Harvest a rich 401(k)

Harvest a rich 401(k)
Would you like your retirement income guaranteed or tax-free? That's the choice you get with two new 401(k) investment options.

By Janice Revell, Money Magazine senior writer
October 9 2007: 8:38 AM EDT
(Money Magazine) -- From the outset, the 401(k) plan has been all about accumulating money, and when you think about your plan during your working life, you concentrate on how much to contribute and what mutual funds to invest in.
Unless you're retired, you probably haven't a clue how you'll withdraw your money, and you've never been offered any official guidance on how to convert your savings into retirement income.
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Well, that's changing.
Recently it has been dawning on the folks who design 401(k)s that the ultimate goal of the plans is to provide a living income in retirement. And that the best time to start planning for that eventuality is when you put the money in. The result is two new 401(k) investment options that may show up in your plan soon.
A new chance for tax-free income
When you tap your 401(k), Uncle Sam gets the first bite: Your withdrawals are taxed at ordinary income rates, which today run as high as 35%.
The new Roth 401(k) changes that. Since Congress gave the Roth a permanent green light in 2006, a growing number of companies have started offering employees a choice between a regular 401(k) plan and a Roth.
Pamela Hess, director of retirement research at Hewitt Associates, estimates that about 25% of companies have already adopted the Roth 401(k), with more to come. "In a couple of years I think we'll see the majority of plans offering it," says Hess.
The Roth 401(k) is a mirror image of a regular 401(k). Instead of getting an up-front tax break on your contributions and an income tax bill on your withdrawals, you pay tax on the money you contribute but none on the money you take out.
You can contribute to both a regular and a Roth 401(k) in any given year, as long as your total contributions don't exceed the annual limit ($15,500 for 2007 or $20,500 if you are 50 or older).
Each version will come with the same investment choices, but if you decide to invest in both a Roth and a regular 401(k), your company will set up a separate account for each.
The Verdict It's pretty simple: For most people, the Roth 401(k) is the better choice. If you're just starting your career, it's practically a slam dunk, says Don Weigandt, an adviser at J.P. Morgan's private bank.
Yes, you'll forfeit the up-front tax savings. But when you retire decades from now, you'll almost certainly be in a higher bracket, making the Roth's tax-free withdrawals far more valuable than any deduction today.
Even if you're mid-career, the Roth is likely your best bet. Here's why: Suppose you're earning a low-six-figure income and you contribute $15,500 to your 401(k) this year. Assume further that you'll earn an 8% annual investment return and that you'll be in the 28% federal tax bracket both before and after retirement. Put your money in a Roth 401(k) and you'll end up with $72,245 tax-free in 20 years.
Now suppose that you put the same $15,500 in a regular 401(k) instead. In 20 years the plan will net you $52,016 after you've paid taxes on the withdrawal - or $20,229 less than you'd have in the Roth.
But when you contributed, you also got to shelter $15,500 from taxes, which in this case gave you $4,340 more in take-home pay. (The lack of that tax break is why you'll see your paycheck shrink if you switch to a Roth.) If you were disciplined enough to invest that extra money, you'd still fall short of the Roth's total. Why? Because to close the gap you'd need to earn 8% after taxes - a tall order over time.
Still, a regular 401(k) can win out in some cases. If you're close to retirement and fairly certain that your income will drop noticeably once you stop working, skip the Roth. Likewise, if you plan to move from a high-income-tax state like California or Minnesota to one with low (or no) income taxes, such as Florida or Nevada, nab the tax savings today.
Not sure where you'll stand? Use the Roth calculator at dinkytown.com. Or hedge your bets by splitting your money between a regular and a Roth 401(k). Bear in mind that your employer match will be in pretax dollars and taxed at withdrawal no matter which 401(k) you choose.
A way to collect a predictable paycheck
If you want guaranteed income in retirement, you can buy an immediate fixed annuity when you stop working and get a check a month for life. Or with a new 401(k) option known as a fixed deferred annuity, you can put together that check bit by bit throughout your career.
With these options - recently introduced by insurers like MetLife and The Hartford - each of your 401(k) contributions buys a dollar amount of retirement income, which varies based on your age and interest rates when you invest.
For every $100 a 40-year-old saves today in MetLife's Personal Pension Builder, for example, he would receive $26.40 a year for life starting at age 65. To date, only a handful of employers have rolled out such annuities, but they are expected to be widely available in a few years.
What's to like Converting 25% or so of your savings into a predictable income can keep you from outliving your money (for more on this strategy, see "Make Your Money Last a Lifetime"). Right now the only way to do that is to spend a hundred thousand dollars or more on an immediate annuity at retirement.
Only problem: It's psychologically impossible to do. When employers offer retiring workers the chance to buy an immediate annuity, according to Hewitt, only 1% take them up on it. That's understandable. "Who wants to part with $100,000 or $200,000?" says Jody Strakosch, national director for MetLife Institutional Income Annuities.
That's where these new deferred annuities come in. By letting you annuitize in small increments over time, they help you get over that psychological stumbling block.
Buying an annuity gradually can also add up to a better deal than you would get by annuitizing at age 65. "One of the advantages is that you lock in an income stream that might cost you a lot more later on," says Moshe Milevsky, an annuities expert at York University in Toronto.
The most important variable when you buy an annuity is interest rates: The higher rates are, the greater your eventual income will be, and vice versa. So building an annuity over time can blunt the risk of annuitizing all at once when interest rates might be low.
Annuities have also been getting more expensive in general because Americans are living longer. Milevsky estimates that increased life expectancies have boosted the cost by some 20% over the past two decades. Start buying now and you may pay less than you would when more longevity gains push prices up even more.
What's not to like The biggest glitch with fixed deferred annuities is that they aren't portable. If you change jobs, you can't roll them into an IRA and keep up contributions, thus defeating the advantage of investing gradually over time. And odds are good that your next employer's 401(k) doesn't offer the same annuity yet.
The verdict If you think you'll be staying with your employer for several more years and you don't have a traditional pension, 401(k) annuities are worth a look. Allocate no more than 20% to them, in lieu of some of your fixed-income holdings. Put the rest of your 401(k) to work in low-cost stock and bond funds. That way you'll be reaping the fruits of both growth and guaranteed income when 401(k) harvest time arrives.

Retirement outlook not bleak

In pursuit of the future
Retirement outlook not as bleak as many think, AgeLab head says
By Robert Powell, MarketWatch
Last Update: 10:22 PM ET Sep 26, 2007
BOSTON (MarketWatch) -- Most retirement gurus are extremely pessimistic about the future. Some are modestly hopeful. But there is one who is "wildly optimistic" about what's in store for the millions upon millions of aging baby boomers. Meet Joseph Coughlin, Ph.D., director of the Massachusetts Institute of Technology's AgeLab.
Coughlin and his team of researchers are stationed in a building like many others on the MIT campus, nondescript and near the banks of the Charles River. But what they are doing is anything but nondescript. They are "innovating" the future. And if half the things the AgeLab is working on become a reality then the future will indeed require shades.


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In short, the AgeLab is working on a future where older citizens not just add years to their life but add life to their years. And it's a life that will include fun, purpose, health, wealth and -- not surprisingly -- technology. "We see that it will be a great time to grow old," said Coughlin, who last week released, along with The Hartford, research about retirement rationalizations.
Yes, there are plenty of reasons why gurus are pessimistic. People tend to tell themselves little lies about retirement, according to the AgeLab's and The Hartford's study. They tend to think that they won't live that long, that someone will take care of them, that they will save whatever they can for retirement and then wing it.
And there are plenty of reasons why people are pessimistic. For starters, there are many depressing "facts" about retirement that are presented under the guise of motivating Americans to save more or prepare for retirement. Trouble is, those facts have not inspired Americans to act at all. "We have done a dismal job of helping people understand why they should think about tomorrow."
But Coughlin isn't keen on a world that has its collective head in the sand, where desperation becomes the mother of innovation. Instead, Coughlin wants to create the future absent the desperation. "We want to invent the future, otherwise we know what it's going to be."
So what will the future hold? Well, I am freshly returned from a visit to the AgeLab where, among other things, I got to drive in the most expensive video game this side of the Mississippi -- a Volkswagen hooked up to a big-screen TV that tested my driving skills (I only exceeded the speed limit a couple times) and I got to check out a shopping cart outfitted with a computer that tell shoppers whether the cookies they are about to drop in their carts are on their diet or not. But that doesn't tell the half of it.
Possibilities
Here's what in store on several retirement fronts:
Thinking differently. Retirement as we know it today is not sustainable, either on a personal level or a public level. So first off, Coughlin says business, government and individuals will have to rethink all things retirement. Most organizations, he says, were created yesterday and use yesterday's thinking to create solutions. "The lifestyle assumptions and calculations based on our parents' retirement are incomplete and incorrect," he said. In other words, Coughlin doesn't want firms to create investment and insurance products that are based on the proverbial nest egg number or vague concepts such as retirement dreams; rather he wants financial firms to design products that will provide income to Americans who want to modify their houses as they age or who still have transportation needs long after they stop driving. In addition, he sees technology - eye-tracking software specifically -- being used to help redesign the best way to present information on food labels and mutual fund prospectuses and the like to buyers. "Boomers are not the first generation to get old, but they are first to have health and wealth and the expectation that things will be different," said Coughlin. "They are the first to make old age cooler... It's a fundamental disruption."
Health and wellness. "We are about to see baby boomers sever the link between health and health care," said Coughlin. Boomers -- thanks in part to the rooting of the ownership society concept -- are intent on pursuing wellness and technology will play a big part in that pursuit. Shoppers will, for instance, use smart cards to learn right in the aisle -- not at the checkout counter -- whether the food they are about to drop in their grocery cart is on their diet or not. And Americans will also use kiosks in their pharmacy to learn about drug interactions and warnings. "We want people to use technology to make the right choice at the right time," he said.
Entrepreneurship. Boomers want to quit what they are doing to do something with "real promise." That means the next crop of entrepreneurs won't be newly minted MBAs but Americans over age 50 and especially the group referred to as "soccer moms." Soccer moms, says Coughlin, are ready to charge back into the work force. Trouble is, most companies aren't set up to bring back them back in a productive way. Most firms can't give soccer moms the flexibility they want so members of that group are likely to launch their own companies.
Working beyond age 65. Time was when people would stop working at age 62 or 65, never to punch a time clock again. Now, however, people are living longer and will need to work longer for a variety of reasons.
Education. Having a college degree at age 21 doesn't make one smart for a lifetime. According to Coughlin, boomers are likely to age not in place but on a college campus where they can enroll in college courses but also have ready access to health care. "Boomers will want to remain alive not just live longer," he said.
Employers. Employers of the future will set the agenda for how people navigate longevity. Indeed, employers will, for instance, establish employee-benefit programs that include not just day-care centers for children but for elders as well. In addition, employers will introduce wellness and lifelong learning programs designed to reduce costs and retain workers. "Employers want their workers to be at the top of their game for a lifetime," said Coughlin. "Employers will give workers a chance to reinvent themselves."
Financial advisers. Way back when, financial advisers were called customer's man. Years later, advisers became more sophisticated. But in the years to come, Coughlin said advisers will become even more sophisticated and multitalented, helping clients not only with their money but with their career and life's purpose.