MMM Newsletter and Website Header 10.2.15

By Suzanne Woolley, Bloomberg appearing in ThinkAdvisor

Social Security recently turned 80, and while news about the program’s financial status is rarely upbeat, most Americans are glad it still exists. Women and lower-earning workers rely particularly heavily on the program.

Here’s why you need to pretend it doesn’t exist: Underfunded as it is, Social Security remains a favorite political football and a target for further trimming. At the same time, we’re living longer, and our savings need to last longer. So whatever happens to Social Security, it’s more important than ever to use all the savings strategies at your disposal. Here are eight additional savings strategies, one for each decade of Social Security.

1. Make saving simple

Just how important will your personal savings be in retirement? The National Academy of Social Insurance, a non-profit group that focuses on “how social insurance contributes to economic security,” says the Social Security program replaces more than 50 percent of income for low-earning workers. They also say that high earners would need to radically reduce their lifestyle if they need to rely heavily on Social Security income in retirement.

The Social Security Administration calculates income replacement rates for retired workers across a range of income scenarios, from those with very low income to those who hit the maximum annual amount of income taxed by Social Security (in 2015, it’s $118,500). Their calculations assume 35 years of contributing to the program and are based on Social Security’s national average wage index (AWI). For 2015, the average is $47,820.

If you’re lucky enough to be at a company that offers a 401k, you may already be funneling money into it every pay period. Maybe you can even save enough to get all of the company match, if there is one. Saving 12 to 15 percent of your salary in a 401k, up to the 2015 contribution limit of $18,000, is what many financial planners suggest.

That assumes you already have a cash emergency fund of three months at the very least. If your budget allows, try setting up automatic deductions from your checking account into other savings accounts, even if it’s just $25 or $50 a paycheck. And if you don’t notice that it’s gone, kick the contribution up a little higher.

If you want someone else to save your money for you, a growing number of online financial companies are offering savings strategies to “personalize” savings. They’re doing this with software that assesses how much you need to keep in checking to pay bills, and then automatically spiriting the excess into savings or investment accounts. Companies with products like this include Betterment and Digit.

2. Keep 401k savings sacrosanct

One challenge millennials face that their parents didn’t is handling 401k accounts while moving jobs every two to three years. Rather than roll an old 401k into a new employer’s plan, many young savers just cash it out, which means paying income tax on it and a 10 percent penalty.

In the year that ended on March 31, more than 40 percent of 401k participants between the ages of 20 and 29 cashed out all or part of their plan balance after leaving a job, according to Fidelity. Even for those between the ages of 40 and 49, the cash-out percentage was high, at 32 percent. That is not one of the best savings strategies.

Barring a lottery win or a fat inheritance, starting to save early, so money can compound over many decades, is really the only way most younger savers are going to arrive at retirement age with a decent nest egg.

3. Wage war on fees

One of the most effective savings strategies is aggressively managing fees. This means, first, knowing what fees you are paying for different investment accounts. Many people have no idea, particularly when it comes to retirement savings accounts such as 401k plans. A Department of Labor rule saying plans must provide participants with fee disclosure has made that information more easily available.

Once you find that information, your plan probably won’t note whether those fees are low, average, or high compared to similar funds. You can get a rough sense of it at brightscope.com or look into a service such as that offered by an Israeli startup named FeeX. Users create an account and connect it to their old and new 401k plans. FeeX automatically calculates how much, if anything, a rollover into an IRA, or a switch into a plan’s cheaper fund options, could save in fees.

I tested it out with funds I own in the Bloomberg LP 401k plan. It flagged the Harbor International Institutional fund (HAINX), an actively managed fund, which has an annual fee of 0.75 percent. It calculated that, over a couple of decades, I could save $10,864 by switching to a lower-cost alternative in my plan, the Vanguard Developed Markets Index Institutional (VTMNX). Vanguard’s fund charges 0.07 percent annually.

4. Check your asset mix

If you have multiple investment accounts outside your 401k or just multiple 401ks, it can be hard to know what percentage of your assets are in cash equivalents, bonds, and stocks. What is the optimal mix?

Everyone’s situation and risk tolerance (more on that in a second) are different, but the asset allocation in target-date funds gives a sense of what some large investment companies think is ideal.

For someone who is about 45 and wants to retire in 20 years, the asset mix in the Fidelity Freedom Fund 2035 is 90 percent in stocks and 10 percent in bonds. Ten years in, the stock portion will drop to 70 percent, bonds will be 28 percent, and 2 percent will be in short-term funds. At 2035, when the account holder is 65, the stock/bond/short-term funds split is 56, 34 and 11 (more than 100 percent partly due to rounding). The net expense ratio is 0.16 percent.

Many people think they should start dialing back on equities when they’re 10 years away from retirement. Problem is, if you pare stocks dramatically at age 55 and live 30 more years, your savings may run out. That said, if you suspect you would panic and sell into any dramatic drop in the market — think back to how you felt and what you did in 2008 — moving some money out of equities might one of the best savings strategies for you.

5. Know your risk tolerance

Financial advisors will say that clients overestimate their risk tolerance, but FinaMetrica, a firm that runs psychometric risk tolerance tests, says it’s the advisors who become more nervous than they expected when markets become volatile. Finametrica says most people are actually pretty good at assessing their risk tolerance.

I am apparently not one of them. I took the company’s 25-question test (anyone willing to pay $45 can take it, or ask his or her advisor to spring for it). After estimating I’d score a 45 out of 100, I scored 39, lower than 85 percent of all scores. As the test report put it, “Most people underestimate their score by a few points. However, yours was an overestimate. When compared to others you are somewhat less risk tolerant than you thought you were.”

To guard against getting too stressed by market swings, investors may want to separate their money in different buckets. Money can be tied to short-, medium- and long-term goals, with each bucket having a different risk profile, says financial advisor Curt Weil.

If the market is swinging wildly and you know your immediate needs are covered in a short-term, conservatively invested bucket, you may feel more comfortable sticking with any higher-risk, higher-return investments in the long-term basket.

6. Be an employee benefits ninja

If you’re offered a flexible spending program or the ability to pay your commuting costs with pre-tax money, take the time to learn about them. You’ll get more mileage out of your money and lower your income taxes to boot. Making the most of tax-advantaged perks is a small way to give yourself a raise in a time of stagnating wages.

Employers have been shifting more costs to employees, often through the use of high-deductible health-care plans. Companies’ adoption of such plans may slow next year, according to a survey of more than 100 large U.S. employers. Employers are waiting to see if lawmakers repeal Obamacare’s “Cadillac tax” on high-cost health coverage, which is a levy on individual health premiums greater than $10,200.

Health care savings accounts (HSAs), which go hand-in-hand with high-deductible health plans, will likely become a greater part of employee’s lives. These are “triple-tax-free”—what you put in is sheltered from income tax, it grows tax-deferred, and the money can be used, tax-free, for medical expenses. Companies usually seed the accounts with a few hundred dollars, pre-tax, and your contributions are tax-deductible. You can contribute up to $3,350 for an individual policy and $6,650 for a family plan. And unlike flexible spending programs, they are not “use it or lose it,” so your money accumulates.

7. Ignore the fancy stuff

There are many benefits to keeping your finances fairly simple, like having a clear picture of where you stand. Unless you’re a seasoned speculator whose retirement is already more than provided for, avoid any investment with the word “leverage” or 2x or 3x (or more) in its name.  It’s been said before, but bears repeating: If you don’t understand it, don’t buy it.

8. Eat your spinach

Good health may be one of the best savings strategies. Health care costs in retirement are the most likely expense to send your finances into the depths of hell. Fidelity estimates that in 2014 a couple who retired at age 65 could look forward to $220,000 (in today’s dollars) in health care costs. That number didn’t rise from 2013, but it’s still way more than most people have saved for all of their retirement.

The AARP has a pretty simple calculator, and there are many others, that will scare you into the gym if you aren’t there already. It’s like making money!

Truth be told, I should have switched into the Vanguard index fund long ago, simply because most actively managed funds cannot consistently outperform the market. While Harbor has handily outperformed the Vanguard fund over 10 years — 7.4 percent compared to 4.6 percent — the Vanguard fund’s returns have been similar or better in the past five years. Vanguard wins on fees.

Vanguard’s 2035 target date fund takes a more conservative approach. It starts with 82 percent in stocks and 18 percent in bonds, and in 2025 assets should stand at 66.8 percent stocks and 33.2 percent bonds. Its expenses are 0.18 percent.  Those over age 50 can make additional “catch-up” annual contributions of $6,000.

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About LRPC’s Monday Morning Minute

Lawton Retirement Plan Consultants, LLC (LRPC’s) Monday Morning Minute is crafted to provide decision-maker’s with important information about the economy, investments and corporate retirement plans in a format that allows a reader to consume the information in less than 60 seconds. As an independent, objective investment adviser, LRPC has access to many sources of research and shares the best and most relevant information with its readers each week.

About Lawton Retirement Plan Consultants, LLC

Lawton Retirement Plan Consultants, LLC is a Milwaukee, Wisconsin-based independent, objective Registered Investment Advisory (RIA) firm providing investment advisory, fiduciary compliance, employee education, vendor management and plan design services to retirement plan sponsors. The firm currently has contracts in place to provide consulting services on more than $400 million in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or bob@lawtonrpc.com or visit the firm’s website at https://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.

Important Disclosures

This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance, tax, legal or investment advice. Each plan has unique requirements and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does Lawton Retirement Plan Consultants, LLC assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations. Investors should carefully consider investment objectives, risks, charges and expenses. The statements in this publication are the opinions and beliefs of the commentator expressed when the commentary was made and are not intended to represent that person’s opinions and beliefs at any other time. The commentary does not necessarily reflect the opinion of Lawton Retirement Plan Consultants, LLC and should not be construed as recommendations or investment advice. Lawton Retirement Plan Consultants, LLC offers no tax, legal or accounting advice and any advice contained herein is not specific to any individual, entity or retirement plan, but rather general in nature and, therefore, should not be relied upon for specific investment situations. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser and accepts clients outside of Wisconsin based upon applicable state registration regulations and the “de minimus” exception.