This week’s chart illustrates why I encourage people to consider their retirement savings with the same weight as they consider aggressively paying off debt. The idea of living debt free is so catchy and liberating, but what if it’s costing you your financial freedom later in life?
The Forbes Advisor article, “Should You Pay Off Debt or Save For Retirement?” walks through a decision tree for how to prioritize your savings and debt decisions. It’s a great read, but I’d add one behavioral hack to your decision-making process: The Rule of 72.
One of the issues with deciding between paying down debt or saving for retirement is that you can’t predict the returns of the market. It’s pretty easy to calculate the interest that you owe over the life of the loan, but it’s hard to know what your investment will be worth later in life.
The Rule of 72 gives you a shortcut to help estimate how long it would take your investment today to double, given an assumed interest rate.
If you assume a rate of 5% then 72/5 = 14.4 years to double your money. If you assume 8%, then it would take 9 years to double your money.
Since you probably know how many years you have until retirement, the Rule of 72 can help you design an estimated range of probable values for your investment.
In the above example, if you have 48 years until retirement, a $10,000 investment given a fairly reasonable rate of return should have a value of between $40,000 to $160,000. In an extreme case, it could be as much as $2,560,000.
This type of table frames-up the impact of saving and gives you more information as you make your decision. If the loan interest you save by prepaying is far less than the gains suggested by the Rule of 72 table, it’s time to consider if “debt free” is really worth the cost.
The Small Business Jobs Act of 2010 modified by The American Taxpayer Relief Act of 2012 gave retirement plan sponsors the ability to offer in-plan Roth conversions. Additionally, plans that don’t currently offer the provision can add the option. An in-plan Roth conversion is a way to convert pre-tax savings to Roth savings.
Participants opting to do so must report the conversion amount as gross income on their tax return in the year of conversion and pay taxes due as a result. The Roth money then grows tax deferred and can be distributed tax free as long as the participant leaves the converted money in the Roth account for five years and has reached the age of 59 ½. This is a complex tax issue and anyone considering an in-plan Roth conversion should consult with their tax advisor.
Some of the reasons to consider an in-Plan Roth conversion are:
Expectation that tax rates will be the same or higher in the future
Taxes due can be paid from a source other than the retirement account
Desire to have a bucket of cash available tax free in retirement
Investing for the long-term, especially five-plus years to avoid penalty and taxes
If you expect your taxes to be lower in retirement, you don’t have cash available to pay taxes due at conversion or you will need access to the money in less than five years, this option may not be for you.
There are a few things to consider before you explore an in-plan Roth conversion. First, does your plan offer the option or intend to in the future? No need to consult your tax advisor if the answer is no. Second, make sure you fully understand the requirements for the money to be distributed tax free (five-year holding period and age 59 ½) or you may subject yourself to a 10% penalty tax and taxes due for early withdrawal.
However, given the current chatter about higher taxes in the future, more and more savers are interested in exploring the in-plan Roth conversion option. Vanguard provides a helpful table here, that explains in further detail the option. ThirtyNorth Investments does not give tax advise. You should consult your tax professional regarding in-plan Roth conversions.
It’s unsurprising that American workers love their retirement plans and don’t want them to change. The Investment Company Institute’s (ICI) recent research report, “American Views on Defined Contribution Plan Saving, 2020” confirms this fact in no uncertain terms. ICI has conducted this study for 13 years. Here are two key takeaways from the report.
First, American workers, who have a 401(k) plan or an IRA, like them and believe the accounts are instrumental in helping incentivize saving.
More than 90% of these workers agree that the plans simplified the saving process, helping them focus on the long term and
86% agreed that the tax treatment was a big reason they were saving. Almost all of these workers agreed that they should be able to choose and control their investments in the accounts. And
83% felt like retirement accounts could help them meet retirement goals.
Second, there’s a lot of talk in the political arena about altering retirement benefits to generate tax revenue, and workers are paying close attention to this. They strongly oppose changes to the tax advantages, contribution limits and removing control of investment decisions that come with 401(k) plans and IRAs:
87% of those saving via a 401(k) plan or IRA disagreed with the concept of the government taking away the tax advantage.
89% disagreed with the idea of reducing contribution limits. And
89% disagreed with the thought of giving away their ability to decide how to invest their money.
These results should clearly indicate to plan sponsors that they offer a benefit highly valued by their workers and that the workers gain financial security by receiving the benefit. The American retirement plan system is functioning well and workers do not want the benefit to change, especially when it is to their disadvantage. As my father used to say, “if it ain’t broke, don’t fix it.”
https://thirtynorth.com/wp-content/uploads/2017/04/LOGO-ThirtyNorth-Rev2017-1.png00Fritz Gomilahttps://thirtynorth.com/wp-content/uploads/2017/04/LOGO-ThirtyNorth-Rev2017-1.pngFritz Gomila2021-04-01 15:59:222021-04-01 17:07:02Thin(k) About Your 401(k) Plan: What A Great Benefit!
Trailing returns can be a fickle beast. We are about to see dramatic examples of why rolling returns can often convey a deceiving message, especially when it involves an unprecedented time period like 2020. The intense market drop in March of last year began moving back upward just about the time the 1st Quarter ended. That means that this quarter, the published 1-year returns will begin at market lows.
If you had new cash, and invested during the crisis, then enjoy those 1-year numbers. They look pretty amazing, even for the hardest hit asset classes. If you were invested through the entire year of 2020, please take those numbers with a grain of salt.
In the chart above, I used a US real Estate ETF. This isn’t actively managed, and it’s designed to represent the general US Real Estate market. In early April, this ETF will publish something around a 50% increase for the 1-year trailing return. If you tick back the performance period to encompass the whole 2020 experience and the first three months of 2021, however, the 15-month return is really more in the 1% range.
If you were fully invested last year, one trick to use in assessing how distorted the trailing 1-year number is by looking for the calendar returns for the same investment. They usually are published on the same factsheets, and they can help you sort out the full story.
It’s no surprise that with the change of presidential administrations that we would see regulations changing. Late in the Trump Administration there were two regulations that particularly affected ESG (environmental, social and governance) investing. Many were concerned about these policy shifts, but as you’ll see, it appears that these rule changes have been put on hold at least temporarily if not permanently.
That was big news, and it didn’t stop there. Another policy was to limit ESG considerations in fiduciary proxy votes. Plan Sponsors serve as fiduciary to the plan and in the selection of investment options must, therefore, take into consideration how the funds they select vote proxies. 401k Specialist reported $7.9 trillion invested in all employer based defined contribution plans, of which $5.9 trillion were invested in 401k plans.* That is a lot of money under the watch of the DOL covered under ERISA Law.
The big news didn’t last long. On President Biden’s first day in office, he issued an executive order directing federal agencies to review existing regulations issued or adopted during the Trump administration “that are or may be inconsistent with, or present obstacles to, the policies” the new president set forth “to promote and protect public health and the environment.”+
Not long after the order, the DOL seemed to back away from its final rule from just a few months back. Here’s what it had to say about non-pecuniary factor consideration and proxy voting by fiduciaries: “Until the publication of further guidance, the department will not enforce either final rule or otherwise pursue enforcement actions against any plan fiduciary based on a failure to comply with those final rules.”+
So much for final rules. The possibility of adding ESG investment options to ERISA governed retirement plans without potentially violating fiduciary responsibility is back on the table. Stay tuned.
*401k Specialist, 401k Assets Totaled $5.6 Trillion in First Quarter 2020, by John Sullivan, Editor-in-Chief, June 17, 2020.
+ ThinkAdvisor, DOL Won’t Enforce New Rules on ESG in Retirement Plans, by Bernice Napach, March 10, 2021.
https://thirtynorth.com/wp-content/uploads/2017/04/LOGO-ThirtyNorth-Rev2017-1.png00Fritz Gomilahttps://thirtynorth.com/wp-content/uploads/2017/04/LOGO-ThirtyNorth-Rev2017-1.pngFritz Gomila2021-03-22 09:45:272021-03-22 09:45:27Thin(k) About Your 401(k) Plan: ESG Investing in Your 401(k) Account
Are we in for a bumpy recovery ride? The above chart shows the average implied volatility on the left axis during the second year of a bull market, which is represented on the bottom axis.
March 23rd will mark the 1-year anniversary of the COVID-19 market low and the start of a new upward bull market environment. Year two of a bull market is about to begin. History suggests that volatility tends to really pick-up a couple months into the second year. If it holds true for this recovery, then May, June and July of this year could see above average volatility.
Our typical portfolio design factors in long-term volatility expectations, although short-term volatility can become a very big distraction. The drama of “the best day” and the “worst day” headlines can cause a significant amount of anxiety. But according to this chart, by the end of the second year, average historical volatility seems to taper down.
Every recovery has its own path, but it can be a relief to know that the bumps aren’t unexpected.
Weekly Market Recap, JP Morgan Asset Management. March 15, 2021. https://am.jpmorgan.com/content/dam/jpm-am-aem/global/en/insights/market-insights/weekly-market-recap-us.pdf
https://thirtynorth.com/wp-content/uploads/2017/04/LOGO-ThirtyNorth-Rev2017-1.png00Sarah Bomhoff, CFA, CIPMhttps://thirtynorth.com/wp-content/uploads/2017/04/LOGO-ThirtyNorth-Rev2017-1.pngSarah Bomhoff, CFA, CIPM2021-03-19 09:10:082021-03-19 09:10:08Thoughts in Charts: A Bumpy 2nd Year
Thoughts in Charts: Retirement Ready vs Debt Free
This week’s chart illustrates why I encourage people to consider their retirement savings with the same weight as they consider aggressively paying off debt. The idea of living debt free is so catchy and liberating, but what if it’s costing you your financial freedom later in life?
The Forbes Advisor article, “Should You Pay Off Debt or Save For Retirement?” walks through a decision tree for how to prioritize your savings and debt decisions. It’s a great read, but I’d add one behavioral hack to your decision-making process: The Rule of 72.
One of the issues with deciding between paying down debt or saving for retirement is that you can’t predict the returns of the market. It’s pretty easy to calculate the interest that you owe over the life of the loan, but it’s hard to know what your investment will be worth later in life.
The Rule of 72 gives you a shortcut to help estimate how long it would take your investment today to double, given an assumed interest rate.
If you assume a rate of 5% then 72/5 = 14.4 years to double your money. If you assume 8%, then it would take 9 years to double your money.
Since you probably know how many years you have until retirement, the Rule of 72 can help you design an estimated range of probable values for your investment.
In the above example, if you have 48 years until retirement, a $10,000 investment given a fairly reasonable rate of return should have a value of between $40,000 to $160,000. In an extreme case, it could be as much as $2,560,000.
This type of table frames-up the impact of saving and gives you more information as you make your decision. If the loan interest you save by prepaying is far less than the gains suggested by the Rule of 72 table, it’s time to consider if “debt free” is really worth the cost.
For disclosures, please click here.
Thin(k) About Your 401(k) Plan: In-Plan Roth Conversion
The Small Business Jobs Act of 2010 modified by The American Taxpayer Relief Act of 2012 gave retirement plan sponsors the ability to offer in-plan Roth conversions. Additionally, plans that don’t currently offer the provision can add the option. An in-plan Roth conversion is a way to convert pre-tax savings to Roth savings.
Participants opting to do so must report the conversion amount as gross income on their tax return in the year of conversion and pay taxes due as a result. The Roth money then grows tax deferred and can be distributed tax free as long as the participant leaves the converted money in the Roth account for five years and has reached the age of 59 ½. This is a complex tax issue and anyone considering an in-plan Roth conversion should consult with their tax advisor.
Some of the reasons to consider an in-Plan Roth conversion are:
If you expect your taxes to be lower in retirement, you don’t have cash available to pay taxes due at conversion or you will need access to the money in less than five years, this option may not be for you.
There are a few things to consider before you explore an in-plan Roth conversion. First, does your plan offer the option or intend to in the future? No need to consult your tax advisor if the answer is no. Second, make sure you fully understand the requirements for the money to be distributed tax free (five-year holding period and age 59 ½) or you may subject yourself to a 10% penalty tax and taxes due for early withdrawal.
However, given the current chatter about higher taxes in the future, more and more savers are interested in exploring the in-plan Roth conversion option. Vanguard provides a helpful table here, that explains in further detail the option. ThirtyNorth Investments does not give tax advise. You should consult your tax professional regarding in-plan Roth conversions.
For disclosures, please click here.
Thin(k) About Your 401(k) Plan: What A Great Benefit!
It’s unsurprising that American workers love their retirement plans and don’t want them to change. The Investment Company Institute’s (ICI) recent research report, “American Views on Defined Contribution Plan Saving, 2020” confirms this fact in no uncertain terms. ICI has conducted this study for 13 years. Here are two key takeaways from the report.
First, American workers, who have a 401(k) plan or an IRA, like them and believe the accounts are instrumental in helping incentivize saving.
Second, there’s a lot of talk in the political arena about altering retirement benefits to generate tax revenue, and workers are paying close attention to this. They strongly oppose changes to the tax advantages, contribution limits and removing control of investment decisions that come with 401(k) plans and IRAs:
These results should clearly indicate to plan sponsors that they offer a benefit highly valued by their workers and that the workers gain financial security by receiving the benefit. The American retirement plan system is functioning well and workers do not want the benefit to change, especially when it is to their disadvantage. As my father used to say, “if it ain’t broke, don’t fix it.”
For disclosures, please click here.
Thoughts in Charts: Beware of the 1-Year Returns
Trailing returns can be a fickle beast. We are about to see dramatic examples of why rolling returns can often convey a deceiving message, especially when it involves an unprecedented time period like 2020. The intense market drop in March of last year began moving back upward just about the time the 1st Quarter ended. That means that this quarter, the published 1-year returns will begin at market lows.
If you had new cash, and invested during the crisis, then enjoy those 1-year numbers. They look pretty amazing, even for the hardest hit asset classes. If you were invested through the entire year of 2020, please take those numbers with a grain of salt.
In the chart above, I used a US real Estate ETF. This isn’t actively managed, and it’s designed to represent the general US Real Estate market. In early April, this ETF will publish something around a 50% increase for the 1-year trailing return. If you tick back the performance period to encompass the whole 2020 experience and the first three months of 2021, however, the 15-month return is really more in the 1% range.
If you were fully invested last year, one trick to use in assessing how distorted the trailing 1-year number is by looking for the calendar returns for the same investment. They usually are published on the same factsheets, and they can help you sort out the full story.
For disclosures, please click here.
Thin(k) About Your 401(k) Plan: ESG Investing in Your 401(k) Account
It’s no surprise that with the change of presidential administrations that we would see regulations changing. Late in the Trump Administration there were two regulations that particularly affected ESG (environmental, social and governance) investing. Many were concerned about these policy shifts, but as you’ll see, it appears that these rule changes have been put on hold at least temporarily if not permanently.
In October of last year, the Department of Labor (DOL) issued a final rule for private-sector retirement plans regarding non-pecuniary factors like ESG ,which limited these factors, stating that, “retirement plan fiduciaries are focused on the financial interests of plan participants and beneficiaries, rather than on other, non-pecuniary goals or policy objectives.”
That was big news, and it didn’t stop there. Another policy was to limit ESG considerations in fiduciary proxy votes. Plan Sponsors serve as fiduciary to the plan and in the selection of investment options must, therefore, take into consideration how the funds they select vote proxies. 401k Specialist reported $7.9 trillion invested in all employer based defined contribution plans, of which $5.9 trillion were invested in 401k plans.* That is a lot of money under the watch of the DOL covered under ERISA Law.
The big news didn’t last long. On President Biden’s first day in office, he issued an executive order directing federal agencies to review existing regulations issued or adopted during the Trump administration “that are or may be inconsistent with, or present obstacles to, the policies” the new president set forth “to promote and protect public health and the environment.”+
Not long after the order, the DOL seemed to back away from its final rule from just a few months back. Here’s what it had to say about non-pecuniary factor consideration and proxy voting by fiduciaries: “Until the publication of further guidance, the department will not enforce either final rule or otherwise pursue enforcement actions against any plan fiduciary based on a failure to comply with those final rules.”+
So much for final rules. The possibility of adding ESG investment options to ERISA governed retirement plans without potentially violating fiduciary responsibility is back on the table. Stay tuned.
*401k Specialist, 401k Assets Totaled $5.6 Trillion in First Quarter 2020, by John Sullivan, Editor-in-Chief, June 17, 2020.
+ ThinkAdvisor, DOL Won’t Enforce New Rules on ESG in Retirement Plans, by Bernice Napach, March 10, 2021.
For disclosures, please click here.
Thoughts in Charts: A Bumpy 2nd Year
Are we in for a bumpy recovery ride? The above chart shows the average implied volatility on the left axis during the second year of a bull market, which is represented on the bottom axis.
March 23rd will mark the 1-year anniversary of the COVID-19 market low and the start of a new upward bull market environment. Year two of a bull market is about to begin. History suggests that volatility tends to really pick-up a couple months into the second year. If it holds true for this recovery, then May, June and July of this year could see above average volatility.
Our typical portfolio design factors in long-term volatility expectations, although short-term volatility can become a very big distraction. The drama of “the best day” and the “worst day” headlines can cause a significant amount of anxiety. But according to this chart, by the end of the second year, average historical volatility seems to taper down.
Every recovery has its own path, but it can be a relief to know that the bumps aren’t unexpected.
Weekly Market Recap, JP Morgan Asset Management. March 15, 2021. https://am.jpmorgan.com/content/dam/jpm-am-aem/global/en/insights/market-insights/weekly-market-recap-us.pdf
For disclosures, please click here.