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How 401K Fees Impact Your Retirement

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401k feesOne of the biggest killers for investment performance over time is high fees. It used to be that many mutual funds would charge a fee for buying, an annual fee based on the balance invested, and a fee when the fund is sold. For most investors, those days are thankfully long gone. Vanguard started the push for lower fee funds, and nearly every online broker has followed suit.

But the lowering of fees is mostly seen in taxable and IRA accounts. In the world of 401(k) plans, this is not always the case. Many 401(k) plans still have investments with fees that are three to four times higher than what one would see when investing in an IRA.

Not only do many employees pay a high annual fee on the funds they invest in with their 410(k) plan, they also pay an annual administrative fee. Most people have no idea they are paying such an administrative fee, and many have no idea what the annual fees on their funds are inside their 401(k) plan.

Finding Your Fees

The administrative fee on a 401(k) plan can be difficult to find, which means you would need to ask your Human Resources director or person in charge of the plan for that information. But the annual fund fee, known as the expense ratio, is now easier than ever to find thanks to all of the great financial planning software and tools available to the public. I used WealthTrace’s financial planning application to view the fees on several ETFs.

Not only can I see the expense ratio for each fund, but I can also view the total dollars I pay each year in fees along with the fund turnover. For taxable investment accounts, the turnover can really make a big difference in taxes. The higher the turnover, the more in capital gains one usually pays.

How High 401k Fees Can Crush a Portfolio

Most of us know that investment gains compound over time as more money is reinvested. But fees work the opposite way. They are a negative and therefore compound negatively over time. I looked at a portfolio that has a balance of $700,000. I ran a fee what-if scenario where the annual fees on all investments were increased by 0.5%.

The portfolio value was reduced by over $655,000 over 30 years. This value does not even take into account inflation over that time frame either. The result is in today’s dollar terms. This just shows how even a small increase in fees can have a huge impact on retirement investments. A hit like this can mean that even $1 million might not be enough to retire on.

What You Can Do

If you have an IRA or taxable investments, make sure you are not paying too much in annual fees. Look for the expense ratio for your funds. For most funds that are not actively managed, you should not be paying more than 0.15% per year. Vanguard is usually the best in terms of fund fees so I always recommend starting there.

For 401(k) plans you should look for your expense ratios. Make sure your company offers index funds with fees that are at least below 0.4%. They should also offer a target date retirement fund that reallocated your investments towards a more conservative approach as you get older. These types of funds are great for those who do not want to worry about reallocating their investments over time. The fund does it for you!

You should also ask the person in charge of your 401(k) plan what the administrative fees are. If they are more than 0.5% per year, you should ask if they can change 401(k) providers. The 401(k) provider industry is becoming more competitive, and more and more companies are moving to Vanguard, which as mentioned earlier, is always a great place to start when trying to lower fees.

Lastly, it is a good idea to roll over a 401(k) to an IRA if you leave a company or retire. This way you will have access to thousands of funds with lower fees. You also will get rid of any administrative fee you are currently paying.

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Deciding When to Take Social Security

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deciding when to take social security

Under today’s rules, a person can begin taking social security benefits as early as age 62. The full retirement age (FRA) used to calculate social security benefits ranges from 65 to 67, depending on when you were born. But one can also wait as long as age 70 before taking benefits, and the annual benefit increases the longer you wait. So an important question arises: How does a person decide when to begin taking his or her benefits?

For those who are in relatively good health and do not need social security payments to meet current expenses, it can be a good decision to wait until the person’s FRA or even as long as possible (age 70) before taking benefits. The reasoning is straightforward: You’ll receive a penalty if you start your benefits early and you will receive a credit if you delay your benefits.

If you decide to receive benefits before reaching the FRA, the benefit reduction is 0.56% for each month before that age, up to 36 months. If you receive benefits for more than 36 months before the FRA, the benefit reduction is another 0.42% per month. But by delaying the first year in which you receive your social security benefits until after your FRA, your monthly checks will be higher over the long-run by as much as 8% each year until you reach age 70.

Running the Numbers

Understanding how much money one needs to retire comfortably is of utmost importance when planning for retirement. In addition to this, it is also extremely important to understand how to generate the most income in retirement as possible.

The best way to take the benefits, penalties, and any credits into account is to look at a break-even analysis, which I performed using a calculator called When to Take Social Security. It is very informative to see at which age the total accumulated benefits break-even with, and then surpass, the accumulated benefits that occur when taking social security at earlier ages.

Social Security benefits chart

The chart above assumes that this person turns 62 next year and has made $70,000 per year (in today’s dollars) for the past 35 years. Also, all projected dollars are in today’s dollars and are not adjusted for inflation.

Let’s start by looking at how this person fares when taking benefits at age 62 vs. age 65. By delaying the first social security payment to age 65 this person will break-even vs. taking the first payment at age 62, in terms of accumulated benefits, when he is 77 years old. If he then lives until age 90, he will receive over $66,000 more during his retirement. Waiting until age 70 gives this person a break-even that is similar. The break-even vs. taking the first payment at age 62 would be 78 years old. The difference in accumulated benefits, if he lives until age 90, would be nearly $162,000.

What It All Really Means

The cold, hard reality of making decisions such as this is that you are betting on how long you will live. Clearly, if you believe you will live until age 90 and you do not need your social security payments right away to meet expenses, you should wait until age 70 before taking social security. The Social Security Administration (SSA) algorithm that determines these payments was set up so that the typical person will receive the same accumulated benefits over time given average life expectancies today.

Of course, not everybody is in average health, so this is probably the biggest factor you should consider if you’re deciding when to take Social Security. Basically, if the person in this hypothetical illustration decides to take his first social security payment at age 65, he is betting that he will live to at least age 77, which is the break-even age for accumulated benefits.

In an attempt to save money, the SSA no longer sends out information on estimated benefits. However, there are a whole host of websites that help you determine what your social security payments will be. It is a good idea to run scenarios yourself in a detailed retirement planning software application, changing the age in which you receive your benefits. You can then see how your accumulated benefits change as you change the age in which you receive your first payment.

Social Security Accounts for 66% of Retirees’ Primary Income

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Social Security Income

It’s no surprise millions of senior citizens depend on Social Security income to pay their monthly bills. However, the number of retirees who rely on Social Security as their primary source of income is steadily increasing. In fact, approximately 66 percent of seniors believe it will be their primary source of income throughout their golden years.

Why You Can’t Depend on Social Security Income

You may be thinking, “well, isn’t that what Social Security is for?” Many Americans don’t realize that Social Security isn’t designed to replace your income. Instead, it is supposed to supplement your retirement income. On top of Social Security, you should have retirement accounts (like a 401K or IRA), investments, and/or a pension to fund your day-to-day expenses.

When it boils down to it, Social Security benefits will only replace about 40 percent of your pre-retirement income. Considering most retirees need about twice that to live a comfortable life in retirement, relying on Social Security as your primary source of income may be a grave mistake when it comes to your financial well-being. Not to mention, future cuts in retirement benefits are still a possibility.

Social Security was only ever meant to prevent poverty in older Americans. Typically, someone’s Social Security benefits will cover basic needs, such as housing, food, utilities, clothing, healthcare, and transportation. However, it won’t cover any entertainment or enjoyable aspects of life. Who would want to live in retirement that way?

How to Financially Survive Retirement

The key to financial success in retirement is finding ways to boost your income before (and after) you leave the workforce. For those who are still working, you still have time to contribute to savings, 401K, and IRA accounts. It also isn’t too late to chat with a financial advisor about investing some of your cash.

Retirees who depend on Social Security still have options to boost their income during their golden years. You can always try a part-time job. Consider consulting in your former field, working for a nonprofit you support or turning a hobby into a small business. For instance, seniors who enjoy crocheting or knitting can make extra money selling items on Etsy or at pop-up markets.

You can also take a look at your assets and see if any of them may serve as a secondary source of income as well. If you have extra space in your home, consider renting it out. You may also look for items you have around the house that are of value that you can sell.

Bottom Line: Don’t Rely on Social Security

Even now Social Security benefits are barely enough to keep retirees afloat, and two-thirds of the retired population heavily rely on them. Looking into the future, those benefits could disappear as early as 2034. The only way to prevent yourself from living in poverty during retirement is searching for new ways to make more money to add to any benefits you’re receiving.

For those who haven’t retired yet but are concerned Social Security benefits won’t be around when they retire, it is never too late to start saving and prepping for your life after you leave the workforce. Start a retirement account as soon as possible.

Readers, do you currently collect Social Security? Do you have supplemental income?

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Do You Need $5 Million to Retire?

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$5 million to retire

Suze Orman nearly broke the web after saying you’ll need at least $5 million to retire if you are part of the FIRE mindset (financial independence, retire early). Is Orman out of touch with the needs of the common man because of her own wealth? Or do you really need $5 million to retire?

The FIRE Movement

Financial independence, retire early.

That sounds great, doesn’t it? The FIRE mindset may put you behind in your retirement years though. Many people are finding that by retiring early, they aren’t able to live the life they hoped they could. Or they find out that what they had saved wasn’t enough.

“There needs to be another downturn to vigorously stress test the FIRE movement,” the Financial Samurai blog’s Sam Dogen said. “My guess is we’ll see a lot of FIRE folks end up going back to work after a decimation of their finances.”

Why You Probably DO Need $5 Million to Retire

After some digging around, many personal finance bloggers found Orman isn’t wrong. Anyone wanting to retire before the age of 60 will need to have at least that much saved. Where most people took an issue with what Orman had to say was that her scenario isn’t an option for most people. Those hoping to retire early had their dreams crushed.

$5 million to retire

Right now, only 18% of Americans retire before the age of 61, as illustrated in the graphic above. More than half of Americans retire between 61 and 65. However, FIRE folks are looking to retire as soon as possible, even if it means their finances take a hit.

Folks who have $1 million invested and try to retire at 40 will only receive $40,000 per year. In many places in the U.S., that won’t get you far. Folks retiring at 50 with $3 million will be able to withdrawal around $100,000 per year for 30 years of retirement. And if you’re willing to wait another 10 years, your paycheck in retirement can be even larger.

Should You Retire Early?

Many financial advisors suggest you don’t retire before the age of 40. If you retire that early, you’ll be heavily relying on your investments. Much of the younger generation won’t necessarily have experience in the market and don’t know how devastating a financial crisis can be. They also may not be prepared for emergencies or changes to their cash flow.

All in all, it is a good idea to consult with a financial advisor if you’re thinking about leaving the workplace for retirement. Speaking with a professional can help you set up a plan to retire when the time is right.

Readers, do you think you need $5 million to retire?

Photo: Freedom To Marry

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Financial Independence Retire Early – What To Do In Case Of FIRE

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Financial Independence Retire Early

The all-caps are intentional. FIRE stands for Financial Independence Retire Early, and it qualifies as a small phenomenon after gaining a lot of momentum in recent years. In short, it refers broadly to younger people who save (and invest) an extraordinary percentage of their income for some period of time, and then retire – or “retire,” in quotes.

We use quotes because the “retire” part of the equation is somewhat fungible. Leaving a career is normally part of the equation, and working at anything full time (at least for one person, if it’s a couple) is too. But engaging in gainful employment on the side doing something you enjoy or have an interest in is still fair game.

Financial Independence Retire Early – The Trade-Off

The trade-off here is that, in exchange for sacrificing for a while, you can get out of the rat race (or stop working for “The Man,” or insert your own euphemism for working here) a lot sooner than most people – even in your 30s. This may mean committing (or condemning, some would say) yourself to living frugally for the rest of your life, and foregoing certain expenses or luxuries that others take for granted. But FIRE adherents say that the trade is worth making because of the freedom it affords them – the “independence” part. Financial security opens up new avenues for people interested in trying something new, whether it’s income producing or not, without being afraid of the opportunity cost (and the potential opportunities lost). Most have done the math and figure that if worst comes to worst, they could do something menial part-time and, between that income and a tiny draw-down on their investments, cover all or most of their living expenses.

On The Other Hand

That all sounds great. Living to work is out; working (as much as you need to) to live is in. The cost of consuming without considering what it means to your wealth is a big focus of the movement and something we happen to have written about too.

But we do have some concerns. Here are a few of them.

The next recession. The FIREd seem like a thoughtful bunch. We’ll give them the benefit of the doubt and assume they have considered, and even quantified, what an extended market downturn or an economic recession would do to their plans. All they need to do is be aware that it could happen and then stick to the plan.

That’s a lot easier said than done, though. Great money managers will tell you that until you’ve been through a bear market (or multiple bear markets), you don’t know how you’ll react (or if you’re cut out to be a money manager in the first place). Most of the FIRE crowd had barely reached an age to have even entered the workforce during the last recession, let alone started down the early retirement path. So they don’t really know if they’ll be able to handle the stress of watching the value of their investments drop by 30% or 40%.

To be sure, it’s probably a certain kind of person that undertakes early retirement in the first place. Self-motivated, frugal, flexible, detail oriented. All of these characteristics will help in case of emergency, and all else equal, such people should manage better than most. Even so, looking for work exactly at the time when there’s little work to be had is no fun for anyone.

Financial Independence Retire Early
A severe market downturn can really impact a retirement plan.

Uncertainty about spending for long stretches can be wrenching. A key piece of a lot of traditional retirement plans is scaling back on luxuries or vacations when times get tight. If you go into retirement with your eyes open about the possibility of having to do this (effectively lowering your portfolio withdrawal rate for certain periods), and you’re in your 60s or so, you can make a plan work that otherwise might not.

But that’s a different situation entirely than being, say, 40 years old, with a child or two, and having to cut back. That would be tough enough to prepare for financially; it’s almost impossible to prepare for mentally. It helps to have an awareness of your personality type. Could you ride out such a stretch without losing sleep or becoming a stressed-out wreck?

Past performance is no guarantee of future results. When we talk about planning for the future, we almost invariably start by looking to the past. Stuff like projecting asset class returns, running Monte Carlo simulations, and our bear market simulator (highlighted above) is based on the idea that the past will repeat itself to some degree.

That’s OK, to a point. After all, we have to start somewhere, and over time, the past probably will repeat itself, at least from a 40,000-foot view.

But the particulars can vary. And early retirees need to be looking at those particulars. The Four Percent Rule is a great example. Any 30-or-so-year retirement period should be able to handle a 4% withdrawal rate, it says, no matter the market environment.

Before the early nineties, though, a lot of planners thought it was more like 5%. More recently, as fixed income yields have been stingier, you hear 3% lot more often.

Might the rule change again? If so, it could certainly be unpleasant if you’re halfway through a long retirement and counting on a rule being a rule.

Whatever your withdrawal rate rule is, WealthTrace can help you get it dialed in.

Leading By Example

We make compromises all the time, and maybe early retirement should be no different. Maybe if you hang it up professionally at 35 or 40 and have done the math and are comfortable with your projections, you’ll chalk up not being able to afford, say, traveling in luxury 10 years down the road to one of those compromises. You can’t live in the shadow of what-ifs all your life.

Even if you’re not ready to be that extreme about it, there’s a lot to learn here. Those who have taken the plunge offer insights that most of us can benefit from, whether we’re retiring early or going the more traditional route.

For a lot of us, maybe it’s simply another lens through which to look at something we already know to be true: If we live like we want to retire early by doing all the things we know we should be doing (maxing out the 401(k), watching our spending, and so on), we might actually be able to do so.

Read More

Don’t Outlive Your Retirement Fund
Saving for Retirement Early is Worth It
How Mutual Funds Impact Your Retirement

House Flipper Tips: Can You Flip Your Way to Retirement?

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house flipper tips

Thanks to television shows like Flip or Flop, house flipping is in its heyday. In fact, many people wonder whether it is possible to flip their way to retirement, either allowing them to retire comfortably when the time comes or using it as a means to exit the formal workforce early. Here are some house flipper tips for retirement.

Can You Flip Your Way to Retirement?

In short, yes, you can flip your way to retirement. However, that doesn’t mean everyone will achieve that level of success, and many flippers who proceed without a plan actually lose money.

Shows like Flip or Flop, Zombie House Flipping, and First Time Flippers don’t always provide flipping newbies with an accurate picture of what it takes to flip a house successfully. While they touch on the financial aspects of the projects and mention some of the challenges, these shows are small glimpses into the reality of taking on a house to flip.

Plus, buying a house to flip is a massive investment. If something goes wrong, losing money is a possibility, at times to the tune of thousands (if not tens of thousands) of dollars.

However, with some care and proper planning, it is possible to flip a house successfully. Then, if you purchase another property and keep flipping, supporting your retirement through house slips is an option.

Consider the Costs of the House

To flip a house, you need to purchase a property that requires work to reach its full market potential. Additionally, you need to focus on homes that, once you pay for repairs and upgrades, is worth substantially more than you put in.

Often, the best way to begin is to find a property with potential and buy it with cash. This eliminates mortgage interest and certain fees from the equation, increasing your profit-making capabilities.

Being realistic and knowledgeable about the actual costs and potential earnings is also critical. Many flippers forget how much closing costs and realtor commissions can run, and they both impact profit margins.

Similarly, not knowing the market can come back to haunt you. You need a realistic picture of the homes potential resale value when complete, a process that usually begins by examining comparable properties, or “comps,” that recently sold in the neighborhood before you make a purchase. If you use an agent to buy the house you plan to flip, they can help in this area.

Additionally, you need to be able to fund all of the repairs and upgrades with cash. Again, this is about avoiding debt, interest, and fees, all of which can eat away at profits.

Plan for Repairs and Upgrades

You’ll need to set a budget for your flip and estimate the costs of repairing the property. This includes both products and labor, as most flippers don’t have the expertise to manage every kind of repair themselves, at least in the beginning. While cosmetic changes, like paint, are fairly easy to take on, electrical, plumbing, structural, and roof repairs usually require a contractor, and their labor comes with a price tag.

Before you complete the home buying process, get a home inspection at a minimum. You may also want to pay for specialty inspections, such as by having a plumber send a camera through the pipes or an electrician to evaluate the wiring, as issues behind the walls may not be caught during a traditional inspection. Then, you’ll have a solid idea of what repairs are necessary beyond cosmetic improvements and can get quotes for the work or plan for expenses for projects you take on personally.

Once the core work is done, you also need to take care when choosing other upgrades. While hardwood floors, marble counters, and soaker tubs may be the dream, you need to make sure that high-end finishes will land you a solid return. Otherwise, you risk over-improving the house for the neighborhood, and that can lead to losses.

How Do You Set a Sale Price?

Once the work is done, you usually list the home for sale with a realtor. By getting help from a professional, they can help you pick a suitable price according to current market conditions. Plus, they act as an objective third-party. Since you put in some much time and effort, you may have an emotional attachment that clouds your judgment, leading you to think the house is worth more than it is realistically.

How Do You Use Flipping to Retire?

Usually, you can’t fund a retirement with a single flip. Instead, once you sell one property, you move on to another, either using your profits from the first to reach higher value markets or investing your profits to save for retirement and sticking in the same zone.

Over time, you may even be able to slip multiple properties at once, accelerating your plan. However, it’s critical to always take the same level of care with each purchase and renovation, as falling quality will hurt your reputation and profit margins.

Have you ever thought about how to flip your way to retirement? Tell us about your experience in the comments below.

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