Let’s continue with the 401k/403b Rollover discussion. Previously, I explored some possible reasons to keep your old employer’s plan. The next option to consider (if only briefly) is to transfer your 401k/403b assets into your new employer’s retirement plan. You can only transfer after-tax contributions between the same type of account (401k » 401k, or 403b » 403b), but more common pre-tax contributions should be able to be transferred between different types as long as the new plan allows rollovers.

The reasons you might want to do an employer-to-employer transfer are very similar to before:

Special investment options
Maybe your new employer plan has some desirable options that aren’t available to a retail IRA investor. The average 401k has something like 7 mutual fund choices though, so this is probably unlikely. Ask your new HR department for details.

Lower minimum balances or fees
If you have a small balance and figure you might as well cash it out as you don’t meet other account minimums, don’t! Your new employer will probably have no minimum requirements and you can continue to build on what you have already contributed.

Ability to take out loans
Your new 401(k) may allow you to take out loans against your savings, which you can’t do with an IRA. In addition, if you already have a loan from your old 401(k), your new one may allow you transfer over that loan. Otherwise, most plans make you pay back the balance immediately or risk having it penalized as an unqualified withdrawal.

Still not sure? Another alternative is to roll your plan into a Rollover IRA, keeping it separate and not merging it with any other IRAs, and then see how you like your new employer’s plan. If somehow you do, then you can transfer the Rollover IRA assets into your new plan.

References: SmartMoney, American Funds

One of the most common questions I get from people when they find out that I like personal finance is “What should I do with my 401k/403b/457 plan from my old job?” My own 401k rollover decision process was one of my first blogging topics. I eventually settled on rolling my 401(k) balance into an IRA at Vanguard, although I have since changed my specific investment choices. This time around, my wife has the ex-401k that needs to be addressed, and so I think it’s a good time to do a more in-depth series on 401k (and similar) rollovers.

To start off, should you really move your retirement plan somewhere else? I think you’ll see that in most cases the answer is yes, but there are some possible benefits to staying put. Here are a few:

Special investment options
While many 401(k) plans offer very limited or expensive options, some of them actually offer investments that you may not be able to get anywhere else. For example, your plan may give you access to a mutual fund that is normally closed to new investors, a special institutional or pooled fund with super-low expenses, or the ability to buy your company stock at discounted prices.

Lower minimum balances or fees
One benefit of many 401(k) is that there are often no minimum balance requirements to invest in an offered fund. For example, my wife might have as little as $10 in a Fidelity Spartan index fund with a tiny 0.10% annual expense ratio while it is in her 401(k), but in an IRA the minimum would be $10,000. At the same time, the account may continue to waive all maintenance fees even after you leave (check with your administrator.) Depending on where you move your money to, other brokers may charge fees for low balances.

Together, it may be a good idea to keep smaller portfolios in such a 401k until the balance grows enough to consolidate with other investments.

Ability to take out loans
Although not necessarily a good idea, many plans do offer the option of being able to borrow money temporarily from your 401(k). This option is not available in an IRA.

I probably missed something, so if you have some more reasons not to move your retirement plan into an IRA, please share in the comments below.

While visiting the parents, I was also asked to provide some input on their retirement savings. I don’t want to invade their privacy, but I’m sure they share common concerns with others out there. My father, who is in the non-profit/education sector, has much of his retirement money with TIAA-CREF (Teachers Insurance and Annuity Association – College Retirement Equities Fund). They are one of the biggest financial services companies in the U.S., and are operated on a non-profit basis.

As you might guess from their name, a very popular option for members is the TIAA Traditional Annuity, holding over $163 billion. I was not at all familiar with this beast, so I decided to learn more about it. Here’s a quick rundown from the website:

A guaranteed annuity backed by TIAA’s claims-paying ability, TIAA Traditional guarantees your principal and a minimum interest rate, plus it offers the opportunity for additional amounts in excess of the guaranteed rate. TIAA has credited additional amounts of interest every year since 1948.

The annuity primarily invests in publicly traded bonds, commercial mortgages, direct loans to business, and real estate. It has no loads, no surrender charges, no maintenance fees, and very low annual operation expense ratios of about 0.25%. (Sources: SURS, Dixie State Univ. )

Accumulation Stage
So you invest in this annuity, your account value will never decrease as long as TIAA is around. In fact, it will go up in value by at least 3% every single year, and most likely more depending on market conditions. Think of the savings on antacids during the next stock bubble! There are two tiers of performance – From what I understand, the higher paying tier is for money that is contributed directly by the employing company or group, whereas the lower paying tier is for voluntary contributions from the individual. Here are the historical returns:

For comparison, the venerable Vanguard S&P 500 Index Fund (VFINX) has a 10-year trailing return of 7.05%, and the Vanguard Total Stock Market Index Fund (VTSMX) has a 10-year return of 7.60%. The Vanguard Total Bond Market Index Fund (VBMFX) has a 10-year return of 5.74%.

Withdrawal Stage
When you reach retirement and are ready to start take money out of your annuity, you have a variety of options. There are one-lifetime income options, two-lifetime income options, fixed-period (ex. 10-year) income options, interest-only payments, and also a few others involving taking a lump-sum or just the required minimum distributions.

Of course, all annuities are simply a promise, not a 100.00% guarantee. In this regard, TIAA does have the highest possible credit ratings from all the major agencies: A++ by A.M. Best, AAA by Fitch, Aaa by Moody’s, and AAA by S&P.

Summary
Overall, it was very interesting learning about this additional investment option. Here were my tentative opinions:

• There is an expected trade-off of lower long-term performance in exchange for a guaranteed minimum return if you purchase this annuity. For those with longer time horizons and the discipline to ride out the market’s ups and downs, it may be better to invest in low-cost stock/bond mutual funds or ETFs instead. Those that are very risk-averse will love this investment.
• The lifetime income options are nice and reliable, but you could also do the same with a portion or all of any retirement portfolio. Just cash out your stocks and bonds, and go buy an immediate annuity with a lifetime payout option.
• Still, if you’re going to buy such an annuity, TIAA-CREF offers some of the best and safest returns along with the lowest fees available in the annuity marketplace.
• As my father is nearing retirement and I think the safety of this investment is very comforting to him, I think this option will work adequately for him. The majority of his annuity holdings are also in the higher-paying tier. I am, however, providing him some guidance in the rest of his portfolio to provide some diversification, as well as telling him what questions to ask his group’s financial advisor.

I haven’t posted my investment portfolio since April, mainly because it hasn’t really changed much. But here’s another snapshot:

Thoughts
Another couple of months have gone by, and my desire to re-define my asset allocation remains unfulfilled. All I did was buy some more of a Total US Market fund (FSTMX) through my self-employed 401(k). You’d think someone who writes about money on a daily basis would be on top of such things!

But really, I think I might actually be spending too much time on this. As Jack Bogle has stated, “The greatest enemy of a good plan is the dream of a perfect plan.” There is no perfect asset allocation, and I know that. I keep telling myself, I’m not looking for the perfect plan, just a better one which has been well-reasoned out, and one which I should have little reason to tinker with for a long time.

To achieve such a better plan, I have been re-reading each of my favorite investing books on top of many new ones (including All About Index Funds by Ferri, Unconventional Success by Swensen, Only Guide to a Winning Bond Strategy You’ll Ever Need by Swedroe), looking at their research, comparing their model portfolios, and trying to balance all the advice given. But after all these months, my slow deliberation has really just turned into what academics call “paralysis by analysis” and have been just been putting off making a decision for weeks. I do have some overall changes planned, including:

• Increasing my allocation to international assets,
• Decreasing my value tilt, and
• Increasing my bond allocation.

I want to avoid trying to time the market, or chasing recent performance. But I also don’t want to base my decisions on simply trying to avoid the impression of trying to time the market. Although I’m always open to suggestions, I feel I need to some fresh input. Got an asset allocation suggestion? Ideas on a better value/size/country tilt? Another book to read? Throw it at me.

Recent articles by Bernstein Wealth Management [pdf] and Kiplinger’s Personal Finance suggest that as we continue to live longer lives, this should increase the percentage of our portfolios that we devote to stocks.

Living Longer…
A 2000 study by the Society of Actuaries states that a male who reaches age 65 has a 50% chance of living beyond age 85 and a 25% chance of living beyond 92. Women can expect to live two to three years longer than men. More importantly for couples, you are now looking at a 50% chance of one of you living beyond 92!

Means Some Potential Changes
Bernstein then ran some Monte-Carlo simulations using historical data (for what years, I couldn’t tell) to “help quantify the impact of alternative allocation and spending decisions over varying time periods and markets.” The basic scenario was a couple who retired at 65. The variables were how aggressive the portfolio was (20%-100% in stocks), and how much you withdraw from the portfolio each year (2-7%). Here are two summarizing charts and some of their findings:

1. If you’re going to spend a relatively high percentage like 5% of your portfolio, it is important to keep your stock percentage at least at 60%. But, increasing it to all the way 100% doesn’t help much, and increases the downside in a bear market.
2. At a low spending rate, like 3%, then your stock percentage doesn’t matter that much either way.
3. Although spending and allocation are both critical factors, the former tends to exert a more powerful influence. Simply working a bit longer in order to delay spending can increase your success rate significantly.

Conclusions
Taking into account these findings, the Bernstein paper concludes that although bonds are a traditional safe-haven for retirees, their increased longevity make the growth from stocks important throughout one’s lifetime. They suggest that a proper compromise between these factors is a portfolio of 60% stocks and 40% bonds, along with a 4% spending rate. This gives the couple an 85% chance of having their money last till death.

Glassman of Kiplinger also makes his own suggestions:

Bernstein emphasizes that individual clients’ needs differ. Certainly, but based on this report and other research, I have decided to raise my suggested quick-and-dirty stock allocations for retirement accounts this way: If you’re under 40, there’s no reason not to own a 100%-stock portfolio. Between ages 40 and 60, you can move to an 80-20 stock-bond ratio. Between age 60 and retirement, shift to keep at least 60%, and in most cases closer to 70%, in stocks.

This is much more aggressive than almost all the Lifecycle or Target-dated Funds (see here for a comparison between Vanguard and T. Rowe Price Target Retirement funds.)

My concern would be that with so much in stocks, when people “fail”, they fail by a lot, whereas with bonds it might be easier to compensate for a slow stock market by working part-time. I’m undecided as to if this study will cause me to make any changes.

Enough with the fluffy stuff, how about some firm numbers. Imagine that a young college grad actually has the forethought to even think about what they need for retirement. They check out an online retirement calculator, and see their needed amount is… 5.7 bajillion dollars!¹ Shocked, they shake their head, walk away, and promise themselves to revisit it again in a few years… hopefully.

A more attainable goal: You should aim to accumulate double your salary by age 40. Doesn’t that sound more reasonable? This is the solution proposed by this Wall Street Journal article A $1 Million Retirement Fund: How to Get There From Here. (Thanks Don for the tip.) Why double?

Let’s say your salary has hit that $80,000, you have amassed $160,000 in savings, you are socking away 12% of your pretax income each month and your investments earn 6% a year. Over the next 12 months, your $160,000 portfolio would balloon to $179,518, or $19,518 more. Your monthly savings would account for $9,600 of that growth. But the other $9,918 would come from investment gains.

In other words, you’ve got to the crossover point, where the biggest driver of your portfolio’s growth is now investment earnings, not the actual dollars you’re socking away.

My only beef is that the math in the article is a bit vague. First, the article means double your expected salary at age 40, by age 40. Now, is the 6% assumed return supposed to be real or nominal? Are we assuming this is all in a 401(k)? How much inflation-adjusted money will this give you at age 65?

However, the main points remain. Money saved now will be worth a lot more than money saved later. Once you generate a “critical mass” in your retirement funds, they really do seem to gain a life of their own.

The graph on the right shows three investors, each of whom invests just $1,000 a year until age 65. However, one begins at age 25, investing a total of $40,000; one at age 35, investing a total of $30,000;
and one at age 45, investing a total of $20,000. Each earns 7 percent per year and, for purposes of this illustration, the effects of taxes and inflation are ignored.

The result? The early bird ends up with more than double the one who waits until age 35 and more than four times the one who waits until age 45.²

I’ve certainly experienced this. As our own retirement balances have grown, the recent stock gains alone are often thousands of dollars each month. So what are you waiting for? Get started with just $50 per month!

¹ Actually if you plugged in 21 years old and $40,000, the goal would be $2,591,000. Still big!
² Source: Investment Company Institute

Vanguard has just announced some changes to their fee schedule, which includes some great news for us smaller investors who like Vanguard but kept getting dinged by their low-balance fees.

Before, you had to dodge the following $10 fees:

• The maintenance fee on index fund accounts with a balance of less than $10,000.
• The custodial fee on traditional IRAs, Roth IRAs, and SEP?IRAs with a balance of less than $5,000.
• The low-balance fee on all nonretirement accounts with a balance of less than $2,500.

These have all been replaced with a single account service fee of $20 annually for each Vanguard fund with a balance under $10,000. Okay, that’s not too special. The good news is that if you agree to get electronic versions of statements and other documents, all the fees are waived!

The waiver is available immediately, so switch now 🙂 If you have $100,000 in total balances, you’re also fee-free. I already have everything set to deliver electronic format, so I’m all set. (Also you save lots of trees! Those prospectuses are thick.) In addition, you can still choose the “E-delivery and mail year-end-statement” option and get the fee waiver. That’s perfect for me.

I’ve always felt the $10 fees were justifiable, as if you were paying for things a la carte, because otherwise at 0.20% of say $5,000, that’s just $10 a year for IRS filings, paper, printing, postage, great customer service, and so on. Still, they were annoying. Even though my wife and I together have over $60,000 invested with Vanguard, we were still being hit with fees.

Now I’m less likely to switch to Vanguard’s ETF offerings, as I was considering for the future when I start putting money into taxable accounts. I prefer the simplicity of mutual funds.

It’s time for another bi-monthly update on my investment portfolio.

Thoughts
Not much going on, I have been contributing a $500 a month to my Solo 401k while trying to build up my cash hoard for a house downpayment. I still plan on tweaking my asset allocation, but I’ve just been distracted by other things and kind of want to wait a full year before making any changes.

All of our Vanguard funds are held at Vanguard.com, where there are no commissions for trading their mutual funds. Currently, everything there is in Roth IRAs, one each for my wife and I. Even though Roth IRAs rock, we haven’t contributed to one this year yet because we might be over the income limits for 2007.

The Fidelity fund is also held in-house at Fidelity, where I have my Self-Employed 401k. Funds are also no transaction fee (NTF) there. It’s a bit annoying that both their Spartan Total US and International funds have high $10,000 minimums, but the 0.10% expense ratio is nice. I could also trade ETFs, but at $20 a trade it’s a bit expensive.

You can see some older posts on how this portfolio came to be here, as well as my previous portfolio snapshots here.

Ben Stein has an good read on Yahoo Finance about what he terms the Six Key Principles of Saving for Retirement. Although I agree with all six main ideas, I question some of the specific numbers. Here are some excerpts and my comments:

1. How much you save.
Simply put, if you’re a typical American (who happens to save close to zero right now), you have to save more. When you’re young, 10 percent of your income will get you there. If you don’t start saving until middle age, aim closer to 15 or 20 percent. If you don’t start until later than middle age, save every penny you can.

Interesting. Is 10% really enough? If so, maybe I really am saving too much for retirement. 🙂 To what degree of certainty is that true?

2. How long you give your savings to compound.
A thousand dollars socked away when you’re 20 and growing at 10 percent per year will be almost $73,000 when you’re 65. The same sum saved when you’re 50 will grow to $4,200 at age 65. That’s a stunning truth that should compel any young person to start saving early — and the rest of us to start right now.

As for timing your retirement, Ray advises that if you can push it back by even five years you’ll allow your money to grow and have fewer years to need it.

Compound interest is truly powerful. A dollar saved now is worth more than a dollar saved later.

Although it hasn’t been helping me control my spending as much as I’d like either, I did make the horribly unpopular true cost of frivolous shopping calculator. 😉

3. How you allocate your assets.
Typically, for those who start early, stocks are the answer. Over long periods, a diversified basket of common stocks wildly outperforms bonds, cash, and real estate. The differences are breathtaking.

But, as we’ve seen lately, there’s also a lot of volatility in stocks. As you age, you’ll want more of your money in bonds and money market accounts. These have lower returns than stocks, but they also have far lower volatility.

Phil DeMuth recommends that, as a basic portfolio, you have half of your savings in the broadest possible common stock index such as the Vanguard Total Stock Market Index (VTSMX) and half in the Vanguard Total Bond Market Index (VBMFX)… To me, that’s a bit conservative if you’re young. I would have more in stocks and also a good chunk in international markets.

Here is a compilation of various model asset allocations from other respected sources. Pretty pie charts included!

4. How much your investment returns annually.

Now, this is largely unknown from year to year. But over long periods, stocks return close to 6.5 percent after inflation, and about 10 percent before inflation.

Can we expect 6.5% real returns in the future? Lots of conflicting opinions out there on this, but I really want to look into this more.

5. How low you keep your fees and costs.

This principle is largely about using index funds and no-load mutual funds, which makes perfect sense.

Costs matter, whether you go actively or passively managed. I’ve seen some really expensive index funds. Always look up the expense ratios and any commissions you have to pay either when you buy or when you sell for all the investments you own.

6. How closely you keep an eye on taxes.
Finally, Ray advises maxing out your tax-protected accounts like IRAs and 401(k)s; keeping high-dividend stocks in accounts that are tax-deferred; and, when retiring, carefully considering what bracket you’ll be in and drawing out your funds to remain in the lowest possible one.

Ah, taxes. Here is a discussion on where you should place investments for maximum tax-efficiency.

J.D. of Get Rich Slowly also shared his thoughts on these six points, and believes the most important factor in retirement savings is psychological.