Rollover Replay

The days of relying on home ownership as a retirement wealth builder have gone the way of the dodo.  Likewise, defined benefit plans as a source of retirement income. This puts renewed importance on savings in defined contribution plans.  It also means paying very close attention to the process of rolling money over from an employer-sponsored plan.  At best a mundane topic but one that merits a closer look.

It's always been table stakes for investors taking a lump-sum distribution to get the paperwork right in order to avoid taxes and penalties. And most providers do a good job in explaining what a plan participant needs to do.  But a new element of risk has been introduced to the rollover process by today's tremendous market volatility that makes a successful rollover not just about the what but the when.

With frequent market swings of 3% or more, it's essential that investors understand when their current 401(k) holdings will be liquidated by the plan and then reinvested by the new IRA provider.  With respect to the former, most plans are self-directed and participants can initiate the sale rather than relying on the 401(k) provider. Getting an exact date when the dollars will arrive at the new destination can be challenging, but it never hurts to ask.  

It's also important to be proactive with the new IRA provider.  Even though you may have agreed on an asset allocation strategy prior to the lump-sum distribution, never assume the investment has actually taken place.  Understand the obligation of both the old and new provider with respect to the timely transfer and investment of rollover assets. Missing that 3% up move can wipe out a year's worth of earnings in today's low rate environment. If assets weren't transferred or invested in a timely manner, throw the challenge flag and ask for a replay.

It's ironic that with trillions of dollars coming out of qualified plans the IRA rollover process remains more of an art than a science. Be assured the last thing asset managers want is money sitting in cash where margins (if any) are razor thin.  But many firms are reluctant to invest in their operations while they continue to reduce back office staffs.  This results in highly manual, error-prone processing which is especially problematic given today's roller coaster markets.

If you're contemplating a rollover, understand the timing on both ends of the transaction.  If you have a rollover in process, look to see when the those assets were sold in the 401(k) or 403(b) plan and stay on top of the new IRA provider.  And if you recently rolled money over look to see if the assets were transferred and invested in the timely manner you expected.

Defined contribution plans will take on even greater importance in retirement as pensions march toward extinction and real estate remains a deeply troubled asset.  Paying close attention to the what and when of the rollover process can help keep your retirement off the endangered species list.

The World Turned Upside Down

As the British surrendered at Yorktown their band played a song called "The World Turned Upside Down" in wry acknowledgment of the improbable American victory.  By underestimating the Continental Army and applying traditional tactics to a guerilla war,  King George III and his Empire unwittingly gave birth to a new superpower that would eventually surpass it in dominance.  The world had indeed been turned upside down.

Arguably, the world of retirement planning is being turned upside down as well.  Underestimating how the rules have changed and applying the wrong tactics will result in too many Americans failing to achieve their retirement goals. Scare tactics that reference cat food as a retirement staple miss the point;  few people will actually run out of money. Instead, the risk lies in dramatically reduced lifestyles due to a lack of quality and relevant planning.

Ironically, the issues and trends that have changed the rules of retirement are hiding in plain sight.  The key is to recognize them and respond accordingly:

• An aging population is straining social programs.

• Longevity is a double-edged sword.

• The onus is now on the individual to accumulate wealth and turn it into retirement income.

• The transition from growth to income planning is counter-intuitive for advisors and clients alike.

• Cognitive impairment will be the next great challenge of retirement planning.

• Home ownership is fading as a way to build retirement wealth.

• Rising taxes will undermine the buying power of retirement assets.

• Low interest rates are rewarding borrowers, not savers.

• Volatility is reducing the appetite for stocks.

• Lost jobs and market declines are causing delayed retirement.

• Income, rather than age, will trigger retirement.

• The cost of healthcare and how to save for it remains the elephant in the room.

Future posts will address these and other challenges we all face when reconsidering retirement.  In the mean time it shouldn't take a midnight ride to warn of the reality that the rules of retirement are changing and we must rally accordingly.

The Problem with Lists

The fact that lists are becoming standard fare in our sound-bite, Twitter-obsessed society is no surprise.  No doubt "Best Places for Capricorns to Retire" is in the works.  And while lists can occasionally be fun (David Letterman) and very useful (The Ten Commandments) they can also be misleading.  Or, to paraphrase Mark Twain's screed against statistics; there are lies, damn lies and lists.

Here's a short list of the problem with lists:

• Lists blur fact and opinion.

It's this distinction that got Socrates into all that trouble with his fellow Athenians, so some perspective is called for.   When you look at the American League East standings and see  the Red Sox in first, that's a fact.  When you read a list that says Hackensack University Medical Center is the best place in the Metropolitan Area to have a heart transplant, that's an opinion. It's a fact that "Unbroken" was a top selling hard back.   Stating "Reconsidering Retirement" is the best retirement blog out there." is an opinion, albeit a very good one.

The best rule of thumb is to always avoid lists and declarative sentences that contain the word "best."

• Lists are pure marketing.

US News and World Report was floundering until it began publishing numbing lists of the "best" colleges, graduate schools, hospitals and the like.  The magazine claims its rankings are based on a scientific formula (Is there any other kind?) which is proprietary. They also deflect any blame if colleges make too much of the rankings and students misuse them. Clearly, this has the same effect as the Surgeon General's warning on that carton of Marlboros.  In any event, it's remarkable how from Princeton to Pepperdine these esteemed institutions allow themselves to be compared like kitchen appliances in Consumer Reports.

Mutual fund rankings also deserve a mention (the credit rating agencies have been pilloried enough.) Many plan sponsors (and retirees) get caught up in a system where they may be reluctant to select funds without a certain number of stars. They fear criticism (and worse as plan fiduciaries) if an investment lineup doesn't have the highest ranked funds.  This over-reliance on rankings can distort the fund selection process by causing investors to overlook funds that in fact may be better suited to meet their goals in spite of "inferior" rankings.  

It's remarkable that the purveyors of lists and rankings have university presidents trembling and plan fiduciaries relying on stars. Pure marketing genius.

• Lists make you lazy.

The goal of most lists is to sell something. In spite of that, they can offer some useful information. Of course the same may be said of SportsCenter, Cliff Notes and retirement blogs.  However, watching SportsCenter's "Top Ten Plays" is no substitute for appreciating the unscripted drama of that particular game.  After slogging through Moby Dick it is tempting to recommend an abbreviated version but, needless to say, the experience won't be the same.  And blogs can be useful, but of course the most important thing is to have a well thought-out retirement plan that is unique to your needs.

If the list of top places to retire in Central America is the catalyst for creating a more serious retirement plan then mission accomplished. Just hold off on buying the banana plantation before conducting the proper research. 

The point is not to confuse information for knowledge. 

• Lists make the listed and listers do crazy things.

Clemson University acknowledged it was taking specific steps to improve its standing in the college rankings, such as manipulating class size.   Other schools have changed policy and awarded bonuses to presidents and administrators who spearhead a leap in rankings.  Football coaches run up scores to better their standings in the BCS rankings.  A number of college presidents have pledged not to participate in the US News survey to avoid being ranked. And did Standard & Poor's with their inimitable track record really have the chutzpah to downgrade the debt of the United States?  The list, if you will, goes on and on.

Clearly there is no best college just like there is no best place to retire.  College, like retirement, is not where you go but what you make of it once you're there.

Faculties Lost

Everyone knows the story of how the Dutch bought Manhattan Island from the local Native Americans for $24 in trinkets and tokens (there were no Metro Cards in 1626). Depending on your point of view, this was one of the greatest real estate deals in history or the first of innumerable financial swindles emanating from Wall Street. Interestingly, new theories suggest the "locals" who sold Manhattan were simply passing through on foot - undoubtedly the Acela had broken down - and were more than happy to part with an island they never owned in the first place. While in all likelihood apochryphal, one can only hope this version of the story to be true.

From Ponzi to Madoff, it's truly remarkable how investors in full command of their faculties are continually duped out of their money. So with an ominous nod to PT Barnum, consider the implications as millions of Americans live longer and, as a result, suffer from the insidious effects of dementia and Alzheimer's. 

This inexorable wave of the cognitively challenged will crash head on into advances in technology that will make it even easier to separate them from their retirement savings.  And more aging investors are living in social isolation given our increasingly mobile society making them especially vulnerable. You can almost sense the bad guys booking their tickets to Florida and other points south.

Addressing cognitive impairment will be the next big thing in retirement income planning.   Unfortunately, the financial services industry has been slow to respond, just as it was late to the game in recognizing longevity risk.  In fact, it's the medical community that's on the front lines of this epidemic that effects one third of Americans over the age of 71, according to a 2008 Duke University study.

Physicians are usually the first to hear about lost heirlooms, missing money or how a patient signed a confusing document.  But there's only so much a health care worker can do beyond notifying regulators, social services, friends and family.  But as seen by the mortifying trial of Brooke Astor's son, who was convicted of embezzling his mother's assets, family members aren't necessarily paragons of virtue.

Clearly this is an area screaming for innovation.  But until that time, it's easy to imagine  Barnum saying if he were alive today "There's a sucker turning 60 every minute." 

Adieu Monte Carlo

The time has come to put Monte Carlo analysis on the shelf as a retirement planning tool alongside privatizing Social Security, 8% load funds and horoscopes.  As a former advocate of stochastic modeling this is hard to admit. But when black swans become as prevalent as pigeons in Saint Mark's Square the whole notion of probability analysis as a planning tool should raise an eye brow. 

Before his conversion, a certain blogger would explain Monte Carlo by piously quoting Aristotle who allegedly said when an outcome is in doubt it makes sense to do what is most probable.  Who could argue with Alexander the Great's personal tutor?   The logic makes sense but the question to ask is what is most probable? (This assumes there is an answer.   Nassim Taleb, author of  the "The Black Swan", would scoff at the notion.)    

Whatever your philosophy, dramatic swings in portfolio values are not the low probability tail risk depicted by Monte Carlo analysis.  In fact, an objective observer might say the white-knuckle markets we've experienced going back to 1987 seem to occur with great frequency.   Accordingly, using  stochastic modeling to develop an asset allocation strategy is like using the metric system to plan a cross-country road trip. Intuitively it makes sense but it's the wrong standard to use at least when traveling in the United States.  This can lead to confusing outcomes that provide a false indication of where you actually are.  In fairness, relying on linear return projections is equally  specious.  Assuming a retirement portfolio will achieve consistent positive performance year after year is like waiting for Godot - it's not happening.  So how does this affect retirement planning?

The first step is to acknowledge that volatility is here to stay.  This can lead to the great temptation of buying several mattresses (which doesn't mean you're diversified) and learning to sleep with one eye open.   As with anything, there's risk in extremes and being fully invested in a particular asset class (or fully uninvested if there's such a thing) is imprudent for most. The key is to be honest with the amount of risk / volatility you're willing to accept.  This will help determine an allocation that's unique to your particular needs and if that includes a little mattress stuffing so be it. 

That's the easy part. The challenge is then sticking with it through regimented rebalancing, dollar cost averaging and periodic reassessment of your risk tolerance.  There are a number of quality planning tools that can help quantify your risk tolerance (just ignore the probability analysis most of them use.)   And an experienced advisor can be helpful in taking the emotion out of this process.

Retirement planning is more challenging today than it's ever been.  That's why using the right tools and measurements is imperative. Reconsidering the relevance of stochastic modeling as a retirement planning tool can be a catalyst in assessing your overall strategy. Doing so may one day get you to the real Monte Carlo.  Just remember they use the metric system in France.

Jack Daniels, Coke and Retirement

Taxes have been imbued in the American consciousness since the founding of the Republic.  In fact, taxes caused the founding of the Republic.  Ironically, many investors (and their advisors) seem unaware of how taxes are a major retirement risk along the lines of inflation and healthcare. Actually, for those in the highest brackets, taxes will be the greatest expense they have in retirement.  And with rates inevitably rising at the federal, state and local levels taxes will become problematic for virtually every retiree.

As an early advocate of Roth conversion, a certain blogger was surprised by how little of the conversion discussion focused on how to invest those assets once they were safe from the clutches of Congress.  Roth conversion presents a brave new world to retirees previously confined to municipal bonds as their sole source of tax free income.  So as a public service announcement please be advised the remainder of this post contains references to annuities that have been known to cause drowsiness due to the guarantees they provide.

On the surface, a single premium immediate annuity (SPIA) in a Roth IRA may seem as horrifying as drinking Jack Daniels with coke. But after a few sips it just might grow on you so consider the following.  Allocating a portion of a Roth IRA to an immediate annuity is a way to generate tax-free income that can't be outlived.  Add an inflation rider which most SPIAs have and you've addressed three of the biggest risks faced by any retiree: longevity, taxes and inflation.

It gets better.  Unlike a municipal bond, SPIAs are not callable and several of the insurance companies that issue them have AAA ratings (if you still believe in that sort of thing) - a nice way to diversify and upgrade the credit quality of your tax-free sources of income. This strategy should be particularly compelling if your state and city have the temerity to tax your income.  As the old Lebenthal ads used to say about municipal bonds, "It's not what you make, it's what you keep."  This is especially wise advice in an environment where low interest rates are rewarding borrowers while punishing retirees stretching for yield.  A back of the envelop example helps make the case.

A 65 year old male can generate about $600 a month by investing $100,000 in a SPIA.  That's $7,200 a year in tax-free income if the annuity is purchased with Roth assets.  For someone in a combined 50% bracket (federal, state and local) that's a taxable equivalent yield of over 14% - an intoxicating number that hasn't been seen since the Reagan administration.   It's important to note this isn't an apples to apples comparison because a portion of the SPIA payments represent a return of principal which wouldn't be taxable regardless of the source of funds. This is called the exclusion ratio.  However, upon reaching your life expectancy, all of the annuity payments would be fully taxable unless purchased with Roth assets.

Of course drinking Jack Daniels has consequences as does annuitizing Roth assets.  First, annuitization has to be right for you regardless of the type of account where the assets are held.  SPIAs also mean you hand your money over to the insurance company in return for the guaranteed paycheck.  However, many do provide some degree of flexibility in terms of returning a percentage of your investment or guaranteeing payments for a certain period of time should your demise come earlier than expected.  Naturally all this comes with a cost in the form of reduced payments.

Then there are the killjoy pundits who rail at the idea of tapping Roth assets until the apocalypse and maybe not even then. Understood, but surely the sanctity of Roth assets should be reconsidered  based on the unique needs and circumstances of the individual.  And with the inevitability of higher taxes this concept shouldn't be dismissed out of hand.  In fact, the retiree who annuitizes their Roth will have more than enough to buy a JD or two.  Just be sure to do both responsibly.

The Big Shift

It's hard to imagine but a mere ten years ago there was little discussion about retirement income planning.  The Baby Boomers were ten years younger and the stock market was rising to the point where there was serious talk about privatizing Social Security.  Home values would always increase - it was only a matter of how much - and those steady gains could be counted on to fund a secure retirement.  The focus was on making money, not making it last.

Of course those sure things proved otherwise, The Boomers aged and today it's impossible to have a conversation about retirement without addressing income.  Consider some of the newest additions to the planning lexicon; annuitization, longevity and Monte Carlo (which was once a place you might visit in retirement).  Ultimately, dream books have been replaced by a stoicism that suggests it's not going to be a walk in the park, let alone on the Riviera, for most.

Income, not age, will trigger retirement.  But in spite of the focus on income planning, many advisors and Boomers remain at a loss. That's because transitioning a nest egg into an income stream is one of the least intuitive, but most important planning steps that we must get right.  Yet this is a generation that's been admonished since childhood not to touch the piggy bank.  In addition, product solutions are complex and  in many cases advisor / client objectives are not aligned.

Adding to the challenge is the fact that retirement income planning has no clearly defined process or end point. Accumulation planning has relative structure in the form of Modern Portfolio Theory, salary deferral, contribution limits and a point in time when you will at least stop working full time.  Income planning is more like a Picasso; abstract, open to interpretation and with no clearly defined end-point.  The goal for financial services providers is to help clients make sense of what they are looking at as they gaze at the distribution phase of retirement.

Future posts will do just.