Rocks that say 401s vs Roth

The 411 on Roth vs Regular 401ks

Traditional 401(k) or Roth 401(k)?

Workers usually don’t know the difference. Yet employers increasingly are asking them to choose. Nearly two-thirds of private-sector employers with Vanguard plans today offer both a traditional and a Roth 401(k) in their employee benefits. Just four years ago, fewer than half did.

For tips on navigating the traditional-vs-Roth decision, we interviewed two members of the American Institute of CPAs: Monica Sonnier is an investment adviser in the Salt Lake City, Utah, area; and Sean Stein Smith is an assistant professor in the economics and business department at Lehman College in New York.

The difference in the two types of plans is the timing of federal income taxes:

  • In a traditional 401(k), a worker who contributes to his or her account will see taxable income reduced by the dollar amount of the contribution. For example, contributing 6 percent of a $30,000 annual salary ($1,800 per year) means the worker pays federal income taxes on just $28,200. The taxes will be paid decades later, when the IRS will require the retiree to pay income taxes on the amounts withdrawn from the traditional 401(k).
  • In a Roth, a worker pays income taxes on his or her full $30,000 salary, as usual. The 6 percent is an after-tax contribution that does not reduce the tax bill. The benefit will come decades later, because a Roth does not require the retiree to pay income taxes when the savings – including the Roth account’s investment earnings – are withdrawn.

If a retiree is taxed at the same rate as he was taxed as a worker, there is no difference in the after-tax retirement income the two 401(k) plans provide. However, traditional 401(k)s have generally been viewed as more advantageous, because people typically have lower incomes – and lower tax rates – in retirement than when they were working.

But things might also be changing. Over the long-term, increasing federal deficits due to increased spending pressures from popular programs to support aging baby boomers are expected to push up individual income tax rates. When that occurs, many retirees might be better off with a Roth so they won’t be taxed when they withdraw their savings.

Of course, each individual’s or couple’s tax situation is unique. Given all these caveats, here are the accountants’ rules of thumb for deciding between a traditional and Roth 401(k): …Learn More

Unaware and in Need of Flood Insurance

West Houston homeowner Mary Sit surveys flooding in her neighborhood caused by a release of dam water several days after Hurricane Harvey made landfall. Photo credit goes to Amy Sit Duvall

Millions of U.S. homeowners may not realize they’re at risk of flooding, due to outdated flood plain maps and even less information about dam and levee “failure zones” and urban storm-water hazards like the river running through downtown Miami during Hurricane Irma.

Hurricanes and floods tend to be low-probability events with enormous consequences.  When they slam our coasts and waterways, they randomly take aim at one of middle-America’s largest financial assets: their houses.  Double-barreled hurricanes in Texas and Florida over the past month underscore just how vulnerable this asset can be to storm surges and the unpredictable effects of climate change.

“Someone on the coast of New Jersey or New York says their home is part of my retirement plan. It’s worth $400,000” – or so they think, said Larry Larson, senior policy adviser for the Association of State Flood Plain Managers in Wisconsin.

“What we’re going to see happening, especially in Florida in areas very close to the ocean, is that with the sea level rise, the value of these structures are probably going to go down 30 percent,” he predicted. The Northeast is also at risk, as Hurricane Sandy reminded homeowners in 2012.

A lack of accurate information about flooding is an issue for people who want to properly insure themselves. For example, the flood plain maps compiled by the Federal Emergency Management Association cover only about one-third of the 3.5 million miles of waterfront property located in low-lying flood plains, according to a study by the Association of Flood Plain Managers.

Most oceanfront property has been mapped, but the crux of the problem is that FEMA can’t keep up with rapid urban sprawl, said Chad Berginnis, the association’s executive director.  “Today’s cow pastures and corn fields are tomorrow’s residential subdivisions and commercial growth areas,” said Berginnis, a former flood plain manager in rural Ohio.

Further, some sections of Houston that flooded, post-Harvey, when water was released from local dams are not mapped as areas where FEMA requires flood insurance.  In northern California, thousands of homeowners around Lake Oroville were unaware they were in a failure zone until they were evacuated last winter for a dam-water release.

Larson sees homeowners make three major mistakes: no or inadequate flood insurance, no contents insurance, and no replacement coverage. …Learn More

Livestream: Financial Empowerment

Today, an ambitious financial education program operated by Delaware state government and the United Way of Delaware is bringing a message of financial empowerment for working people to a national stage.

The organizations have partnered with Ted Talk in Wilmington, Delaware, to film 15 financial education videos. The videos will be livestreamed on Sept. 12 starting at 10:30 a.m. Eastern time.

Since 2011, the state program, known as Stand by Me, has provided one-on-one financial coaching to some 16,000 Delaware residents, said Mary DuPont, who runs it. Today’s Ted videos grew out of DuPont’s 2016 presentation for Ted-X Wilmington.

The videos feature various proponents of financial education, including Javier Torrijos, chair of the Delaware Hispanic Commission, who will tell his personal story about the trials and aspirations of growing up as a child of Columbian immigrants, DuPont said.

Kevin Gilmore, executive director of Habitat for Humanity in Delaware’s Sussex County, will speak about his realization that preparing people financially to buy homes is just as important as building the physical structures.  And “Why a Steady Job is No Longer Enough to Feel Financially Secure” is the title of a talk by New York University professor Jonathan Morduch, who has been featured on this blog.

The 15 videos will be archived on the Ted website and on standbyme.org, probably in November. If you don’t want to wait, here’s the livestream. …Learn More

Why Many Retirees Choose Medigap

Medicare facts

The Medicare open enrollment period starting Oct. 15 applies only to two specific insurance plans: Part D prescription drug coverage and Medicare Advantage plans.

But before choosing among various plans sold in the insurance market, the first – and bigger – decision facing people just turning 65 is whether to hitch their wagons to Medicare-plus-Medigap or Medicare Advantage.  Squared Away spoke with insurance broker Garrett Ball, owner of Secure Medicare Solutions in North Carolina, who sells both. Most of his clients buy Medigap, and he explains why.

In a second blog post, we’ll interview a broker who deals mainly in Advantage plans. Another source of information about Medigap and Advantage plans are the State Health Insurance Assistance Programs

Q:  Let’s start with explaining to readers what your company does.  

We’re an independent Medicare insurance broker that works with some 2,000 clients on Medicare annually who are shopping for supplemental plans. My company began in 2007, then in 2015 I launched a website tailored to people just turning 65 to answer the questions I get every day. We’re not contractually obligated to just one insurance company. When we work with someone, we survey the marketplace where they live, assess their needs, and help them pick a plan.  We get paid by the insurance companies when someone signs up for a plan.  Different states have different commission levels, and there is more variation state-by-state than company-by-company. Insurers typically pay fees of $200-300 per person per year.

Q: What share of your clients buy Medigap policies, rather than Medicare Advantage plans?

Approximately 10 percent of my clients end up with Medicare Advantage vs 90 percent with Medigap. Some states have a higher percentage in Medicare Advantage. I do business in 42 states, so this depends on the insurance markets in individual states.

Q: Why do you sell more Medigap plans? …Learn More

Senior Hunger in Decline but Still High

Saturday morning at a Boston-area farmers market.

While hunger has eased among older Americans, millions still worry about having enough to eat from day to day.

A new report by two non-profits – Feeding America and the National Foundation to End Senior Hunger – found that food insecurity among people 60 and older declined by a meaningful amount between 2014 and 2015, the latest year of data available. This marked the first decline since the Great Recession.

Nevertheless, the percentage of the older population fitting the various definitions of being food insecure used in the report is much higher than in 2001.  In 2015, 15 percent of older Americans felt threatened by hunger – the broadest definition – compared with 11 percent in 2001.  And hunger is not isolated to the poor, said James P. Ziliak, founding director of the Center for Poverty at the University of Kentucky and co-author of the new report.

A big reason for rising food insecurity among seniors is that only 40 percent of those with low incomes who are eligible for federal food stamp assistance are actually enrolled in the Supplemental Nutrition Assistance Program, or SNAP, he said.  This compares with 80 percent of the eligible population as a whole enrolled in SNAP. …Learn More

Mid-sized Employer Meets Big 401(k) Goal

Thomas Automotive Family’s service department in Bedford, Pennsylvania.

When Peggy Zembower became the human resources director for Thomas Automotive Family about four years ago, she was dismayed that some long-time employees had never increased their retirement saving above the measly 1 percent of pay they’d started at.

One big issue was that the lowest-paid workers at the auto dealership – like low-wage workers everywhere – felt they couldn’t afford to save in the 401(k). A lack of knowledge about investing and a reluctance to give up control of their money seemed to frighten others out of saving, which meant forfeiting their employer’s matching contribution.

“It bothered me when I saw employees who’d been here five years and up and saw what small amounts they were investing,” she said. “Many lower-paid employees saved little or nothing.”

With her boss’ blessing, Zembower got to work.

Thomas Automotive is a mid-sized company with 280 full-time and part-time workers. Their earnings run the gamut, from employees in the service department earning $11 per hour (or about $23,000 per year) to car salespeople earning as much as $100,000, and Thomas Automotive’s owner, who has four dealerships in Pennsylvania and one in Maryland.

By doing the things retirement experts recommend, Zembower increased participation to 87 percent of employees, up from 53 percent. She did this by instituting automatic enrollment in the 401(k) at 4 percent of workers’ pay and auto-escalation, over time, of the amount saved. (Employees have the right to pull out or to maintain past contribution levels.) These techniques are far more common at large companies.

She goes further, re-enrolling all non-participating employees each April 1st, which requires them to revisit their decision before opting out of the retirement savings plan again.  “We have a few employees who feel we don’t have the right to do this,” she said, “but we do.”

One gets the impression when interviewing Zembower that it is not what she’s done to make the 401(k) plan work better.  It’s how she’s done it, with her gentle insistence that saving for retirement is best for the workers.  Sometimes this means she’ll ask a worker to wipe off his greasy hands and look with her at the retirement calculator placed front and center on the employee page of the company website. …Learn More

needle in haystack

Mutual Fund Fees: Here’s What Matters

Investors will probably see good news in Morningstar Inc.’s annual report showing that the fees charged by actively managed mutual funds continue to come down.

The truth is that focusing on fees alone misses the point. What matters is a fund’s after-fee return. There are always fund managers who excel at picking stocks and can deliver strong after-fee returns to investors year after year, justifying the high fees required to pay them. The early years of Fidelity’s Magellan fund is the classic example.

The trick is finding that clever manager, which requires a combination of luck and the skill and inclination to compare numerous investment options. One thing making this task a little easier is the mutual fund industry practice of reporting returns, net of fees. But the research shows that stock funds that consistently outperform their benchmarks are few and far between – and finding them would be particularly challenging for 401(k) investors who already struggle with basic decisions.

Morningstar’s fee report indicates investors might be getting the message.  In 2015 and 2016, they pulled a total of $627 billion out of the group of actively managed funds charging the highest fees. During the same two years, they funneled $429 billion of new money into lower-fee index funds.

Yes, active funds’ average fee (called the expense ratio, in a prospectus) declined last year to 0.75 percent – or three-quarters of 1 percent – from 0.78 percent in 2015. This continued a downward trend: fees averaged 1 percent in the early 2000s.

But compare this with 0.17 percent for index funds. In contrast to actively managed funds, passive index funds aren’t set up to beat a market benchmark: their goal is to simply mimic the performance of a specific market index, whether it’s the Standard & Poor’s 500 or a Bloomberg Barclay’s bond index. …Learn More

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