Why does the 401(k) fail?

Everyone looks forward to retirement lived in comfort and relative abundance after several decades of working. Ideally, 401(k) savings are supposed to help individuals attain this end. However, this is not what usually happens in reality, according to this Forbes article.

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401(k) offers a convenient way for many workers to create and maintain a savings account for the future. Generally, an average worker’s 401(k) savings amount from only $25,000 to around $75,000. Needless to say, these figures are hardly adequate for any retiree to maintain a lifestyle far from want. In the end, not a few retirees end up living in forced frugality, sometimes with debts to spare.

Many believe that the deficit occurs due to people’s tendency to purchase unnecessary items beyond the acceptable limits of their finances. Conversely, the article from Forbes proved this assumption false.

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The article stated that nearly three-fourths of workers are forced to dip into their retirement savings to pay for short-term and often unforeseen expenses, like medical and car bills. The same is also true for individuals raising children or sending kids to college. Furthermore, the article revealed that people with lower income are more likely to tap into their retirement savings prematurely.

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To avoid using up one’s retirement fund early on, the article suggested that employers can help by allocating funds for emergency savings, which their employees can tap into in times of sudden need. In the long run, this would prevent them from dipping into their 401(k) savings, giving them more opportunities to utilize the funds for a more comfortable retirement.

JSK Associates helps retirees manage their retirement finances. Visit this website to learn more.

The Economist: Cuts on the sly

Everybody wants to cut costs nowadays, but some do it at the expense of others.  In this article, The Economist explains how cost-cutting is often achieved in pension benefits, at the disadvantage of retirees, of course.

 

TO THOSE on fixed incomes, including many retirees, inflation is the enemy. Workers can generally expect their wages to rise with inflation (if not in one-for-one lockstep). But after retirement income is set, and erodes in real terms as prices increase. Some retirees are protected; their pension benefits increase with inflation each year. That protection may now be vulnerable. A smaller cost-of-living increase is a sneaky, and sometimes only barely legal, way to cut benefits when a pension is under-funded.

Indexing benefits to inflation is expensive, but it’s not always appreciated. The value of inflation indexation is less apparent early in retirement, particularly when inflation is dormant, as has been the case since the mid-1980s. That may help explain a new enthusiasm for fiddling with indexation as a means to address funding shortfalls in a financially-strapped post-crisis world. Dutch defined-benefit plans only offer conditional indexation; benefits will in some cases go up by 100%, 50% or even 0% of inflation, depending on the health of the particular pension fund. State defined-benefit pension plans in America are increasingly considering tinkering with their indexation rates. The hope is this will provide a loophole for states to cut benefits. That’s because pension benefits, at least in nominal terms, are often guaranteed by state constitution.

Lowering inflation indexation is also in vogue for national pensions. Pension benefits are still fully indexed, but Britain recently moved to a different measure of inflation which increases at a lower rate. A similar move was recently under consideration in America: indexing Social Security to chained-CPI, which would also lead to smaller cost-of-living adjustments. That would mean smaller real benefits in turn for retirees whose spending is often weighted toward health care, for which prices typically rise faster than normal inflation. No surprise: chained-CPI isn’t a popular idea and has been tabled for now.

Benefit cuts are unfortunate but inevitable. Moving to a chained-CPI is not adequate to put Social Security on firm financial footing. It only delays trust fund exhaustion by a few years. A reduction in nominal benefits would be better than smaller cost-of-living increases. It’s more transparent and easier to plan around. Lowering indexation not only lowers real benefits but also introduces another source of risk to retirees. Unfortunately, it seems that straightforward benefit cuts aren’t politically viable; smaller cost-of-living increases, though bad for retirees, may be the only realistic option for bringing spending closer in line with available funds.

What more inflation risk will mean for future retirees is uncertain. Perhaps there will be more demand for inflation-indexed annuities or other inflation-linked assets. I expect retirees will be more aware of inflation, and perhaps more vocally opposed to expansionary monetary policy. Future policymakers may be tempted to increase inflation to erode their nominal debt. When that happens retirees, who have lots of political clout, will feel the pinch. In that case there may not be much space for a high-inflation future.

Yahoo Finance: 401(k) and IRA Changes Coming in 2013

The coming of a new year also means the coming of changes in IRA and 401(k).  Emily Brandon expounds through her article posted in Yahoo Finance.

 

Workers will be able to defer taxes on an additional $500 in their 401(k) and IRA plans in 2013. Retirement accounts will also be tweaked in a few other important ways. Here’s a look at the retirement account changes you can expect to see next year.

 

Larger 401(k) contribution limit.

The contribution limit for 401(k) plans, 403(b) plans, and the federal government’s Thrift Savings Plan will increase from $17,000 in 2012 to $17,500 in 2013. However, the catch-up contribution limit for employees age 50 and older will remain unchanged at $5,500. “One of the best ways to take advantage of the increased limits is to perform a year-end checkup of your 401(k) and make sure that you are contributing the maximum allowable by law,” says Garth Scrivner, a certified financial planner and senior investment counselor for StanCorp Investment Advisers in Albuquerque, N.M. “One strategy to avoid the pain of increased savings is to consider giving your 401(k) contribution a raise at the same time your annual pay raise occurs.”

 

Higher IRA contribution limit.

The IRA contribution limit for workers who meet the income requirements will increase from $5,000 in 2012 to $5,500 in 2013. The catch-up contribution limit for older workers is still $1,000, which is unchanged from 2012. “The enhanced limits have the additional benefit of increasing current tax deductions (assuming pre-tax salary deferrals) or increasing the amount of client’s tax-free investments (assuming Roth salary deferrals),” says Matthew Davis, a certified financial planner for Davis Financial Management in Leawood, Kan.

 

New 401(k) fee information.

Next year is the first full year that 401(k) participants will receive quarterly and annual 401(k) statements listing the fees charged to their accounts and showing returns compared to a benchmark, due to new Labor Department regulations that went into effect in 2012. “Next year, the biggest changes will be a continuation of the new disclosure rules regarding fees that are just hitting participant statements now,” says Rick Meigs, president of 401khelpcenter.com. “You are going to get an annual notice and you are going to start seeing more disclosure of fees and costs on your quarterly statements.” These statements can be used to evaluate whether the funds you are investing in are worth the fees you are paying.

 

Increased IRA income limits.

The tax deduction for people who have a retirement plan at work and make traditional IRA contributions is phased out for singles and heads of household who have a modified adjusted gross income between $59,000 and $69,000 in 2013, up from $58,000 and $68,000 in 2012. “Many of the pension plan limitations will change for 2013 because the increase in the cost-of-living index met the statutory thresholds that trigger their adjustment,” according to the IRS announcement. For couples in which the spouse who makes the IRA contribution is covered by a workplace retirement plan, the income phase-out range is between $95,000 and $115,000 in 2013, up $3,000 from 2012. For IRA contributors who don’t have access to a workplace retirement plan, but are married to someone who is covered, the deduction is phased out if the couple’s income is between $178,000 and $188,000, $5,000 more than in 2012.

 

Roth IRA limits grow.

Single people and heads of household can contribute to a Roth IRA until they earn between $112,000 to $127,000 in 2013, $2,000 more than in 2012. For couples, the modified adjusted gross income phase-out range for making contributions to a Roth IRA is $178,000 to $188,000, up from $173,000 to $183,000 in 2012. However, people who earn above these limits may still be able to contribute to a Roth IRA by converting some of their traditional IRA assets to a Roth. “For many clients who are not eligible to fund Roth IRAs due to income limitations, the increased limits provide an opportunity to add to their tax-free investment buckets through Roth IRA conversions,” says Davis.

 

Higher saver’s credit income limits.

Couples can earn up to $1,500 more next year and still claim the saver’s credit, a tax credit for retirement savers worth up to $1,000 for individuals and $2,000 for couples. The modified adjusted gross income limit for couples is $59,000 in 2013, up from $57,500 in 2012. For singles, the limit will jump from $28,750 in 2012 to $29,500 in 2013. And heads of household can claim the credit until they earn $44,250, $1,125 more than in 2012.