Advanced Personal Finance

Until recently, I worked for one of the few remaining companies to offer a real, old-fashioned pension.  When I quit a few months ago, I did something I’d read you’re never supposed to do.  I cashed out and took a lump sum from the pension plan.  Here’s why I did it.

My old employer is one of the few that still offers a pension (only 11% of private employers still do, according to the BLS and the Fed).  Well, they still kinda offer a pension.  A couple of years ago they stopped contributing to the plan.  You didn’t lose anything if you worked there, you just didn’t get anything more than what was already there.  Since 1985, the commonality of defined benefit plans (i.e. ‘pensions’) has dropped off a cliff.  For most people going forward, retirement savings depends almost entirely on defined contribution (i.e. IRAs and 401(k)s) plans and Social Security.

When you leave a company that has a pension, though, you have a choice to make.  You can either take your pension as a lump sum or take the annuity (monthly payments).  It wasn’t even close - I took the lump sum for four reasons.

1. There were no negative tax consequences of doing so.  I was able to roll the money directly into an IRA without paying taxes or penalties.  This was a biggie.
2. I strongly suspect I can achieve greater returns investing the money myself.  Not because I’m some genius investor (check out my super-duper asset allocation) but because I have a long time horizon and am risk tolerant.  Pensions have a lot of advantages when investing money, but they can’t lose money.  I’m not in the position of having to pay out money every quarter.  With the money in an IRA, I can literally invest in anything.
3. The array of choices for the annuity was ridiculously lengthy and confusing.  Seriously, there were easily twenty-five choices for how you could get the annuity.  I like to think I’m a reasonably smart guy, but I couldn’t make heads or tails out of that list.
4. It is a reasonable possibility that by the time I retire in 30 years that money won’t be there if I’d left it in the pension plan.  Pensions not only suspend contributions like mine did, they also fold completely like several airline pilots’ plans did in 2005.  And while there exists the federal Pension Benefit Guaranty Corporation that’s supposed to insure against it, the PBGC is hurting real bad.

The process itself was pretty straightforward.  Fill out a couple of forms, get them notarized (In my case twice.  Don’t ask.) and tell the pension manager where to send the money.  I actually never saw the money in the form of a check.  Strangely, they could send the money directly to my investment company (USAA) but I couldn’t do that with my 401(k) money.  In the case of a 401(k) rollover, you get a check made out to the investment firm and you send it to the them.  Whatever.

So that’s it.  I was able to put something like $30K into my IRA instead of leaving it with the pension fund.

It’ll be a little something extra come retirement time.

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How’s that for a thrilling title?  Anyway, that’s what I’m going to write about. 

I quit a job recently and rolled over my 401(k) into an IRA.  I’d been hesitating on how to invest the money, so for the past couple of weeks, it was in a money market.  I wanted to do a reallocation of everything related to retirement savings but I wasn’t sure if different types of accounts (Roth and Traditional IRAs) should have different asset allocations.  Just a couple of days ago, I finally decided and invested the money.

Asset allocation - different accounts get different treatment?

So on the question of whether a Roth IRA gets a different asset allocation than a Traditional IRA, I came to conclusion that for my time horizon and risk tolerance (medium-long and high, respectively), they can be the same.  As I get closer to retirement, I imagine they’ll diverge, since you’re supposed to tap Roth funds last.

Here’s the allocation I settled on:

50% US stock index

40% Internation stock index

10% Bond index

Specifics of my investment

I had planned on using USAA mutual funds as my investment vehicle, but I ran into a couple of reasons not to.  First, they don’t offer a true bond index fund or an international index fund.  Second, I have a lump sum to invest, so ETFs really make more sense.  I won’t be trading, so commission fees aren’t an issue for me, nor will I be adding additional money.  With an ETF, I take a one-time commission hit, then it’s done.  More importantly for me, though, is that ETFs deliver what I’m looking for (boring, vanilla index funds) with super low expenses - even lower than an index mutual fund charges.

Specifically, I chose the following ETFs for my mix (numbers in parentheses are expenses):

50% Vanguard total market (0.07%)

40% Vanguard FTSE index (0.25%)

10% Vanguard bond index (0.11%)

So now Vanguard has a very substantial portion of my retirement money.  It’s still held through a brokerage account at USAA, incidentally.

Anybody out there have any thoughts/opinions about my allocation or use of ETFs?

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After recently changing jobs, I rolled over my 401(k) into my existing IRAs.  I learned an interesting tax quirk along the way, too.  Now I’m to the point where I need to rebuild the asset allocation I had in the 401(k)…or not.  My question about this is really simple.

Should my Roth IRA asset allocation be the same as my Traditional IRA asset allocation?

I can think of a couple of reasons why and why not.

Yes, the asset allocations should be the same.

1. Since both IRAs are for the same goal (retirement) and the same time frame, asset allocation theory seems to say they should be identical.
2. They should be the same just for simplicity.  Since you’re possibly going to change the asset mix as time passes (to reduce risk, say), keeping both IRA types the same makes it considerably easier.  However, the use of a lifecycle fund might mitigate this factor.

No, the Roth IRA asset allocation should be different than the Traditional IRA.

1. Using both a Roth and Traditional IRA allows you to do tax diversification.  As such, your goals and objectives for the two types of IRAs may be different.  [Thanks to Lily who pointed this post from Dough Roller out to me on this subject.]
2. Since conventional wisdom says there’s a certain order in which you draw down retirement assets, the allocations of those assets should differ.
3. There are some peculiarities about Roth IRAs that may dictate a different asset mix.  Specifically, you can withdraw contributions to your Roth IRA penalty free at any time.  That’s generally not so with a Traditional IRA.  This may mean the two types should hold different assets, especially if you anticipate you might need to take a withdrawal.

Anyone have any thoughts on this? 

I want to take action and set up my asset allocations, but I’m not sure which way to go.  Right now, I’m leaning toward having them a slightly different mix simply because of how I’ll (hopefully) be drawing down the retirement assets.

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In an article in the Wall Street Journal, Jonathan Clements made an offhand comment that I thought had particularly important ramifications.

“All of the above presumes your income rises at the inflation rate between now and retirement. What if your income rises much faster? Ironically, that could make it tougher to retire.”

I’d never thought about it explicitly, but that’s exactly correct. To date I’d always sort of figured that fact into my planning for retirement without stating it outright, but it’s worth stating again.

A rising income can make it harder to save for retirement.

At first this might seem counterintuitive. I mean, who doesn’t want to make more money, right? In a situation like that, you have the ability to save more toward retirement, getting to the level we’re ’supposed’ to save according to personal finance gurus and countless university studies. Or you might be able to retire earlier than you’d planned.

Only, in practice it rarely works that way. Why? Human behavior.  When their income goes up, most families (including ours) experience ‘lifestyle creep.’ As income grows, so too do expenses. Sure some of them are necessary or even the result of that rising income (Mom going to work and earning a nice paycheck but having to put the kids in expensive daycare springs to mind). Regardless of the underlying reason, most of the time increases in income flow right out the door for the most part.

That ‘for the most part’ is keenly important. Obviously, one of the bedrock principles of good personal finance is the old saw ‘keep a portion of everything you make.’ So you dutifully save 10% of your increased income. Or maybe you don’t. It’s really easy to forget to increase savings with an increase in income. Did you increase your 401(k) contribution when and if you got a raise last year? I know I didn’t - my raise was laughably small. So every bit of that small raise went to lifestyle inflation.  We spent it.

What this means for trying to save for retirement

Back to the topic at hand - retirement. We see how increases in income often flow right back out the door. Another way of saying that is when you get an increase in income, your standard of living increases. The core challenge of saving for retirement is to match your sources of income to your expenses. In other words, you need to match your standard of living right before retirement (unless you plan on taking a lifestyle hit).

As your standard of living increases right before retirement, you need that much more retirement income and hence, retirement savings. Thus, increases in income, unless a portion of them are saved, result in increased difficulty in your ability to retire how you want.

I’ll have to keep that in mind the next time our family’s income goes up. It was easy to remember recently since I just accepted a new job with lower pay. But that’s another story…

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We’re in the midst of adjusting our family budget to account for some major changes that will be happening over the next couple of months. In the process, everything is getting looked at, including savings. Just like anybody, we have lots of things competing for our dollars. We save a pretty sizable portion of our income right now:

• Retirement
• College
• Short-term savings for known expenses
• Taxable index mutual fund

Since everything is being evaluated, the topic of saving for retirement versus college came up. This should be an easy one. Everything you read says save for your own retirement first and college funds come somewhere lower down on the list. It’s in any personal finance book or blog. Easy.

Only it’s not so easy if your a parent.

Any way you look at it, saving for yourself first seems like putting yourself in front of your kids. And something happens to your mind when a child arrives. You become incapable of putting yourself before your offspring. What’s a positive genetically speaking can be a serious negative financially speaking.

So we’re at a decision point. Which gets reduced and by how much? First, the changes to the budget will be temporary. Second, they may not be necessary at all if things fall right.  As things stand right now, though, it looks like they’ll each take a hit.  We’ll be saving a little less in each of our children’s college funds and a little less for retirement.  It goes against all the personal finance advice I’ve read, but it’s the right decision for us.

Now let’s cross our fingers and hope it won’t be necessary…

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