Addressing Your Client's Concern About Suitability of 401ks
The effectiveness of 401(k) accounts has been in the news lately, including in the Wall Street Journal and the Washington Post. With the Fed announcing that it will raise the interest rates “until something breaks”, your clients may be worried about their 401(k) and thinking of other options. The major concerns of most clients regarding their investment methods will most likely be: savings, taxes, return, convenience, flexibility, and cost of administration. Of course, there are plenty of other client specific needs including amount of control over return on investment and potential socially conscious or religious concerns.
So if not the 401(k), then what? A quick overview of other investment and retirement options for clients include: IRAs, both Roth and Traditional, Investment/Brokerage Accounts, Bonds, REITs, Real Estate Rentals, Direct Investing, and Annuities.
Here are six key reasons why a 401(k) is still the best method for most clients based on those six areas of concern.
First: the news isn’t quite accurate. The conflict in public opinion on 401(k)’s appears to be over whether 401(k)’s are getting the job done. Research by economists John Karl Scholz and Anath Seshadri points towards average U.S. households having enough in their accounts to maintain their pre-retirement standard of living after they hang up their hats. On the other hand, the National Institute for Retirement Security claims that the retirement savings of Americas are about 25% lower than needed. Part of the public option debate also includes the shakeups in state pensions moving from defined benefit plans to 401(k)’s. Some political pundits have been asserting that defined benefit plans, with their guaranteed benefits and low risk, are a better retirement investment plan than 401(k)’s, with their guaranteed contribution, but higher risk and potentially higher costs through fees.
Second, the 401(k) is still the most convenient. The basic 401(k) ranks high on convenience with some advisors calling it an “auto-pilot” program, something that requires little from the client in terms of input and can exist forever on automatic deductions from payroll. Most 401(k)s have the benefit too of allowing clients to choose groups of funds and match funds to their own risk tolerability levels. However, more investors are thinking about their funds from a socially conscious standpoint. A client might rank the ability to divest from companies that might seem ethically sound and later be found to have profits from prison labor created materials, for example, as a higher need than the ease of administration. And, automatic deductions at set amounts don’t always account for increases in salaries over time, or decreases in salaries with the birth of children or other family needs.
Third, the 401(k) option allows for greater amounts of investing. In comparison to 401(k)s, IRAs allow for slightly more liquidity for clients that might need to access their accounts. The IRS allows for early withdrawal to pay health insurance premiums in the event of a job loss, for example. Like a 401(k), IRA early withdrawal penalties also decrease after age 59 ½. While an IRA may provide slightly more flexibility, the maximum contribution of $5,500 might not be enough to reach a client’s retirement goals as compared to the maximum 401(k) contribution limit of $18,000. And an IRA’s catch up amount, an amount allowed by the IRS to those over age 50 to increase retirement funds, is limited to $1000 for IRAs versus $6,000 for 401(k)s. However, an IRA usually has considerably more flexibility over the investments being made than a 401(k) might: IRAs often act like brokerage accounts. This means that IRAs have higher flexibility than 401(k)s. And not all IRAs are the same: keeping the difference between a traditional IRA and a Roth IRA in mind for clients whose tax rate will be the same or higher in their retirement will be important.
Fourth, 401(k)’s involve less direct involvement, and possibly less worry. Of course the alternative to tax deferred accounts like IRAs and 401(k)’s is to have a straight investment in the market itself. That may require a client who is willing to have more involvement in their day-to-day administration of the account, and may also require a higher tolerance for risk than in other investment methods. For some clients, watching the market daily may be crazy making, for others it may be the perfect match, especially those who have high social consciousness concerns. Brokerage accounts will lose tax benefits, but are greatly more flexible than other programs. Some clients may choose brokerage accounts for investing in bonds as well.
Fifth, 401(k)’s have better tax treatment than other options: It may also make sense for clients to have a variety of investment methods. A mix of 401(k)’s, IRAs, and brokerage accounts may meet a client’s need for security and flexibility. REITs, or Real Estate Investment Trusts, may also be a helpful investment method to add into a client’s mix of investments. REITs are required to pay dividends each year to their investors, so from a tax standpoint they may not be the best option for a client, but they have other attributes that may balance out changes in the market. As a point of comparison, they offer high liquidity and diversification.
Additionally, clients may choose to opt for investing in real estate for the rental income potential. While rates of return being higher there are limitations on liquidity involved in directly investing in real estate, versus opting for an REIT, which trades on exchanges like a stock. Clients may benefit from depreciation on rentals that could assist clients in need of balancing their tax loads. Even more direct than rental income may be to invest directly in businesses. The tax implications for direct investment are thorny and should involve a qualified attorney.
Sixth, 401(k)’s often have a lower cost of administration. Including a mix of annuities in an investment portfolio may also make sense for clients that need a steady stream of income in their retirement. And, taxes can be annuitized as well. Annuities may have a higher cost of administration, and for clients that need to maximize their investment, they may not be an appropriate choice.
No matter what the current temperature of public opinion is on 401(k)’s, it may be worthwhile to review options for alternatives with your client to make sure that their needs for liquidity, tax benefits, ease of administration, social or religious concerns, and rate of return are met.
Before leaping into the unknown, we recommend a thorough examination of your plan. Because we are experts in the field, we know the marketplace and know what your existing vendor is capable of offering. Through this examination, we can help you optimize the service you receive.get xpress proposal