Mark Hoaglin: This is the MyRetirementPlaybook.com Podcast episode number two. Hello, everyone. I'm Mark Hoaglin, Certified Financial Planner, founder of MyRetirementPlaybook.com and Retirement Mastery Now, and your host of the MyRetirementPlaybook.com Podcast. I'm also your financial coach leading you through this journey we call retirement, because you see, I believe that if you desire true peace of mind in your financial life, then getting consistent financial education and coaching is a must. And that's what this podcast is all about, is providing you with the education that you need to empower you so that you can retire on your own terms.

Mark Hoaglin: Today, we're going to focus on the 401(k) plan. It is the most popular defined contribution plan. If you're in a 457 plan, for example, if you're in the education field, that's typically the plan that educators have available, or a 403(b), you could still take away some information, but what I'm going to talk about today really pertains to getting the most from your 401(k) plan.

Mark Hoaglin: So as we begin our discussion today around the 401(k) plan, I think it's important to have some perspective. How did we get to this point where it's up to us as employees to take care of our retirement? Well, if we look at the last part of the 20th century, we saw a lot of change in the financial services industry. I started my career in the savings and loan industry, and among other things, savings and loans got the ability to compete with banks. If you go back to the late '70s and early 1980s, savings and loans started offering checking accounts. I know it's hard to believe that up until that point, they didn't have the power to offer checking accounts. And I can remember the first ATM that was installed right outside the branch that I was managing, and that was a revolution for the savings and loan industry, because now they could compete with banks.

Mark Hoaglin: Well, the growth was short-lived as we know what happened to savings and loans. They really, in my opinion, squandered their opportunities to be part of what was then very much an evolving financial services world. (singing) You might recognize that voice as the voice of Lorne Greene, the famous actor from the show Bonanza. Ben Cartwright was the character he played. Like me, you probably didn't realize that he could sing as well, but he sings that famous songs 16 Tons, and that well-known line, "I owe my soul to the company store."

Mark Hoaglin: Among the many changes as we approached Y2K was the death of the company pension. My grandfather retired in 1959 from the Goodyear Tire and Rubber Company. He worked 40 years for Goodyear, and he expected the company to take care of him. So he got a pension and they gave him a car in his retirement, and that was the way the world looked at, at least in this country, the way we looked at retirement. A company would take care of us.

Mark Hoaglin: Well, it all started changing in 1978. Congress passed what was known as the Revenue Act, which included a section, 401(k), hence we get the term 401(k) plan. That section of the Revenue Act gave employees a tax-free way to defer compensation from bonuses and stock options. So by 1983, almost half of the large companies in this country started thinking about offering a 401(k) to their employees, and they soon discovered that, well, the 401(k) was a less expensive way to provide for employees' retirement, because it shifted the responsibility largely to the employee versus what was up to that point traditionally the company's responsibility.

Mark Hoaglin: Well, then as we got into the 21st century, there were laws passed that started improving the attractiveness of the 401(k) plan, but unfortunately it was oversold as an alternative to pensions. Well, companies saw that because it was a less expensive way to offer a retirement plan and it shifted the burden to the employees. So as a result, over the years, most companies stopped offering a pension and they switched to what we call defined contribution plans, 401(k), 403(b), Thrift Savings Plans, versus defined benefit plans, which is what pensions were known as. There was a defined benefit. You worked for the company for X number of years, and you were this old, and you were earning this much, and so you could define what your retirement was going to be even before you retired.

Mark Hoaglin: Defined contribution? No, it's up to us. We, as employees, have to determine what our retirement is going to be. So, as I mentioned, companies have not done a very good job of helping employees maximize their 401(k) plans. So as a result, that's why today we see what I would say are severely underfunded plans as employees start approaching those traditional retirement years, 65, 60. So what I want to focus on today are two things. What if you're still planning on saving in your 401(k) plan for the foreseeable future? And then secondly, well, what if you're getting ready to look at leaving your company, maybe retiring, or even if it's just changing jobs? What can you do?

Mark Hoaglin: Before we get into what do I do with my 401(k) if I'm ready to retire, let's talk about, well, what if I'm still investing in my 401(k)? What are some of the things that I should be concerned about? Because as I mentioned earlier, most of our companies have not done a very good job of educating us. They tell us that we have to fund our own retirement plan and we have a plan sponsor. And from my experience, they rarely show up to help the employees with their investing because it's a monumental task.

Mark Hoaglin: You can imagine if you have a company of 100 or 200 or 500 employees, every one of you has your own unique risk tolerance and your own vision of what retirement is. So they typically address this in a blanket way. That, "Well, if you're conservative, you should invest this way. If you feel more confident about the market and you have a higher risk tolerance, you can invest this way." Well, the blanket approach just doesn't work. So what I'm going to talk about are some things that you should consider, and hopefully will take this information and work with a financial advisor who can really drill down more on your unique situation, your risk tolerance, to help you come up with a plan for the money that's in your 401(k).

Mark Hoaglin: There was a study done by the Mintel organization, which does a lot of financial surveys, and they focused on retirement and they found that 42% of the people that they surveyed indicated that they have a 401(k) plan. 55% of those people stated that they've done no retirement planning whatsoever, so to say the least, there's a need for better understanding of how your 401(k) fits into your overall retirement plan. So again, we've moved to this defined contribution retirement environment, no more pensions for the most part. So we have to take care of our own retirement, fund our own retirement basically, in conjunction with social security and other sources of income that we might have available to us.

Mark Hoaglin: So every year, the IRS sets what's known as contribution limits. So this year, in 2020, if you have a 401(k), you can contribute up to $18,000 on a pretax basis. In other words, it comes out of your account before it's taxed. So it gives you that advantage from a tax standpoint. It actually reduces your taxable income. Now, they've also added a little extra bonus. If you happen to be 50 years old or older, then they have this thing called a catch-up provision. So you can contribute an additional $5,000 on top of that 18,000. So you can contribute $23,000 on a pretax basis. Why the catch-up provision? Well, because Congress and the IRS figured out that, in particular, the Baby Boom generation hasn't done a very good job of saving for retirement. I think the last statistic I saw was the average 401(k) balance for the Baby Boom generation was about $70,000, and we all know that that is not going to last in what could be a 25- or 30-year retirement. So the major problem with longevity of course, is that you're going to run out of money in retirement.

Mark Hoaglin: So what do we do if we feel like we're going to run out of money in retirement? Well, the episode of my podcast from last week, I talked about that. So what I want to do is talk a little bit about what I call the magic of compounded interest. So whether or not you started saving 20 or 30 years ago, or whether you started saving 5 years ago, the magic still works. So I want to give you a little example here, just to show you the power of starting where you are and not worrying about what I could have done or what I should have done.

Mark Hoaglin: So let's just use an example. Let's just say that you put $3,000 a year into an investment. It could be your 401(k), it could be a taxable investment, but let's just assume, we're not going to worry about taxes right now, you put $3,000 a year into an account, investment account, and it grows at an average rate of 6% per year. And we're going to assume that you're going to reinvest all of your earnings. You're not going to take anything out of it, you're just going to leave it in there to compound. So if you'd started that $3,000 investment at age 20 and you left it in there, and every year you put in another 3,000, left it in there, another 3,000 and so on, and you retire at age 65. So again, you started with $3,000, it's now 45 years later, 6% compounded interest. How much money do you think you'd have. Well, if you have an HP12 calculator, you probably figured it out. You'd have $679,500 for that 45 year investment of just $3,000.

Mark Hoaglin: All right, now let's just say you weren't as proactive, and you started at age 35. So 15 years later, you started. $3,000 annual investment, 6% a year, reinvest all the earnings. So in those 30 years from age 35 to 65, you would have earned $254,400. So again, if you'd started at age 20, 15 years earlier, you would have had $679,500, but you waited, for whatever reason, and you have $254,400. Okay, let's just say you were more of a procrastinator and you didn't start until age 45, so 10 years after the previous example. Same $3,000 investment, same 6% return. At age 65, so in 20 years, you would have 120,000. So you can see the example of 679,500 to $120,000. The value of time in the market, time compounding, the impact that it can have on your 401(k) plan or your taxable investments, for that matter.

Mark Hoaglin: So a lot of you might be thinking, "Well, thanks, Mark. You're really making me feel bad that I waited so long." Well, that's not the reason why I'm giving you this example. It's really about a favorite saying of mine. "The best time to plant a tree was 20 years ago. The second best time is today." And that's really the point of this, is wherever you are in this process, if you haven't started saving or you feel like you've done a poor job of saving, just start today. Start where you are, because time is moving on and you can't keep beating yourself up for, in some cases, what you think might be a poor job of saving in your 401(k). Start where you are now. Put as much as you can into your 401(k), because the other advantage of the 401(k) is tax deferral. With tax deferral, the compounding effect increases even more dramatically, because the example that I just went through assumes there are no taxes, so that would be more like your 401(k) plan.

Mark Hoaglin: In a taxable account, it's a little different because every year Uncle Sam is reaching his hand in there to take out taxes from our investment, our taxable investment accounts, but with tax deferral, the compounding effect continues because you're not getting taxed every year. You're only getting taxed when you start taking money out of your retirement plan in the future years when you're 65 or older. So that's another reason why I always recommend that people max out your 401(k) before any other type of an investment account, because you have that tax deferral built in.

Mark Hoaglin: Now of course, I use the 6% guaranteed return example, which we know is not necessarily real world. The assumption that you've invested wisely in your 401(k) is one that I can't make, that's up to each one of you. But this is where asset allocation, the concept of asset allocation helps. It's one of the keys to successfully investing in a 401(k). It's the old, "Don't put all your eggs in one basket," approach, spread the risk among different asset classes, which is why mutual funds have become so popular, is because they have an automatic diversification because they invest in a number of different companies and sectors in the market. So there's somewhat of an automatic asset allocation, although it may not be specific to your risk tolerance. So you can't just assume that putting money into a mutual fund is going to take care of everything. It has to be the right mutual fund based on your risk tolerance.

Mark Hoaglin: So another way, if you're not familiar with asset allocation, the way I like to describe it is if you have a single pencil in your hand, and that represents a stock that you've invested in, if you take that pencil and you try to break it with two hands, it's pretty easy, right? It didn't take you much to break, didn't take much energy to break that pencil. So that's kind of the concept of investing in one stock. Doesn't take much to bring it down, right? Well, let's assume you have a group of different stocks or in this case, pencils. Let's just say you have 10 pencils now and you put a rubber band around them, and now you try to break those pencils with your hands. It may not be impossible, but it's a lot more difficult than that single pencil. Well, this is what asset allocation is all about. So the next question is, "Well, how I decide which pencils or investments to have in my 401(k)?" And that's where this concept of risk tolerance comes into play.

Mark Hoaglin: Knowing your risk tolerance is another important factor for successful investing. We all have our own unique risk profiling, so I strongly encourage you not to let anyone try to lump you in with Uncle Johnny or your coworker at the office. Just because they feel comfortable investing in the latest hot stock tip doesn't mean it's okay for you. Make sure you know your risk tolerance, and you can do that by working with a financial advisor or a financial coach who is experienced in providing a risk tolerance assessment. If you work with a financial advisor and in the first 20 minutes they don't talk about risk tolerance, you're probably working with the wrong person, in my opinion.

Mark Hoaglin: If you are looking at a risk graph right now, and let's just say the horizontal axis is risk and the vertical axis, excuse me, is performance, investment performance, a return on our investment or the potential return on that investment, and we list on the, let's just say we have a line going at a 45 degree angle from the lowest risk and the lowest potential return all the way up to the highest risk and the highest potential return. Well, on this graph or on this line, this 45 degree angle, we would have a number of investments that in some cases we can invest in through a 401(k), but just in general, they're typically going to be through mutual funds.

Mark Hoaglin: So for example, at the very low end, you have things like treasury bills and CDs, right? Government-insured, low risk, and the return is commensurate. It's relatively low for that type of an investment. And then as we work our way up that line, we have government bonds and then we have corporate bonds, we have preferred stock, common stock, and at the very top, we have things like options and futures, very high risk with a very high potential for return. So this idea of our risk tolerance is we have to figure out well, where on that continuum, that line, do we feel the most comfortable that I can sleep at night if the market goes down and my government bonds or my corporate bonds have a drop in value, or my stocks have a drop in value. How comfortable do I feel?

Mark Hoaglin: So the goal of our 401(k) is that we create a mix. A mix of maybe lower potential return with higher potential return, so that way if the market goes down, my entire portfolio doesn't necessarily decrease. And there's really no perfect mix, because this idea of risk is a combination of stability, income and growth. There's a trade off between those three factors when we look at risk. If I have too much stability, I minimize the potential for growth, and if I'm looking for income, also the potential for income. So if I have too much growth, then I reduce the potential for stability. And so that's the trade off that each one of us has to consider. And that's why I say it's a personal decision. You can't expect 20% returns and say that you want low risk. And anyone who tells you that you can, please run the other way as fast as you can.

Mark Hoaglin: So as we're bringing it back to the 401(k), that's the reason mutual funds are a great way to spread risk and stay ahead of inflation. And if you're confused by the selection that you have in your company's 401(k), first of all, speak to the plan sponsor, because again, that is their responsibility. And if you're not getting the satisfaction there, then I would speak with a financial advisor if I were you. By law, your plan sponsor has to provide education regarding the various funds that you can choose from, and they typically do this online with kind of a self-serve approach, which is okay, because again, they're serving thousands and thousands of employees so it's more challenging for them to give you that personal service. But with something as important as your retirement, I would work with a financial advisor, a certified financial planner, or a financial coach.

Mark Hoaglin: You remember the magic of compounding interest that I just discussed takes advantage of time? So a great strategy to use is dollar cost averaging. It will help you become a much more disciplined investor, and you probably don't, or you might not be aware of it, but if you're having money come out of your paycheck on a regular basis to invest in your 401(k), then you're already dollar cost averaging. So let me explain exactly what that is and how it works. So let's just say you have $60,000 taken out of your 401(k) plan over the course of a year. So how would it work if you invested all that at once versus the way you're currently doing it, which is having it taken out of your paycheck every week or every other week, or in some cases every month?

Mark Hoaglin: So in our example, let's just say you have $6,000 that you're going to invest, and you can either invest that over the course of six months or you can invest it all at once. So let's say we decide we're going to take it and we're going to invest it all at once, and we buy 600 shares at $10 a share in month one. So we own 600 shares at a value of $10 a share. Well, what if we took that $6,000 and we spread it out over six months? So let's just say month one, we invest one sixth, or $1,000, at $10 a share. So we now own 100 shares at $10 a share. Month two, the price has gone up a little bit, so we can only buy 77 shares with our thousand dollars. In month three, it goes down. So now we can buy 167 shares with our $1,000. In month four, it goes up a little bit. I can buy 91 shares, and in month five I buy 143 shares, and in month six, it's back up to where I can buy 100 shares at $10 a share.

Mark Hoaglin: So let's look at what's happened over the course of that six months. In option one, where I invested all $6,000 at one time, I was able to buy 600 shares at $10 a share. That was the price in month one. Well, by spreading it out over the six months, I've actually bought more shares at a lower average price. So I bought 678 shares at an average price of $8.85 So for the same investment amount, I potentially have more shares, because it lowers your market risk by averaging the prices out. And again, that is similar to what you're doing in a 401(k).

Mark Hoaglin: Okay, so that's a very high level overview of basic investing. So how you can approach investing in your 401(k). I'll talk a little bit more about mutual funds, just because that is the most popular type of investment in a 401(k) plan. And as I mentioned before, mutual funds offer you this, what I'll call instant allocation, right? Because they're spreading the investments over a number of different companies within that mutual fund, and you have your choice typically of a variety of sectors, investment classes. You can tailor them to your risk profile, and they're typically managed to an objective. So the objective could be growth, it could be growth in income, it could be capital preservation. So again, once you know your risk tolerance, you can tailor the type of mutual fund that you select in your 401(k) plan to your risk tolerance.

Mark Hoaglin: The other option are what we call exchange traded funds. These have become much more popular, and they're typically based on an index, the S&P 500, for example, the Russell 1000, and mutual funds are what we call actively managed. That means that they have a fund manager whose day-to-day, he or she is talking to the companies that they're investing in and getting all the latest information and looking at suppliers and all the different nuances with that particular investment. And so because of that, there's a fee that's typically charged in that mutual fund, a management fee, if you will. Exchange Traded Funds, or ETFs, they are what we call passively managed. So there's no fund manager. They're like a stock. They're traded throughout the day, you can buy them on margin, you can short them just like stocks, and there are some tax efficiencies with ETFs. So if your plan, your 401(k) plan, offers ETFs, that's another option that you can consider when you're looking at how to invest your money in your 401(k).

Mark Hoaglin: Now, there are a number of investment options within the mutual funds. As I mentioned, there are money market funds, bond funds, stock funds, and just like that risk continuum that I described earlier, the same thing with mutual funds. They fall along that same risk/potential return continuum. So your money market funds and your bond funds are going to be lower risk, and as you move up the risk/return scale, things like balanced funds and growth funds and international funds, they tend to be at the higher level of risk, but they offer you also a potential for higher return. So that's where you have to think about exactly how comfortable you are with the risk and the potential return.

Mark Hoaglin: So again, that's why I recommend that you work with a financial advisor that can really dig more into the specific investment options that you have available or talk again to your plan sponsor who can and should be able to provide you with educational material around which funds are the best investment based on your risk tolerance, your time horizon that you have until you might retire. There are things like target rate funds that try to take all of the thinking more or less out of the decision in that if you have 20 years or 30 years to retire, you can buy a target fund that is targeted for a retirement in 20 years. And so they base the investments within that particular fund on a 20-year horizon, or in some cases a 30 year time horizon. So target date funds have also become very popular in 401(k) platforms. So that might be something that you're comfortable with as well.

Mark Hoaglin: Okay, so I hope that was helpful in terms of the types of investments, and investing considerations that you should take into account when you are putting money and still putting money into your 401(k) plan. Let me get back to the options of if you are getting ready to retire or leaving your company, if you're still planning to work, but maybe you're going to leave your company. What are your options? And I talked about the three options. You can leave it, you can roll it, you can take it with you.

Mark Hoaglin: So let's look at that first option. You can leave your 401(k) with your current employer, and in many cases, this is allowed. So you need to check with your human resources representative just to make sure. And in some cases, you might be in a plan that offers some very unique advantages, and maybe it's better than, if you're going to another company, the plan that you're going to. So it's at least worth considering if you're not going to roll it into a 401(k) plan, or excuse me, into an IRA, an individual retirement account. Your second option is taking a distribution in the form of a cash, and then reinvesting the remainder in an individual retirement account, and that may be your best option. I always recommend against taking a cash distribution just because of the penalties and tax consequences, but that's something, again, that you should decide or discuss with your financial advisor.

Mark Hoaglin: The third option is to take what's called a lump sum distribution. And again, that's not always the best option. Sometimes the temptation is too great. I've seen clients take their hard, earned retirement savings and go buy an RV or a boat or vacation home, and essentially deplete their retirement savings. So they have their kind of quick fix or their toys, but now they don't have enough money to live on. So a lot of problems with that, for that option. First of all, you could lose up to 50% of your savings if you take a lump sum distribution, depending on your income tax bracket. So let me give you an example of what that could look like. So if you take a distribution, you're going to pay a 10% penalty if you're under the age of 59 and a half. Then you're going to pay federal and state income taxes on the amount of the distribution. So let's assume in some cases, I know you don't have state income taxes, but let's just assume a 5% state tax and a 28% federal tax. So now you can see almost 50% of your money could go to taxes and penalties.

Mark Hoaglin: The fourth option is to roll the balance of your retirement account to an IRA account at a bank or credit union or another financial institution. And there are a number of advantages to this option, again, if you decide to move your 401(k) out of your current plan. First, you can transfer the money without incurring penalties and taxes. You'll have flexible investment options in an individual retirement account, and you can designate your own beneficiary. So rolling over your funds, it may be the best option if, for example, you're a middle aged to older job changer, you're a pre-retiree who's thinking about or close to retirement age, or you're close to one of the key milestones. For example, you're 59 and a half, which is when you can take withdrawals from retirement plans without penalty or you're age 70 and a half, when you can start taking minimum distributions from qualified plans. That's actually being increased to age 72 with the passing of the CARES Act, which I'll talk about in just a minute. Or you're a current retiree who might be interested in some legacy planing, for example. So those are your four options when it comes time to taking money out of your retirement plan.

Mark Hoaglin: All right. It's time for our question of the week, and this week it's about the CARES Act. I mentioned I was going to touch on that, and it comes in the form of our question of the week from Nancy, from Austin, Texas. And she writes, "I understand there are some significant changes that involve distributions from 401(k) plans as a result of the CARES Act. Can you please go into that in a little more detail?" Yes. Nancy, happy to. Just as a reminder, March 27th of this year, the Coronavirus Aid Relief and Economic Security Act, I don't know why those bills always have to be a mouthful, but nonetheless, so fortunately it's shortened to the CARES, C-A-R-E-S Act, CARES Act, and it does bring some significant changes, and in some cases relief, to 401(k) plans.

Mark Hoaglin: So let me just touch on what some of those changes are. First of all, you have a distribution right of $100,000 from the plan as long as that does not exceed the amount that you have in your plan, so obviously you can't take out 100,000 if you only have 60,000. So up to 100,000 from the plan through the end of this year, so through December 30th, and that's subject to a special tax relief. So work with your CPA or accountant on that, if that is something that you're considering. There's also a loan limit increase. So there's an increase in the loan limit that, you can take a loan against your 401(k) plan. So there's an increase now, which used to be 50,000 and they increased that to 100,000, or 100% of the participant's account balance, if it's less. So if you had 60,000, you could take a loan of 60,000 if that's all you have in your plan. And that's for loans made from March 27th of this year through September 22nd, so you still have time to look into that if that's something that you're interested in.

Mark Hoaglin: They've also implemented a loan suspension program. So if any loan payment that was due from March 27th through the end of this year, they've suspended the payment on that for up to one year. So if you have a loan against your 401(k) and you've been making payments, then if you have a payment due after March 27th through December 31st, they are suspending the loan payments. So check with your plan sponsor on any outstanding loans or any loans that you would plan to make.

Mark Hoaglin: And the final point is that the CARES Act essentially suspended required minimum distributions for 2020 across the board. However, if you took a required minimum distribution in 2019, there have been some questions about the impact on taxes and inherited accounts, for example. So my recommendation is talk with your tax advisor about the implications and what is essentially waived and what is not waived if you took a distribution in 2019. But essentially for 2020, the CARES Act suspended required minimum distributions. And I've included a couple of links in the show notes if you'd like more details on the impact of the CARES Act on required minimum distributions and 401(k) plans specifically. So thank you, Nancy, for your question about the CARES Act and its impact on 401(k) plans.

Mark Hoaglin: Well, that'll wrap up this week's edition of the MyRetirementPlaybook.com Podcast. I hope you found the information today about 401(k) plans beneficial, and if you'd like more information, feel free to visit the MyRetirementPlaybook.com website, and you can click on the Retirement Mastery University. I have a number of courses. I have one specifically around 401(k) plans if you'd really like to dig into this topic in more detail, more information there, as well as in the show notes as always. Well, thanks again, everybody, for investing a little bit of time with me this week to learn about how you can retire on your own terms. Have a great week, everybody.