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Maybe it’s my age, but when new things come out and people are “crowing” the wonderfulness of it, I get suspicious. My first question is what’s in it for the people promoting it so much? Two new developments from the current administration now apply to 401(k) retirement plans and other contribution defined retirement plans. They are the following:
- Plans may continue to offer annuity contracts for lifetime income, and
- Alternative investments can now be offered. These include private equity investments, hedge funds, cyber coins, and other various derivatives.
Gary Logan
Wes Shannon
Both of these rule changes benefit large finance companies and insurance companies. Though it is clear that these interested parties will profit from the changes, the big question is whether we the participants/workers will see additional benefits to our retirements.
The short answer is, yes, we the participants in these retirement plans will benefit from having more options. That’s assuming that more freedom and options are good (which I believe to be true). However, both of these two new offerings in 401(k) plans have some “gotcha” features that are not beneficial to plan participants namely, higher fees.
Annuities are insurance products and as insurance they pay commissions to insurance agents. These commissions are offset by higher fees for mortality and administration and with longer and larger surrender charges. Alternative investments generally have fees, loads, and shares of profits that can run more that 20 times an exchange traded fund or mutual fund.
Annuities offer guarantees and low risk to principal investments and can provide a guaranteed lifetime income for a person. There are certain circumstances that some people have which makes an annuity a great option. People who don’t handle money well or people with a limited amount of money who cannot afford to outlive what they have. Having an annuity option in a retirement plan is rather unnecessary because anyone with a balance in a 401(k)-retirement plan could roll out their account into an annuity of their choosing and not incur a taxable event. So having one in the plan is just giving a marketing advantage to one insurance company or agent.
Alternative investments come with the double edge sword of potentially higher returns with higher risks and more volatility. Alternatives offer returns that are not necessarily correlated to stock and bond markets. Giving some counterbalance to an investment portfolio.
One very important thing to note about all is the most critical thing a person can do in order to have enough money in their plan to retire on is contributing more money to the plan. Getting a few points extra returns on the investment doesn’t come near the benefit of increasing your contributions to the plan. With most individuals I have counseled about their 401(K) plans for their retirement, we talk about making the maximum contribution under the current law first. If a person can’t contribute the maximum, I suggest setting up a goal to get to that level soon. After that goal is met, then let’s look at investing in some Alternative investments in the plan. Before that gets done the regular stock and bond fund options will do nicely. Remember this is the money you will live on when you can’t work anymore. Taking undo risks is not wise.
Now don’t go thinking you can buy Bitcoins, invest in the newest startup tech company, or get in on a newest real estate development tomorrow in your 401(k) plan. The rules governing the fiduciary responsibility of the plan sponsor (employer who set up the retirement plan) are still in effect. Those rules require the sponsors to review and do a due diligence on each investment offer that will be made available in the plan. We have a lot of questions in the industry about how these alternatives will fit those criteria. A major problem with private equity is liquidity. Often private investment opportunities are not bought and sold on a secondary market like stocks and bonds. When a person retires how will the plan deal with that lack of liquidity?
As in all important financial decisions — retirement is a pretty important one — it is best to seek the advice of a professional financial planner. Look for a Certified Financial Planner® who will be a fiduciary and can give you guidance as to what investments in your 401(k)-plan work best for your overall goals and needs.
Wes Shannon CFP® is a Certified Financial Planning Professional for Brazos Wealth Advisors in Fort Worth.