September 21, 2014

Do You Know What to Expect in Retirement? Part 3 - Common Misconceptions

Over the past three weeks I have received numerous emails with various questions about retirement and social security. Most of the social security related questions revolve around the Windfall Elimination Provision (WEP) or Government Pension Offset (GPO), but a few have "struck" a different tone - and that is what I wish to cover today.

One of the most intriguing comments to me was the notion that paying into Social Security and an educator pension was somehow double paying into retirement. I guess I can somewhat see that point of view, but I want to back up and explain how the corporate world works versus the government/educational world in terms of retirement.

Corporate Retirement - Most corporations did away with pensions 20+ years ago since a "defined benefit plan" (i.e. pension) could potentially be much more expensive than a "defined contribution plan" (i.e. 401K or similar plan). Businesses set up 401(k) plans to entice employees to contribute to their retirement with "matching" contributions and possibly "discretionary" profit sharing contributions. Depending on the plan, the company's matching and contributions "vest" over a set timeframe between immediate and 6 years. The benefit of this type of plan for employees was that they could "see" their retirement accounts, and if they left the company, they could roll the vested balance to an IRA. The bad part is that the employee is responsible for their own retirement.

Essentially, the company has made their contribution to the employee and left it up to them to figure it out. There may be some educational aspect of what they are doing, but the burden of responsibility has shifted. The company is only a contributor and not responsible. Also, if the employee has not contributed enough, it is on the employee...

As a rule of thumb, an employee should be contributing around 15% of their gross income to a retirement plan, so if an employee is putting 10% in the 401(k) and has a 4% match, then they are at 14%... pretty close to what we hope our clients are doing. Then you add on Social Security. The employee still has to contribute to an additional 6.2% (up to the current income limit) to Social Security (the employer does too).

We can all do that math for the employee - 10% to the 401(k), 6.2% to Social Security... 16.2% total, AND the employee is still on the hook for making sure the 401(k) is enough to fund their retirement.

Government/Educational Retirement - Most of the people reading this post will know about their own pensions contributions, so I will try to make this section brief.

In Georgia, educators have the Teachers Retirement System of Georgia (TRS). Currently, employees contribute 6.0% of their salary with employers contributing and additional 13.15%. These contributions are the foundation of your future TRS pension. Think about though - 19.15% of your salary is being contributed to a fund that ultimately helps to pay for your pension.

If the school system does participate in Social Security, then the employee contributes 6.2% (and so does the school system). In total, the employee will have contributed 12.2% of their salary.

If the school system does not participate in Social Security, then the educator does not contribute anything else. The TRS contribution of 6.0% is the total contribution by the educator. While I understand that this amount is not zero, it is also worth noting that corporate employees contribute 10.2% more of their salaries and educators in Social Security contribute 6.2% more.

For the educators that do not contribute to Social Security, the discrepancy between those that do contribute and potentially the lack of any retirement funds outside of TRS are the reasons why I have preached over and over about starting a 403(b) and making contributions. Even contributing only an additional 4% (10% total) to a 403(b) will make your potential retirement income substantially more. Additionally, if/when you are effected by the WEP, these additional funds will help to offset the reduction of Social Security.

In conclusion, corporate and educational/government retirements are quite different in how and by whom they are funded, but in both cases, it is the employee's responsibility to know and understand what their potential retirement looks like. If they do not work to make sure that their retirement is secure early in their careers, employees may end up scrambling at the end to make up for any shortfalls.

September 6, 2014

Do You Know What to Expect in Retirement? Part 2 - Naming a Beneficiary

After last week's two posts, I received numerous emails, and the most troubling questions to me dealt with a lack of knowledge regarding beneficiaries. This post will hopefully be a good basic resource to use for individuals trying to understand why and how to name beneficiaries. This list is not exhaustive though, so please make sure you talk with your financial advisor or attorney if you have one. They should be able to answer any additional questions.

Can't I just make my retirement account a joint account?

A retirement account is only titled to a single individual. It does not matter if it is pension, IRA, Roth IRA, SEP-IRA, 403(b), 401(k), etc. They are only "owned" by a single person. They cannot be made into joint accounts with your spouse, children, etc. One owner only.

Do I really need to name someone as a beneficiary?

YES!!! There are numerous advantages including being easier to access, not having to deal with the probate court, and tax advantages/options for your beneficiaries.

If you are married, a pension or 401(k) account must have your spouse as the primary beneficiary (unless they allow themselves not to be named), but you should always name contingent beneficiaries too. If something happens to both of you, this will direct who should receive the funds.

My brother, Brad, opened a small Roth IRA as an additional savings account with his bank a few years ago, and while completing the application, Brad forgot to name someone as his beneficiary. Not good.

Brad obviously rarely thought of the account, and when Brad and I discussed his financial accounts, he did not even mention the account. It only had a balance of only $500, and I managed essentially all of his money anyway.

Brad passed away in February 2013, and a few months later Wells Fargo alerted my parents to the account. Since Brad was not married and did not have kids, numerous court documents and forms would need to be completed. One of the documents was a small estate claim form that costs $300 to file along with an appearance in probate court. An additional letter signed by an attorney verifying that Brad did not have children. The costs of these items was close to $400 plus personal time... all to get $500.

Honestly, I do not think my family would have cared if Brad had named a charity, relative, friend, or even some random person... any of that would have been better than the cost and hours of time that has been spent (and still being spent) to collect $500.

Yes... name a primary beneficiary(ies) and contingent beneficiary(ies). It will help those you leave behind.

Doesn't my will cover my retirement accounts?

Actually, not necessarily. If your will says your retirement account(s) should go to Joe Smith, but the beneficiary form(s) with the financial institutions say that they should go to Bob Black - the money goes to Bob Black. Joe Smith can try to fight it in court, but I have never seen a single case in which the will overruled the beneficiary form.

If you name "The Estate of 'your name'" as the beneficiary, your will would be used, but this involves going through probate court, and generally takes much, much longer and is far more difficult than simply naming those you wish to name.

Also, changing your will is generally expensive. Changing your beneficiary on a retirement account is usually one form, one signature, and free. You tell me which is the better option?

What if my child(ren) is young?

This is a common question since people are worried that the child(ren) is too young now to handle any funds. Two things - 1) you may not die for many years; 2) the custodian of the child(ren) generally is the one that becomes responsible for the funds. The funds though are the child's under the guidance of the custodian.

One thing to note though is that a custodian of a child's account has a "fiduciary" responsibility to do what is in the best interest of the child. If the custodian mismanages the funds, the child can actually sue the custodian - and it has happened.

Name your children as beneficiaries (normally after your spouse) and in your will, make sure to name a responsible person to serve as custodian for your children and the funds.

How often should I update the beneficiaries?

This is a very good question. We usually try to remind our clients to update their beneficiaries when big life events happen - marriage, children being born, a death of a beneficiary, divorce, etc. There can be other times, but these are the basics.


Remember that the reason you are naming a beneficiary is to make sure that your hard earned retirement funds are going to the person/people that you want. Do not forget to do this one little thing that will save your survivors time, money, and frustration.