retirement accounts, your problems are more exacerbated and your fears (of postponing retirement, paring current or future lifestyle or not being able to make up shortfalls) are much more real. The strategies remain the same from earlier in that you have to make some urgent and difficult decisions. These are decisions that cannot be postponed any longer.

Note: First released “All Things Financial Planning Blog” on December 18, 2009.

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

Link: http://feeds.feedburner.com/HealthcareFinancialsthePostForcxos

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

OUR OTHER PRINT BOOKS AND RELATED INFORMATION SOURCES:

Product Details  Product Details

Filed under: Financial Planning, Investing, Retirement and Benefits | Tagged: , , , , , , , , | 7 Comments »

About Healthcare Employee Cash-Balance Plans

Posted on March 23, 2009 by Dr. David Edward Marcinko MBA MEd CMP™

What they Are – How they Work

By Staff Reportershuman-drones

Motivated by cost savings, an increasing number of hospitals, healthcare systems and large healthcare organizations are converting their traditional legacy defined benefit pension plans to cash balance plans. While the trend seems sudden, it is not surprising. Healthcare related companies are reaping substantial savings from cash balance plans. And for the most part, younger doctors and other employees are enthusiastic about the plans.

However, older employees (age 50 or above) realize  that in switching from a traditional defined benefit [legacy] plan to a cash balance plan, their retirement benefits decreased, initiating an onslaught of overwhelmingly negative publicity. Indeed, several years ago, Congress rushed to pass legislation requiring employers to provide benefits computations to affected employees.

Overview

Even though many defined-benefit plans are under/over-funded, they are calculated on an actuarial basis and are quite costly to maintain. And because plan costs can vary from one year to the next, budgeting is difficult.

However, if a healthcare company terminates a pension plan, replacing it with a defined contribution plan such as a profit sharing plan, all employees must be 100% vested, any surplus is subject to income tax, and a portion of the surplus is subject to an additional excise tax even if all of it is transferred to a succession plan. A cash balance plan is a pension plan, so the change is viewed as an amendment to the pension plan. This is true even though in many respects the cash balance plan operates like a defined contribution plan.

The Cash Balance Planfp-book13

A cash balance plan works in the following manner: The sum accrued in a hospital’s employee’s defined benefit plan is converted to a lump sum cash value; the employer agrees to make specified contributions to the employee’s account based on compensation; and the account earns a specified rate of interest, say 5%. The employee receives regular statements showing the current cash value of his or her account. [The amount is listed as a lump sum amount even though it is usually paid as an annuity].

If the hospital or other employer already has a defined benefit pension plan and converts it to a cash balance plan, there is no tax on the surplus. The reason, as noted above, is that a cash balance plan is treated as a pension plan. Thus, the employer merely amended its pension plan and can use the existing surplus to provide the required contributions, which are usually less than the actuarial costs of maintaining a traditional pension plan. And, in the former bull market this recent decade, many employers did not have to make contributions at all. Today, of course, the opposite may be true.

Example

Let’s say the average earnings on an investment is 15%, and the rate of interest payable to the plan is 5%. In recent years, many funds have earned 15% or more if they invested in an index fund. It was thought that, if continued, it would be quite some time before some employers are required to make any contributions out of their own funds. Not so today, however.

Clearly, the savings can be substantial, and the costs of maintaining the plan are easily budgeted for. These advantages convinced some public utilities, telephone companies, financial, hospitals and healthcare institutions to convert their plans to cash balance plans.  

Impact on Employees

The cash balance plan is actually a hybrid plan—a cross between a traditional defined benefit pension plan and a defined contribution plan. But one of the key differences between the cash balance plan and a defined benefit plan is the manner in which the benefits are calculated. In a traditional defined benefit plan, an employee’s retirement benefit grows slowly in the early years and more rapidly as he or she approaches retirement. By contrast, a cash balance plan increases growth in the early years and decreases growth in later years of employment.

Youngsters

Younger healthcare employees usually liked the change; before the recent financial meltdown. Their accounts were portable; they grew quickly; and could be rolled over into an IRA or into a new employer’s plan. And, their account balances were listed as lump sums, so they know precisely how much they’ve accumulated. Today unfortunately, they have mostly been decimated.

Oldsters

Older healthcare employees initially liked the concept because the values of their pensions (on an actuarial basis) were converted to dollar amounts so they could see how much had accrued in their accounts without having to calculate an anticipated pension award. But, after further review, it was evident that upon retirement the cash bonus plans would yield smaller pensions than the defined benefit plans. Opinions differ today?

Health Workers in the Middle

When a hospital or similar entity converts from a defined benefit plan to a cash balance plan, employees their late 40s may see their pensions reduced by 25% or more while older employees see reductions of up to 50%. If the formula for calculating benefits under the defined benefit plan is 2% times years of service, and high-five compensation, then each year of service increases an employee’s pension. More importantly each time high-five compensation increases, the amount is accrued back to the employee’s original date of employment. So, as a hospital employee gets older, the high five-has tremendous impact. An employee who is age 60 can actually accrue most of his or her pension in the last five years of employment.

www.HealthDictionarySeries.com

dhimc-book5

No “Mo”

Cash balance plans don’t have that type of momentum [“Mo”]. The company contributes a certain amount based upon compensation and a specified interest rate. Usually, the interest rate is based on the 30-year treasury rate (approximately 2.5%).

Closing the Gap

Some employers are offering a grandfathered benefit designed to reverse the penalty for older workers. For example, employees within 10 years of retirement (usually age 65) will receive the greater of the cash balance plan or the pension under the original plan. This reduces the cost savings for the company.

Some employers increase the contribution percentage for employees based on age (i.e., 7% of compensation is contributed for employees aged 40—rather than the standard 5%—and 9% of compensation for those aged 50).

Assessment

Finally, some hospital employees are offered special “sweetners” in the form of additional lump sum credits when converting from an existing plan to a cash plan. The best benefit provides that all existing employees will receive the greater of the old plan or the new plan upon retirement. Only a small number of employers typically adopt this approach.

Conclusion

And so, your thoughts and comments on this Medical Executive-Post are appreciated. Nurses, hospital workers and hospitalists – please opine and subscribe to the ME-P here – it’s fast free and secure:

Link: http://feeds.feedburner.com/HealthcareFinancialsthePostForcxos

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com  or Bio: www.stpub.com/pubs/authors/MARCINKO.htm

Get our Widget: Get this widget!

Our Other Print Books and Related Information Sources:

Practice Management: http://www.springerpub.com/prod.aspx?prod_id=23759

Physician Financial Planning: http://www.jbpub.com/catalog/0763745790

Medical Risk Management: http://www.jbpub.com/catalog/9780763733421

Healthcare Organizations: www.HealthcareFinancials.com

Health Administration Terms: www.HealthDictionarySeries.com

Physician Advisors: www.CertifiedMedicalPlanner.com

Subscribe Now: Did you like this Medical Executive-Post, or find it helpful, interesting and informative? Want to get the latest E-Ps delivered to your email box each morning? Just subscribe using the link below. You can unsubscribe at any time. Security is assured.

Link: http://feeds.feedburner.com/HealthcareFinancialsthePostForcxos

Filed under: Accounting, Career Development, Financial Planning, Investing, Retirement and Benefits, Taxation | Tagged: , , , , , , , , | Leave a comment »