There’s good news for investors who are looking to add a little spice to their retirement accounts. For the first time ever, defined contribution plans – like 401ks – have access to private equity investments.
U.S. Secretary of Labor Eugene Scalia said in a statement yesterday that this step “will help Americans saving for retirement gain access to alternative investments that often provide strong returns.”
Typically viewed as a way to outperform the stock market, the average private equity investment has actually underperformed the stock market over the last 10 years. According to a study by Bain & Company, private equity investments returned an average of 15.3% compared to 15.5% for the S&P 500. The study does mention that top-tier private equity funds did manage to outperform the market.
Scalia’s announcement went on to add, “The Letter helps level the playing field for ordinary investors and is another step by the Department to ensure that ordinary people investing for retirement have the opportunities they need for a secure retirement.”
You won’t be able to invest directly into private equity funds in your 401k. You’ll only have access through specific investment vehicles like target-date funds. Defined benefit plans – like pensions – have had access to private equity investments for some time now. So, as Scalia mentions, this move now levels the playing field for investors.
Securities and Exchange Commissioner Jay Clayton supports the decision to allow defined contribution plans access to private equity investments. He also mentions that the new capital coming in will increase the funding sources available to private businesses.
How It Should Be Perceived
Investors, however, shouldn’t look at the ability to invest in private equity funds as a panacea of retirement riches.
Private equity investments are often much riskier than traditional stocks. As we mentioned earlier, they don’t always provide greater returns.
In an interview with Fox Business, Ed Slott, founder of IRAHep.com, said that investment losses in February and March may have caused a sense of panic among savers who might be searching for larger returns.
“Some of those [private equity] returns are sensational but, with anything, you could lose a boatload too,” Slott said. “It doesn’t mean private equity always makes money.”
You may lose money while investing in private equity funds. When that happens, you’ll likely have no recourse against your broker or fiduciary who put you in those investments.
As part of the announcement, Slott noted that there is a “liability shield” for fiduciaries. As long as they follow the guidelines set out by the Department of Labor, they will be within their fiduciary obligations. This makes it harder for investors to sue over losses.
The ability to invest in a private equity fund is alluring. However, the best advice comes from Alano Massi, the managing director of Palm Capital Management.
“Should that investor not feel comfortable with private equity, or simply does not understand it, then he or she should not participate,” Massi said.
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4 Ways To Get Your Retirement Plans Back On Track
Whether you are nearing retirement or already enjoying your golden years, the recent market correction – and subsequent rally – has millions of Americans reconsidering their retirement plans.
If you’ve found that your retirement accounts aren’t quite where you would like them to be, don’t worry, there’s still time – and steps you can take – to improve your financial situation.
Play “Catch Up” In Your Retirement Accounts
If your nest egg isn’t as sizable as you had hoped it would be by this stage, there is some good news. If you are over the age of 50, you can make what are called “catch-up contributions to your retirement accounts. These allow you to put more money into your retirement account each year than is permissible for those under the age of 50.
For example, the 401(k) contribution limit for those 50-and-under in 2020 is $19,500. But for those over 50 years of age, you can contribute an extra $6,500 this year as a “catch-up” contribution, for a total of of $26,000.
The same thing goes for a traditional IRA. The typical limit for 2020 is $6,000 per person. But for those over 50, you can contribute an additional $1,000 to catch up, for a total of $7,000.
Convert Your IRA To a Roth IRA
As Suze Orman recommended a few weeks ago, if you have a traditional IRA, it might make sense to convert over to a Roth IRA this year. With a traditional IRA, your money is invested pre-tax and you don’t pay any taxes until you start withdrawals.
With a Roth IRA, your deposits are after-tax, so you don’t pay any taxes when you withdraw money in retirement. Given the massive budget deficits our country is running, there’s a very strong likelihood that taxes will be much higher in the future than they are today.
So while it may be appealing to let your money grow tax-deferred in a traditional IRA, you could end up paying a higher tax rate in the future. If you convert your IRA to a Roth IRA, you would pay your taxes in the year you convert. This could be extra-beneficial if you will fall into a lower tax bracket this year due to job losses or retirement. Pay the taxes this year at a lower tax rate and let the money grow tax-free going forward.
Review Your Social Security Blanket
Social Security is a major part of every retiree’s monthly income. Fortunately, that monthly income won’t ever decrease, and is automatically adjusted for inflation every year. So it makes the decision of when to start collecting Social Security very important.
You can start collecting as early as age 62, but your benefits will be permanently reduced as much as 30%. If you were born between 1943 and 1954, your full retirement age is 66, and for those born between 1955 and 1960 the full retirement age is 67 – and is also 67 for everyone born after 1960.
Here’s where some patience can pay off: if you can afford to wait until age 70 to collect your benefits, your monthly checks will be 8% larger for every year you delay claiming your benefits.
Pay Off Loans Against Your Retirement Savings As Soon As You Can
Pay off any 401(k) loans as soon as possible. A loan against your 401(k) is counter to your goal of saving for retirement. inadequately funded.
Also, the money you are paying your loan back with has already been taxed, so you are paying back pre-tax money with after-tax money. To further frustrate you about taking out the loan, when you eventually retire and start withdrawing from your 401(k) you will be taxed again.
So you will end up paying taxes twice. It’s better to not take a loan against your 401(k). Although, if you must, pay it back as soon as you can.
Are Traditional 401(k) Accounts Bad For Your Retirement Dreams?
If your retirement account is in a traditional 401(k), you might want to consider switching to a Roth IRA, according to personal finance guru Suze Orman.
The reason, says Orman, is the idea that you will be withdrawing funds from your 401(k) in retirement when your personal tax rate is lower than it is today is likely not going to be true.
The amount of debt the country is carrying means tax rates in the future are going to be higher than they are today, not lower.
With a traditional 401(k) account, you put your money in “pre-tax” today and let it grow tax-deferred until you start your withdrawals. Those withdrawals will be at whatever the future tax rate is, which Orman says will be higher than today.
With a Roth IRA, you put in “after-tax” money today, but because you already paid taxes, your withdrawals are tax-free.
“The main thing really is this… please, if you have the ability to do a Roth 401(k), 403(b) or TSP, or a Roth IRA, those are the type of retirement accounts you want to be in,” says Orman. “Stay away from the “traditional” ones, that’s what they are called “traditional” IRAs or 401(k)’s, where you get a tax write-off today, but in the long run when you go to take your money out, you’re going to have to pay taxes on it. A Roth, you pay taxes today, and in the long run when you take it out, it’s tax free.”
Orman says the government can see all the money sitting in individual retirement accounts and knows when the tax-deferred accounts will need to take required minimum distributions, the first time the government will get their chance to tax the money.
“Do you really think that tax brackets aren’t going to have to go up 5, 10, 15-years from now in order to pay for all the debt we are carrying? Of course they are going to have to. When you put money in a retirement account, the government knows exactly how much money you have in there. The government knows you have to start taking required minimum distributions out by the time you are 72,” says Orman.
She suggests we just bite the bullet today and fill our accounts with “after-tax” money so we don’t have to worry about rising tax rates in the future.
“So given everybody’s going to get there soon rather than later, I’m telling you, I would rather pay the taxes today when we’re in the lowest tax brackets of a long time still, and let the money grow tax-free versus tax-deferred.”
Financial Advisers Agree
Mark Beaver, a financial adviser at Keeler and Nadler, agrees with Orman’s preference for a Roth IRA over a traditional 401(k).
As per Market Watch, “Orman is right in that these tax rates are a deal right now. ‘The tax code today is about as favorable as it’s ever been and the likelihood of that changing (to be higher) in the future is pretty good … Because of that, we look to add to Roths directly or do things like backdoor Roth contributions or conversions where it makes sense.’”
Monica Dwyer, vice president at Harvest Financial Advisors, warns that the government can also change the rules at any time about how it taxes retirement accounts, so today’s benefits of a Roth IRA could disappear in the future.
“Congress can get pretty creative about where they are going to collect taxes from and there is no guarantee that they won’t someday go after Roths,” she said.
Senator Rand Paul: Pay Off Your Student Loans With Your 401k
Senator Rand Paul says you should pay for your student loans with your 401k. Paul’s new legislative proposal, the HELPER Act (Higher Education Loan Payment and Enhanced Retirement), would allow benefits like tax-free money for college, tax-free employer-sponsored plans, no cap on student loan interest deduction, and many others. Essentially, it would allow students and parents to withdraw retirement funds to settle expenses for college.
The act “would allow Americans to take out up to $5,250 from a 401(k) or IRA tax- and penalty-free each year to pay for college or make monthly student loan payments,” explained CNBC.
According to Forbes, “Paul seeks to reshape the way people save and pay for higher education, driven through tax and savings incentives.” He notes that “the current student loan interest rates can be as high as 7% for graduate students and parent borrowers.” Student loan refinancing rates, on the other hand, have dropped to below 2%.
Paul’s critics will likely note objections such as removing money from a retirement account for any purpose that is not related to retirement may not be a wise financial move; many students cannot both save for retirement and pay off student loans; and the annual amount may not be enough to help borrowers make a meaningful impact.
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