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.
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