401ks are still preferred

by Tim Kenyon

CORRIDOR – 401k accounts remain a good choice for most retirement plans, two Corridor experts believe.

Professors John Spitzer and Rob Rittenhouse recommend employees use a patient approach toward their investments, particularly 401k accounts.

“I’m a stay-the-course person. My reasoning goes like this: for most of us we will need investment income for retirement income as Social Security wasn’t designed to meet all of our retirement needs and pension plans have dwindled to where we have just a few of those,” said Mr. Spitzer, a finance expert at the University of Iowa Tippie College of Business.

Additionally, many employers match 401k contributions, although some have reduced the match because of economic challenges, he said.

“Even at a reduced level, that’s still basically free money,” he said.

“I don’t think there is a better alternative for employees,” said Mr. Rittenhouse, an associate business professor at Mount Mercy College in Cedar Rapids.

Another advantage is that traditional 401k earnings are tax deferred until they are withdrawn, Mr. Rittenhouse said.

“That can make a huge impact become even greater if you have more time for retirement,” Mr. Spitzer said.

Most plans give employees several investment options to choose from, including bond and stock mutual funds and other possible selections, Mr. Rittenhouse said.

Convenience is another advantage to 401k funds. Contributions are deducted directly from the employee’s paycheck, saving the person time.

“As for trends with investors, there has been a trend of more money going into bond mutual funds and overseas stock mutual funds as opposed to domestic stock mutual funds,” Mr. Rittenhouse said. “However, domestic stocks are up nearly 60 percent since bottoming out last March, so those that have stayed the course with domestic stock investments have recouped a great deal of their earlier losses.”

He said 401k drawbacks include:

— A 10 percent tax penalty in addition to normal income taxes on any early taxable distributions (generally distributions before age 59 1/2 with few exceptions)  

— If the money is needed early, there must be a triggering event to distribute it to the investor (such as first-time homebuyer, qualified domestic relations order in a divorce and financial hardship are a few examples).

— All taxable income withdrawn is taxed at ordinary rates rather than the more favorable long-term capital gains rate and qualified dividend rate, which is a maximum of 15 percent under tax law.

Contribution limits are much higher than on IRAs. Employee contributions are limited to $16,500 for people under age 50 and $22,000 for those 50 and over.

If the person is maxed out on contributions and looking for other options, Mr. Rittenhouse suggested a Roth IRA is a good option.

Once maxed out on both, an individual looking for a tax-advantaged investment for retirement purposes can invest in annuities. As for small employers, it may be advantageous to administer a Simplified Employee Pension plan or a Simple IRA instead of a 401k, he said.

Iowans seeking investments for children’s college (post-secondary education) costs have a good option in the state’s 529 plan administered by Vanguard, Mr. Spitzer said.  

Contributions can be up to $13,000 per beneficiary per year or a $65,000 lump sum. Up to $2,800 can be deductible for each spouse’s income involved in the 529 contribution.

Other benefits include a low minimum investment of $25, no commission or annual fees, gift and estate tax benefits and no loss of control over assets.

Waiting pays
In summary, Mr. Spitzer stressed that waiting provides the advantage of smoothing out ups and downs over time whereas constantly changing stock picks can be more difficult to pay off.

“For stocks you need time. I like 10 years better because in a period of a few years, the stock market can really hammer you,” he said.

“Total index markets” are increasingly used, he said.

Investing gurus often recommend the Wilshire 5,000 or the Russell 3,000, he said.

The Wilshire 5,000 Total Market Index represents the broadest index for the U.S. equity market, measuring the performance of U.S. equity securities with instant price information.

The Russell 3,000 Index measures the performance of the largest 3,000 U.S. companies representing about 98 percent of the U.S. equity market.

That index is compiled to provide a comprehensive, unbiased and stable barometer of the broad market and is remade annually to ensure new and growing equities are considered.

The investment sector of the economy appears shaped enough for a positive move up, Mr. Spitzer said.

“I’ll go along with the crowd on that one. I am cautiously optimistic, too, that it’s looking better,” he said.