Convert Your 401(k) into a Cash Cow

By Jeff Harris, ChFC

Retirement plans like 401(k)s and pension/profit-sharing plans are great for building a nest egg. They give you numerous benefits, including the ability to deduct contributions from your taxable income and enjoy tax-deferred growth of earnings inside the plan. However, eventually you will have to convert your retirement plan into an ongoing income stream so you can have the money to do what you want, when you want.

When that day comes, you’re going to find that the investment choices inside your existing 401(k) are generally not the best options for funding your retirement lifestyle. Why? Because retirement plans are designed to attract and retain employees so they can save for retirement, not to provide an income stream for retirement.

Knowing that, following are the main three reasons why you shouldn’t leave money in a 401(k) when you retire:

• Fiduciary responsibility limits investment choices. Congress requires business owners and officers to make sure their retirement plans are run for the benefit of the employees. This makes them Fiduciaries, which means they have a legal obligation to select prudent investment choices for the retirement plan.

• This law, known as ERISA (the Employees Retirement Income Security Act), means owners and officers could be subject to unlimited personal liability if they don’t fulfill their obligations. Therefore, most plans limit the number of investment choices they offer employees to no more than eight to twelve.

• You needed growth while you were working but you need income after retirement. If you look carefully, you’ll find that most of the investment choices in retirement plans are usually geared toward growth, not income. They’re chosen because that’s what the employees and owners want. Little thought is given to income generating investments.

• Expenses can be higher than you realize. While most people believe that 401(k) plans are “cheap” because you’re getting a group deal, that’s not necessarily true. According to the U.S. Department of Labor’s report on 401(k) Plan Fees and Expenses, “…many 401(k) plans charge ‘excessive’ fees and expenses with the consequence that workers’ opportunities to achieve their financial goals will be diminished.”

• In fact, 401(k)s are much more expensive to administer than private retirement accounts like IRAs, because of all the complex IRS rules and regulations. But you may never know how much you’re paying because the Department of Labor study also found that “participants in many plans are not being furnished information about the total amount of fees and expenses being charged against their accounts.”

The Income-Generating Secret: Fortunately, you can put your money in a savings vehicle that enables you to generate an attractive retirement income. But in order to do so, you must have investment choices that aren’t in most 401(k) plans.

What does that mean? Quite simply, you need to create a portfolio that generates the income you need to live on from dividends and interest alone. However, this is next to impossible in most 401(k)s, because these plans are designed for growth, not income. But if you rollover your 401(k) to your own self-directed IRA, then you can enjoy a whole new world of investment options, including everything you need to convert your retirement plan into an amazing cash cow! Here’s how:

Step 1: Determine what you want: Suppose you’ve calculated that for retirement you’ll need about $50,000 per year in addition to your Social Security benefits, in order to enjoy the lifestyle you’ve become accustomed to. Now you’re ready to build that income portfolio. You’ll need some or all of the following types of investments, depending on your unique situation. The numbers in brackets represent the estimated annual income you could expect from each item. Of course, this will vary depending on market conditions.

• Preferred and Common Stocks that pay high dividends (4%-8% plus growth potential)

• Real Estate Investment Trusts (REITS) (5%-7% plus some growth potential)

• Government Bills, Notes and Bonds (2%-5%)

• Corporate Bonds of various maturities (4%-8%)

• FDIC insured Bank CDs for safety (3%-6%)

• No-Load Mutual Funds (3%-5% plus growth potential)

Ideally, all the money you’ll need to live comfortably in retirement will come from the income these holdings generate. Now you don’t have to worry about stock market ups and downs, because your income isn’t necessarily tied to stock market growth.

Step 2: Make your move: With your plan in place, you’re ready to rollover your 401(k) into your own IRA tax-free. Now you can diversify your money into each of the investment classes identified. If you need help, go to www.morningstar.com for insight on deciding which investment choices make the most sense for you.

So let’s say you have approximately $750,000 in your IRA. If you were to earn an average of 6% interest and dividends from this money, you’ll have $45,000 to supplement your social security income. It’s not quite the $50,000 you were hoping for, but it’s close. At this point you need to decide if you’re going to take more income from your portfolio (not recommended) or adjust your lifestyle to fit what you have coming in (highly recommended).

Remember, this money has to last you the rest of your life, so you simply can’t afford to take unnecessary chances with it. Therefore, if keeping your withdrawals to these levels means adjusting your lifestyle, so be it. Better to live modestly within your means than stressfully outside them.

Step 3: Keep a watchful eye: You’ve calculated how much money you need to live on, rolled your 401(k) into an IRA with many more investment options, and built a diversified income portfolio generating about 6% annually. So can you forget about your investments? Absolutely not! You need to review how you’re doing at least quarterly and compare the various investment choices to make sure they’re continuing to do the job. Again, www.morningstar.com can provide statistics and data to help you with this.

Unfortunately some people create more problems than they solve with their monitoring. It’s easy to fall into the trap of jumping from one hot investment to another. But that’s a trap that can cost you a lot of money. Why? Because you usually won’t know which investments are “hot” until after they’ve gone up in value. By the time this is brought to your attention, the smart investors have already taken their gains and moved on to more lucrative prospects.

Inevitably, “hot” investments cool off, and you can be left holding the bag if you jump in at the wrong time. The flip side is that it’s easy to get spooked when things aren’t going so well and you sell at the wrong time. That’s why the most successful investors develop a sound investment plan and stick to it. When it comes to investing, emotions are your enemy.

What If You Need Help? When it comes to your retirement money, you certainly don’t want to take any chances. If you make a mistake with a small sum of money, it’s not a big deal. But if you make the same mistake with a large sum of money, the damage is magnified. And you don’t have years to make up for losses like you did when you were working.

So if you need help creating your portfolio, look for a Registered Investment Advisor. These professionals will work with you on a fee-for-service basis, so you don’t have to worry about sales commissions. Also, choose someone with a professional designation like a Certified Financial Planner or a Chartered Financial Consultant. They’re required to meet minimum levels of proficiency and attend continuing education programs. Finally, your candidate should have a minimum of ten years of experience working with retirees.

So when you’re ready to retire, seriously consider rolling over that company 401(k) to your own self-directed IRA. This way you can have a cash cow to give you all the moolah you’ll need to fund your rich and happy retirement.

Read other articles and learn more about Jeff Harris.