How to Save for Retirement When Your 401(k) Plan Sucks.

I switched jobs last year and along with a better position and bigger salary came a host of benefit changes. One of these changes was my 401(k) plan.

Regular readers know that I’ve been a steady contributor to my 401(k) at every job I’ve had since I started work professionally about 12 years ago.

Consistent contributions (even through employer match cut-backs and the recent Great Recession) an good plans have allowed me to watch my savings cross the 6-figure mark at the end of last year. But I realize now how lucky I have been to have had such good options in my 401(k) plans to date.

I realize this because I’ve hit a problem with my current plan, and I bet I’m not alone.

The problem

The problem is this: The investment options in my current employer 401k plan stink.

The plan is administered through a well known insurance company with a catchy jingle and fees that top the range of what is considered average for the funds.

I’m a big believer in low fees. Research has shown that most portfolios have a greater chance of outperforming their peers and the benchmarks averages when they invest in lower cost mutual funds or ETFs. It’s just common sense that when all other things are equal, the fund that charges less with leave you with more money in the end.

Of course, some funds out perform their peers and have higher fees. That’s OK too, but the key is that you’re getting a demonstrated track record of out performance for that extra cost.

My problem is that few of the funds in my 401(k) out perform their peers, but still have higher fees.

So, I have a few options and if you’re in the same situation, you do too!

Retirement plan options

The 3 basic retirement plans available to me in my career are:

• Traditional IRA
• Roth IRA
• Employer’s (lousy) 401(k) plan

Each one has benefits and drawbacks, but the Traditional IRA and Roth IRA are slightly different beasts given that the Roth contributions are after tax, while the tradition are pre tax.

I don’t want to roll over my 401(k) to a Roth, because I don’t want to pay the taxes on the conversion. I’m considering opening up a Roth in addition to pre-tax retirement plans in the future, but the Roth is not being considered by me at this time.

That leaves the Traditional IRA and the crappy 401(k).

Rolling over my 401(k) to a traditional IRA seemed liked a no brainer – I would be able to invest in a wider range of funds, stocks and bonds – but then I realized this startling discrepancy:

The contribution limit for a traditional IRA is only $5,000!

By contrast, the limit on a company sponsored 401(k) plan is a whopping $16,500!

With all the talk of financial reform in Washington D.C. over the past two years, and all the discussion about ending the 401(k) plan in favor of another social security style plan, I wish Congress would just make the contribution limit of the IRA as large as the 401(k)!

The total solution

Well, this left me with the choice of saving less in my IRA but paying less fees, or paying higher fees and potentially saving more by using my 401(k).

After much pondering, and poking around the Internet (to no avail), my solution is this…

I will rollover my old 401(k) to a new IRA. I will make the maximum contributions per year ($5,000) to that plan and any remainder I will contribute to the least offensive options in my 401(k).

For example, I’m used to contributing about $7,000 a year to retirement. I will be splitting up that amount like so:

• $5,000 to funds in my IRA
• $2,000 to funds in my 401(k)

I call this the “total solution” because it reminds me to consider the total holding in these two accounts as my portfolio – I have 1 unified portfolio instead of 2 portfolios.

The trick is determining which holding to keep in my 401(k) considering that an future increase in contributions will need to go into those funds. I’m tempted to hold my bond allocations in my 401(k). That way I will automatically increase my bond exposure over time as my contributions increase and I get closer to retirement age.

It’s not an ideal solution by far, but it’s the best I could come up with and I couldn’t find a better one. If you have any suggestions, I would gladly welcome them!

Related Posts:

• Are You on Track to Retire Comfortably?
• Conversion to Roth IRA Still Possible for 2011.
• Generation Y slacking on Savings?
• Spring Cleaning My Finances and Looking Ahead.
• Don’t Sabotage Your Retirement (Like Kris)!

Conversion to Roth IRA Still Possible for 2011.

While 2010 is already wrapped up, there are still financial considerations you need to make about the previous year in the near future when it comes to Roth IRAs. In 2010, the conversion rules have changed regarding converted Traditional IRA accounts and Roth IRAs. The government made it effective in 2010 that account holders could spread the income tax payments owed on the conversion over the following two years – 2011 and 2012.

This rule change would allow you to keep half of the income tax amount you owe still in the account, earning compound interest until the tax deadline for the following year. It is currently too late to take advantage of that tax incentive if you have not already made the conversion. But there is still good news for those wanting to convert to a Roth IRA in 2011.

Making the Change

In the past, there were strict limitations on who could make the conversion from a Traditional IRA account to a Roth IRA based on income. For now those laws have changed and are beneficial to anyone. Since you can still convert tax deductible investments as permitted by the government, making the switch in 2011 is a good investment strategy.

To make the conversion, you will have to pay the taxes you will owe later now but once the funds are converted, you will not have to pay income taxes on the amount you save ever again. For those who can afford to pay the income tax due out of there own funds rather than their investment funds, the conversion will be that much more beneficial.

When You Shouldn’t Switch

There are certain circumstances that may not prove to be beneficial to convert to a Roth IRA. First, if you know for sure that the rate of your income taxes will be lower in your retirement years than where they stand today, making the conversion does not really benefit you financially.

Secondly, if you don’t have the cash necessary to pay the income taxes you will owe from making the conversion, it is not wise to use your investment funds as a payment source as you will be required to pay a penalty on those funds as well as the tax.

Retirement Power

The most beneficial aspect of converting from a Traditional IRA account to a Roth IRA in 2011 is the investment power you are using towards your retirement years. Retiring with tax-free funds available later in life is a strategic move anyone can accomplish. For those who do not qualify for a Roth IRA account because of the income limitations, consider opening a Traditional IRA account and converting to a Roth IRA in the future.

Choosing your investments wisely for an easier, more comfortable retirement is part of your overall good financial health. If you have not taking the steps to plan for a financially healthy retirement, it is never too late to start investing, though it is always best to being when you are young. Not all financial strategies meet the needs of every future retiree but it is worth your time and money to explore what works for you. The Roth IRA account definitely has many advantages and it may be the ideal starting point for your retirement investment planning.

Related Posts:

• Don’t Sabotage Your Retirement (Like Kris)!
• How to Save for Retirement When Your 401(k) Plan Sucks.
• How To Start Saving For Retirement At 40.
• Rosland Capital – U. S. Gold Eagle Coins in Your IRA.
• Are You on Track to Retire Comfortably?

Will The Roth IRA Remain Tax Free?

Many financial planners recommend that investors salt at least some of their retirement savings away in a Roth IRA – and with good reason!

Roth IRA Eligibility Rules.

Eligibility rules are simple – if you earned taxable compensation, you are eligible. If you’re eligible, you next need to see if you qualify. For 2009, if your adjusted gross income (AGI) is less than $105,000 when filing single, or $166,000 when filing jointly then you qualify. NOTE: if you earned more than those amounts, you may still qualify for a Roth IRA, but at reduced levels of contributions.

Speaking of contribution levels, for 2009 the maximum contribution is $5,000. Like 401(k)s, there is a catch up clause, but I won’t go into that here.

Roth IRA benefits.

Any qualified distribution (withdrawal) is tax free. A “qualified” distribution is what that occurs at least five years after you first started to contribute to a Roth IRA and after you’ve reached age 59 1/2.

See http://www.money-zine.com/Financial-Planning/Retirement/Roth-IRA-Rules/ for more.

The problem.

The best selling point for most people is the tax free withdrawals, but this may be in jeopardy. Consider the following…

• Obama’s deficit is projected to be over $10 TRILLION in the next decade.

Now, deficits are not always evil and are sometimes necessary. Personally, I happen to believe that $10 trillion is excessive and dangerous. But regardless of how such deficits make us feel, one fact remains: It will need to be paid back.

The interest payments alone are set to take on a run-away snowball effect right around the time other social programs like Medicaid, Medicare and Social Security are projected to go bust.

In order to pay down this debt, the government will have two basic options: 1) Borrow the money, 2) Increase tax revenues. Borrowing the money is not going to work, not only because it will be difficult to find countries able and willing to lend that kind of cash, but because it would be pushing the deficit around without actually lowering it. This leaves option #2.

The current crop of politicians in Washington will interpret this to mean raising existing taxes and imposing new taxes. Ironically, in doing so they will stifle economic growth further, exacerbating the problem. But that’s another matter…

Higher taxes needed.

Modern Democrats have adopted the “Tax the Rich” mantra as a solution to their runaway spending, but this strategy falls short. First of all, they won’t be “Rich” after they’ve been taxed at the levels required to fund the spending projects. The whole “tax the rich” philosophy is little more than class envy and ignores the fact that most Americans do not remain fixed at any particular income bracket.

Another solution that is often proposed is to apply FICA taxes on all income. Congress has been sliding the maximum up year after year, but for 2009 only the first $106,800 of income is subject to the FICA tax. But even opening up all of a worker’s income to the FICA tax would not produce enough revenue to cover the funding gaps.

Conclusion.

Since there exists no single solution to generating the increase in revenue required to pay for the spending occurring today, and since the Federal Government is unlikely or unwilling to adopt a fiscally responsible policy the likelihood exists that we will not only see increased tax rates, but also an increase of new taxes. Already, politicians have targeted the 401(k) plan. One of their criticism of the plan is the money the Government misses out on while workers funds grow tax deferred. In this light, can we really expect that withdrawals from Roth IRA plans will remain tax free? Never mind that this would, in effect, tax workers twice (once when the earned the money to contribute, and then again when they withdraw their savings).

Well, those are my thoughts on the matter. What are yours?

Related Posts:

• How to Save for Retirement When Your 401(k) Plan Sucks.
• Conversion to Roth IRA Still Possible for 2011.
• Tax Alert: Fate of 401(k) when relocating.
• Tax Time: Last Minute List of Overlooked Deductions.
• Tax Time: Kiplinger’s “Do It Yourself Pay Raise” (Video).