George Cones, JD's Answers and Guides

Vickie,

Sometimes those terms are used interchangeably. There are two major forms of retirement plans. Defined Benefit "DB" and Defined Contribution "DC" plans. What is the difference and why does it matter?

Defined Benefit plans pay benefits from a pool of assets often called a pension "fund." The DB Pension Plan pays benefits when a plan participant retires, often based on salary and years of service. The employee may or may not contribute, and the employer is often responsible for adequately funding the plan. The body that administers the plan often is a group of trustees. The trustees oversee the operation of the pension fund. They have to make sure there is enough money in the fund to pay future benefits, establish procedures, and invest the assets. These plans may have a number of folks help them reach their objective. The plan may employ actuaries, attorneys, accounts, custodians, investment consultants, specialty consultants and investment managers. They often spend a lot of time on plan matters. They must develop a strategic asset allocation (the mix between stocks, bonds, real estate, cash and so forth). They may spend months researching and selecting investment managers. These type of retirement plans tend to have good track records for providing benefits and getting good returns on plan investments. Unfortunately, these plans have been and are being replaced by DC plans.

In a DC plans, like 401k or 403 b plans, the employees contribute to the plan (usually on a pre-tax basis) from their wages. The participants contribution may be matched or partially matched by the employer. There are limits to contribution in these plans (although we have found that many if not most employees contribute too little).

Now the plan participant is responsible for planning his or her own retirement, without the army of consultants that the pension funds have. The results so far have not been great. Many studies show that Individual investors usually underperform institutional investors. Many workers are unprepared for retirement. There may be several reasons for this underperformance and under preparedness, for example, on the part of the participant: failure to establish and maintain a long-term strategic allocation, failure to contribute adequately to DC plan over the participant’s lifetime to reach his or her investment goals.

Some of the factors over which the plan participant has little control, are plan costs and poor plan choices. Every dollar paid in fees detracts from performance. Poor investment choices may not make it impossible for the plan participant to achieve sufficient market diversification to reduce risk and/or add significantly to returns. It is incumbant upon DC plan fiduciaries to make sure plan participants have resources available to help develop a retirment plan, provide decent investment choices, while managing the costs of the plan.

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Most of the target date funds that we have seen are on a glide path, that is they are mechanically reallocated as they approach their target date. Target date funds tend to have higher expense ratios as well. You may be able to build your own diversified portfolio, but If you are talking about your 401(k) plan, your choices may be limited. There are actively managed models, that are part a 401(k) plan structure, but they are not easy to find.

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Elliott,

Robert Harper's answer is terrific, and explains the B-Share issue well. There is a lot of information that we don't have which an advisor would need to help guide you. Some important factors on deciding where to invest these funds, once you get past the 8 year issue, are:

-Your age and cash flow needs. If you are young and don't intend to touch this money for 7-10 years, you may want to be more aggressive building a portfolio of index ETF's and/or actively manged mutual funds. If you are going to be relying on this portfolio for income you may want to build an income generating portfolio.

-Your tax situation. Will this investment be subject to long-term capital gains, was it a pass through, or was the cost basis established (stepped-up) at the date of death. As Mr. Harper pointed out, after 8 years this may be convertible to an A-Share with no tax consequences, so this has to factored into the analysis.

After you consider these issues, It may be useful for you to look at Morningstar's analysis of the fund. You may find you can find a less expensive alternative asset allocation mutual fund that has had as good or a better track record. Vanguard may be a good place to look. Or if there are enough assets you my be able to build your own diversified portfolio using ETF's and/or mutual funds.

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Toni,

Questions to ask, better in writing:

What are the internal expenses for the investments? What is his or her commission? When can I get out of the product?

This last question is very important. You may find that you can not get out of the product for some number of years (5, 7, 10, 12). There is often a contingent deferred sales charge if you get out prior to the date spelled out in the contract or fund prospectus.

The up-front commission could be 5%-over 10%. You are correct in assuming nothing is free, but rather the costs are hidden in the contract or prospectus.

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Dear Ada,

Great to see that you are thinking about saving now, at an early age. You told us you are thirty, but there is some other information that would be useful in answering your question.

Do you think you are going to been needing or using this money in the near-term or mid-term?

    Are you planning to be using the money to buy a house, for example?

Do you have a 401(k), 403(b), or other similar plan at work?

Are you maxing out on your 401(k) contribution?

Without this information, we can only go through a hypothetical checklist, as follows:

If you don't plan to touch this money until you are over 59 1/2 years old, you would be better off contributing the maximum possible to your 401(k) plan, 403(b), or other "deferred compensation plan," if you have one. In your deferred compensation plan, your contributions are pre-tax, that is you don't have to pay taxes on the contribution, so your taxable compensation is reduced which lowers your taxes. In addition, the assets in your plan grow tax deferred, so you don't pay any taxes on asset growth until you begin taking money out of the plan (in your case almost 30 years).

Assuming that these are your only assets at this point, If you plan on using this money before 59 1/2, then you should consider opening an account at a firm like Vanguard. At Vanguard you can find many low-cost well diversifed funds. Therre are funds that own most of the stocks in the US, and the World stock markets, as well as bond funds that do cover the same broad markets, or funds that cover all stock and bond markets. Once you you have enough assets in a few years, than you may want to consider finding a fee only advisor.

Remember also, that many 401(k) plans provide for plan loans, which may make investing in the 401(k) plan the more attractive investment choice, even if you would like to be able to get to a portion of the plan assets.

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It is terrific that you are concerned about your plan participants, not enough plan sponsors are. Your plan may be the only chance some of your employees have of having a decent standard of living in their retirement years.

While it is true that you should be cautious in giving personal advice, there are tools available that can help the plan fiduciaries provide their plan participants with the knowledge to make better choices.

A good 401(k) interface (where your participants log on to the 401(k) website) often has very good analytical tools that can can show expected return of the particpant's portfolio. The website may also have gap analysis tools to help the participant determine what they will need in retirement and how much they need to be saving each month over their working life.

Unfortunately, without training on these tools many participants find such analysis daunting, so you can lead a horse to water....

That is why it is important to have an outside expert, that could be a fee only advisor, or an outside benefits consultant, help you and your participants understand how your plan is working to achieve your plan’s and the participants’ goals.

You may want to consider talking to someone at a shop like Investment Horizons for some ideas (we have no affiliation with them) : www.investmenthorizons.com .

There is nothing wrong, in fact it would be prudent, to be sure that participants know how important saving for their retirement is, and to monitor participants’ investment choices. Your concern is commendable.

As Mr. Henriques mentioned you may want to find someone who is willing to sign on as a 3(38) fiduciary. Look at a few, and always check references.

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Without speculating on Hartford’s reasons for withdrawal from the retirement plan space, it would be an excellent time to look for 401(k) services providers.

We would suggest you look for a fee-only advisor, who can hopefully show you how to build a plan using "unbundled" services That means, the record keeper is separate from the custodian, and the advisor is separate from them both.

There are much better options, even for smaller plans, than there were a few years ago. The new 408(b)(2) regulations should make the selection process clearer. You should spend a lot of time getting familiar with all of the fees and what you get for them.

Be sure that you understand the service provider’s role, asking them to sign on as a fiduciary and to avoid any transactions that would be potential conflicts of interest. Depending on the assets in the plan, you may find that you can have a plan with significant number of choices, using a combination of index ETF's and/or best-in-class active managers.

An investment advisor should take on fiduciary responsibility and build a platform with a number of decent investment choices at a reasonable cost would be the minimum expectation.

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Octavio, Your question does not include some information that would be helpful to this discussion, for example we can't be sure what other assets or income you have, nor do we know your age, so we will attempt to give you an general answer that would include various scenarios. In general, once you reach retirement age (59 1/2), the withdrawals from the 401(k) will be taxed as ordinary income, while the distributions from a Roth will not be taxed as long as you meet all of the qualifications (since you have already paid income tax on this account). If you have other income, such as from a retirement plan that pays monthly benefits, social security, or employment income, you should consider trying to postpone your distributions from both your 401(k) and Roth accounts until you have to take a required minimum distribution (RMD), after you are 70-1/2 years old. If you wait, your assets will continue to grow tax deferred. If you can't wait until 70-1/2, your choice can be driven by several factors: Would the distribution affect your overall federal or state tax bracket? If so, you may want to use your Roth account. What is the treatment of these distributions in your state? Is there a date at which a “senior” tax-credit or other tax reduction kicks in bases on age? If so, which way would give you better tax treatment. If you have taxable assets in another account, the allocation of assets between your taxable account and your 401(K) or Roth can be a way to reduce taxable income, for example you can focus the assets that pay dividends and have large distributions in the 401(k) and Roth portfolio. You can also use tax exempt money markets, and bond fund to further reduce taxasble income. For detailed information of the Roth rules, you can find the IRS factsheet here: http://www.irs.gov/publications/p590/ch01.html#en_US_2011_publink1000230701 hide

The 403(b) is a tax deferred retirement plan available to employees of educational institutions and certain non-profit organizations as determined by section 501(c)(3) of the Internal Revenue Code.

If the person you were talking to has any documentation concerning the demise of 403(b) plans, or is contending that your organization can set up a 401(k) plan, have them provide that to you in writing. Be sure to talk to an attorney or tax adviser before attempting to set up a 401(k).

When selecting an investment service provider, the services provider should make you aware of any potential conflicts of interest, such as revenue sharing, 12(b)(1) fees, loads, contingent deferred sales charges, etc. You should consider hiring an Registered Investment Advisor, who contractually accepts fiduciary responsibility. It is best that the Advisor or Broker signs on as a Section 3(38) fiduciary, but they should at least sign on as a Section 3(21)(A) fiduciary. In either case, your agreement should spell out with specificity what their duties and obligations are and what all the costs are.

You should also consider an unbundled solution, for your plan. That is you can hire a Third Party Administrator, custodian of the assets, record keeper, and investment advisor separately. There are advantages not being locked into a proprietary platform, in terms of cost, flexibility, and robustness.

A Registered Investment Advisor may be in a good position to help you find competent TPAs, custodians, and record keepers.

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Gershom,

The mutual fund company publishes a prospectus and fact sheet where you can find all of the information about the mutual fund share classes. If you go to the following link you will find a discussion of different share classes:

http://www.brightscope.com/financial-planning/advice/guide/2768/How-Different-Mutual-Fund-Share-Classes-Affect-Your-Retirment-Plan-Or-Investment-Portfolio/

A way of determining how a mutual fund performs and how he fund invests, you should go to www.morningstar.com . You can get some good basic information on the free site. If you want to upgrade your account to the plus version of their service, they have some very good information available to investors which only used to be available to investment professionals a few years ago.

While an investment advisor can help you interpret the data and guide you in your asset allocation decision, the more educated a client you are the better.

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