Steady Eddies and dividend payers may be too inflated to keep you afloat if the market sinks.
In early fall, you got a reminder of how risky stocks can be. The market sank more than 7% from Sept. 18 to Oct. 15, on fears that the global economic recovery was losing steam. Stocks eventually rebounded, with the S&P 500 and Dow back to setting record highs by early November. Even so, spooked investors did what you’d expect: They pulled $17 billion from equity funds and ETFs from late September to late October, while seeking shelter from the storm in the market’s usual hiding spots.
This flight to safety, which comes on the heels of several similar bouts of anxiety in recent years, has driven up valuations on conservative fare. This includes dividend-paying equities and “low volatility” stocks—you know, boring but stable giants such as Clorox or 3M.
Over the past half-century, low-volatility stocks have traded at about a 25% discount to the broad market, according to the investment firm Research Affiliates. Yet today many of these shares sport higher price/earnings ratios than the S&P 500. The same goes for dividend-paying stocks.
Why is this important? It means the market’s safe havens don’t offer as much protection as you think. Here’s what defensive-minded investors need to know:
If You’ve Been Loading Up On Safe Havens, Stop
It’s easy to see why dividend and low-vol stocks have been popular. Both strategies have beaten the market in downturns—as was the case in this pullback (see chart)—as well as over the long run.
Alas, rising valuations change the calculus. For starters, there’s no guarantee defensive stocks will hold up better in the next slide. In the October 2007–March 2009 bear market, the iShares Dow Jones Select Dividend ETF plunged 61%, vs. 55% for the S&P 500, owing to the fund’s large stake in financial stocks that were pricey at the time. “The higher the valuation, the greater the risk of a steep drop in a bad market,” says Chris Brightman, chief investment officer of Research Affiliates.
Meanwhile, there’s a simple reason why these stocks have traditionally beaten the market: “You’re really buying value investments, since they’re lower-priced stocks,” says Gregg Fisher, head of investment company Gerstein Fisher. Yet you can’t really make the case now that these shares are undervalued and therefore likely to outperform.
Focus on Real Value
If what you’re really seeking is the protection that low-priced stocks can sometimes provide, go with a traditional “value” fund that focuses on shares with cheaper-than-average P/E ratios.
Over the past 15 years, American Century Value has outpaced the S&P 500 by more than three percentage points annually. Yet in months when the market fell, the fund lost only around three-quarters as much, according to Morningstar. Prefer a passively managed option? Vanguard Value Index has also beaten the S&P over the past 15 years while falling less in down months.
And Don’t Forget Bonds
Say you held a 60% stock/40% bond portfolio in 2009 and haven’t reset that mix since. You’re now sitting on a 73/27 portfolio, as stocks have outpaced fixed income. If you’re in your thirties or forties you may not have to worry, as your lengthy time horizon warrants a big stake in equities.
If you’re older and your tolerance for risk has changed, then you may choose to dial back that stock allocation, perhaps even shifting more to high-quality bonds, says Vanguard senior analyst Chris Philips.
Aren’t bonds themselves frothy? Yes. And they grew more expensive in this pullback, as yields on 10-year Treasuries sank from an already low 2.63% to an even lower 2.09% before recovering. But here’s the thing: When bonds lose, they lose a lot less. The worst year for equities was a drop of 43%. For fixed income, it was only an 8% slide.
In fact, bonds made you money in the 2007–’09 bear. And isn’t that the ultimate defense—something that zigs when stocks zag?
Paper Social Security statements are back. Here’s how to use that information to plan smarter.
This fall the Social Security Administration began mailing out benefit statements for the first time since 2011. It’s crucial information, especially if you’re poised to move to your beach condo in Boca soon. “For many upper-middle-class couples, those benefits can be worth as much as $1 million over the course of your retirement,” says Chris Jones, chief investment officer of 401(k) adviser Financial Engines.
To save money, Social Security had been directing people to its website for benefits information. After a backlash, the agency resumed mailings to most workers reaching landmark birthdays—ages 40, 45, and so on. Of course, you don’t need to wait for a paper statement to find out how your benefit stacks up. For an estimate, simply sign up online.
That’s well worth doing if you’re within a few years of retirement. Your future Social Security income is key to determining if your financial strategy is on track. Then take these steps.
Proofread it. Make sure your earnings history is accurate. “If Social Security doesn’t have an earnings record for a particular year, there will be a zero, which may reduce your benefit,” says Boston University economics professor Laurence Kotlikoff, who heads MaximizeMySocialSecurity.com, an online benefits calculator.
Set your target. Your statement will have the income you can expect at three different retirement ages, assuming you keep working at your current salary. But you have far more options for when to start collecting benefits. If you are single, have never married, and don’t plan to work in retirement, your choice will be straightforward most of the time. Your main decision is whether to delay filing, which will boost your benefit by 6% to 8% a year up until the maximum at age 70. Financial Engines and AARP have free online tools that let you compare your annual and lifetime benefits based on the age you claim.
Plot the best strategy. If you’ve ever been married, your choices are more complex. “Your claiming strategy can be the biggest retirement decision you’ll make,” says Jones. Coordinating benefits with your spouse the right way can add as much as $250,000 to your lifetime Social Security income, according to Financial Engines. That’s why you may want to pay for a calculator that allows you to add more variables, such as working in retirement or a wide age gap in your marriage. MaximizeMySocialSecurity.com ($40) and SocialSecuritySolutions.com (starts at $20) both do that.
Get a reality check. Once you have a rough idea of your future benefit, plug that number into a retirement-income calculator, such as the tool at T. Rowe Price. You’ll see if your payouts, plus your portfolio withdrawals, are enough to ensure a comfortable retirement. If not, use the tool to see how saving more or working longer can help, or consult an adviser. Given the dollars at stake, devising a smart Social Security strategy can be well worth a fee.
Badly designed 401(k) plans are a key reason Americans are headed towards a retirement crisis, a new book explains. Here are three moves that can help.
Every week seems to bring a new study with more scary data about the Americans’ looming retirement crisis—and it’s all too easy to tune out. Don’t. As a sobering new book, Falling Short, explains, the crisis is real and getting worse. And if you want to preserve your chances of a comfortable retirement, it’s time to take action.
One of the most critical problems is the flawed 401(k) plan, which is failing workers just as they need more help than ever. “The dream of the 401(k) has not matched the reality,” says co-author Charles Ellis. “It’s turned out to be a bad idea to ask people to become investing experts—most aren’t, and they don’t want to be.”
When it comes to money management, Ellis has plenty of perspective on what works and what doesn’t. Now 77, he wrote the investing classic Winning the Loser’s Game and founded the well-known financial consulting firm Greenwich Associates. His co-authors are Alicia Munnell, a prominent retirement expert who heads the Center for Retirement Research at Boston College, and Andrew Eschtruth, the center’s associate director.
What’s wrong with the 401(k)? For basic behavioral reasons, workers consistently fail to take full advantage of their plans. Most enroll, or are auto-enrolled, at a low initial savings rate, often just 3% of pay— and they stay at that level, since few plans automatically increase workers’ contributions. Many employees borrow money from their plans, or simply cash out when they change jobs, which further erodes their retirement security. Even if investors are up to the task of money management, their 401(k)s may hamper their efforts. Many plans have limited investing menus, few index funds, and all too often saddle workers with high costs.
When you add it up, investor mismanagement, along with 401(k) design and implementation flaws, have cost Americans a big chunk of their retirement savings, according to a recent Center for Retirement Research study. Among working households headed by a 55- to 64-year-old, the median retirement savings—both 401(k)s and IRAs—is just $100,000. By contrast, if 401(k)s worked well, the median amount would have been $373,000, or $273,000 more. As things stand now, half of Americans are at risk of not being able to maintain their standard of living in retirement, according to the center’s research.
Can the 401(k) be fixed? Yes, the authors say, if employers adopt reforms such as auto enrollment, a higher automatic contribution rate, and the use of low-cost index funds. But even those changes won’t end the retirement crisis—after all, only half of private sector workers have an employer-sponsored retirement plan. Moreover, Americans face other economic challenges, including funding Social Security, increased longevity, and rising health care costs.
To address these problems, authors discuss possible policy changes, such as automatic IRAs for small businesses and proposals for a new national retirement plan. Still, major reforms are unlikely to happen soon. Meanwhile, there’s a lot you can do now to improve your odds of a comfortable retirement. The authors highlight these three moves to get you started:
Aim to save 14%: The best way to ensure that you actually save is to make the process automatic. That’s why few people consistently put away money without help from a company retirement plan. If you save 14% of your income each year, starting at age 35, you can expect to retire comfortably at age 67, the authors’ research shows. Start saving at age 25, and put away 12%, and you may be able to retire at 65. If you get a 401(k) matching contribution, that can help your reach your goal.
Choose low-cost index funds. One of the smartest ways to pump up your savings is to lower your investment fees—after all, each dollar you pay in costs reduces your return. Opt for index funds and ETFs, which typically charge just 0.2% or less. By contrast, actively managed stock funds often cost 1.4% or more, and odds are, they will lag their benchmarks.
Adjust your goals to match reality. You 401(k) account isn’t something you can set and forget. Make sure you’re saving enough, and that your investments still match your risk tolerance and goals—a lot can change in your life over two or more decades. The good news is that you can find plenty of free online calculators, both inside and outside your plan, to help you stay on course.
If you’re behind in your savings, consider working a few years longer if you can. By delaying retirement, you give yourself the opportunity to save more, and your portfolio has more time to grow. Just as important, each year that you defer your Social Security claim between the ages of 62 and 70 will boost the size of your benefit by 8% a year. “You get 76% more at age 70 than you will at age 62,” says Ellis. If working till 70 isn’t your idea of an dream retirement, then you have plenty of incentive to save even more now.
You'll likely need some form of long-term care in retirement. Too bad long-term care insurance isn't the right choice for most people.
It’s one of the biggest risks in retirement, and it’s one that hardly anyone is ready to face: long-term care costs. Some 70% of those over 65 end up needing some form of long-term care, which is likely to be costly.
What to do? One commonly recommended option is to purchase long-term care insurance, which would reimburse you for the cost of getting help with daily activities, including in-home health aides and nursing home care. But these policies are pricey, and few people buy them—only 13% of those eligible do so, according to some estimates. It’s a problem that researchers call the long-term care insurance puzzle.
Turns out, it’s not really a puzzle. That’s the conclusion of a new study by Boston College’s Center for Retirement Research, which found that long-term care insurance makes financial sense for far fewer people than originally thought—only about 20% of those eligible vs. earlier estimates of 30% to 40%. “Previous research has overstated the financial risks of going into nursing home care,” says study co-author Anthony Webb, senior research economist at the Center.
Make no mistake, long-term care is dangerously expensive. As a recent study by EBRI found, when you factor in long-term care costs, most lower-income households will run short of money in retirement, and even among middle-class and upper-income families, the odds of running short soar.
But the Center’s analysis, which focused on single individuals, found that the odds of requiring long, expensive stays in a nursing facility are lower than previously thought. By using longitudinal data, the Center found that individuals typically transition through different care stages—from living independently to needing some assistance to nursing home—and, often, back again. That brings down the odds of a long and costly stay in a facility, Webb says. (A typical nursing home costs $212 day or $77,000 a year, according to a recent survey.)
One factor not addressed by the study is that long-term care insurance is becoming a riskier purchase. After discovering that they had underestimated the likelihood that policyholders would file claims, many insurers have raised premiums or stopped selling this coverage altogether. Recently Genworth, one of the leading long-term care insurers, posted steep losses, and some analysts warned that its business outlook is dicey.
For most people it makes more sense to spend down their assets and rely on Medicaid rather than purchase long-term care insurance, the study found.”There’s a Medicaid crowd-out effect,” says Webb. (Many people mistakenly believe Medicare pays long-term care costs, but that program only covers short-term care.) Medicaid will pay for nursing home stays, as well as in-home care, for those with low incomes and few assets. Each state has its own eligibility rules. Most families end up spending down their assets before qualifying for Medicaid coverage.
Even if you never need a long nursing home stay, chances are you’ll need some form of in-home care, and that can be costly too—home health aides charge an average of $20 an hour. Most seniors end up relying on family for most of their at-home care.
What the Center’s study shows most clearly is that better options are needed. Studies have found that more people would be willing to purchase a supplemental policy that would transform Medicaid into a more comprehensive, means-tested insurance. Other experts are pushing for an expanded form of social insurance for long-term care. It’s unlikely, of course, that any major reforms are likely to happen soon.
Meanwhile, your best options is to plan ahead with your family about care—including living in a place that will make it easy to get around, receive services, and see friends. Living a healthy and happy life is one way to help reduce your chances of needing costly care in retirement.
One-time star manager Bill Gross is leaving. The case for choosing an index fund for your bonds has never looked better.
For many bond fund investors, star fixed-income manager Bill Gross’s sudden leap from Pimco to Janus is a moment to rethink. Gross’s flagship mutual fund, Pimco Total Return long seemed like the no-brainer fixed-income choice. Over the past 15 years, Gross had steered Total Return to a 6.2% average annual return, which placed it in the top 12% of its peers. And based on that track record it became the nation’s largest fixed income fund.
But much of that performance was the result of past glory. Over the past five years, Pimco has fallen to the middle of its category, as Gross’s fabled ability to outguess interest rates faded. It ranks in the bottom 20% of its peers over the past year, and its return of 3.9% lags its largest index rival, $100 billion Vanguard Total Bond Market, by 0.5%.
Nervous bond investors have yanked nearly $70 billion out of the fund since May 2013. Those outflows are driven not only because of performance but also because of news stories about Gross’s behavior and personal management style. Still, Pimco Total Return holds a massive $222 billion in assets, down from a peak of $293 billion, and it continues to dominate many 401(k)s and other retirement plans as the core bond holding.
If you’re one of the investors hanging on to Pimco Total Return, you’re probably wondering, should I sell? Look, there’s no rush. Your portfolio isn’t in any immediate trouble: Pimco has a lot of other smart fixed-income managers who will step in. And even if you can’t expect above-average gains in the future, the fund will likely do okay. The bigger issue is whether you should hold any actively managed bond fund as your core holding.
The simple truth is most actively managed funds fail to beat their benchmarks over long periods. Gross’s impressive record was an outlier, which is precisely why he got so much attention. That’s why MONEY believes you are best off choosing low-cost index funds for your core portfolio. With bond funds, the case for indexing is especially compelling, since your potential returns are lower than for stocks, and the higher fees you pay to have a human guiding your fund can easily erode your gains.
Our MONEY 50 list of recommended funds and ETFs includes Harbor Bond, which mimics Pimco Total Return, as an option for those who want to customize their core portfolio with an actively managed fund. When issues about Pimco Total Return first began to surface, we recommended hanging on. But with Gross now out of the picture, we are looking for the right replacement.
If you do choose to sell, be sure to weigh the potential tax implications of the trade. Here are three bond index funds to consider:
*Vanguard Total Bond Market Index, with a 0.20% expense ratio, which is our Money 50 recommendation for your core portfolio.
*Fidelity Spartan U.S. Bond, which charges 0.22%
*Schwab Total Bond Market, which charges 0.29%
All three funds hold well-diversified portfolios that track large swaths of the bond market, including government and high-quality corporate issues. Which one you pick will probably depend on what’s available in your 401(k) plan or your brokerage platform. In the long-run, you’re likely to get returns that beat most actively managed bond funds—and without any star manager drama.
Yes, you need a cash reserve in retirement, but you can go overboard in the name of safety. Here's how to strike the right balance.
As you close in on retirement, it’s crucial to minimize the risk of big losses in your portfolio. Given how expensive traditional safe havens, such as blue chips and high-quality bonds, have become, that’s tricky to do today. So for many pre-retirees, the go-to solution is more cash.
How much cash is enough? Many savers seem to believe that today’s high market valuations call for a huge stash—the average investor has 36% in cash, up from 26% in 2012, according to a recent study by State Street. The percentage is even higher for Baby Boomers (41%), who are approaching retirement—or already there.
That may be too much of a good thing. Granted, as you start to withdraw money from your retirement savings, having cash on hand is essential. But if you’re counting on your portfolio to support you over two or more decades, it will need to grow. Stashing nearly half in a zero-returning investment won’t get you to your goals.
To strike the right balance between safety and growth, focus on your actual retirement needs, not market conditions. Here’s how.
Safeguard your income. If you have a pension or annuity that, along with Social Security, covers your essential expenses, you probably don’t need a large cash stake. What you need to protect is money you’re counting on for income. Calculate your annual withdrawals and aim to keep two to three years’ worth split between cash and short-term bonds, says Marc Freedman, a financial planner in Peabody, Mass. That lets you ride out market downturns without having to sell stocks, giving your investments time to recover.
This strategy is especially crucial early on. As a study by T. Rowe Price found, those who retired between 2000 and 2010—a decade that saw two bear markets—would have had to reduce their withdrawals by 25% for three years after each drop to maintain their odds of retirement success.
Budget for unknowns. You may be able to anticipate some extra costs, such as replacing an aging car. Other bills may be totally unexpected—say, your adult child moves back in. “People tend to forget to build in a reserve for unplanned costs,” says Henry Hebeler, head of AnalyzeNow.com, a retirement-planning website.
In addition to a two- to three-year spending account, keep a rainy-day fund with three to six months of cash. Or prepare to cut your budget by 10% if you have to.
Shift gradually. “For pre-retirees, the question is not just how much in cash, but how to get there,” says Minneapolis financial planner Jonathan Guyton. Don’t suddenly sell stocks in year one of retirement. Instead, five to 10 years out, invest new savings in cash and other fixed-income assets to build your reserves, Guyton says. Then keep a healthy allocation in stocks—that’s your best shot at earning the returns you’ll need, and you can replenish your cash account from those gains.
A group of Vanguard enthusiasts offers sound financial advice to other ordinary investors. Here are three tips from one of their founders.
Wouldn’t be great to get advice on managing your money from a knowledgeable friend—one who isn’t trying to rake in a commission or push a bad investment?
That’s what the Bogleheads are all about. These ordinary investors, who follow the teachings of Vanguard founder Jack Bogle, offer guidance, encouragement and investing opinions at their website, Bogleheads.org. The group started back in 1998 as the Vanguard Diehards discussion board at Morningstar.com. As interest grew, the Bogleheads split off and launched an independent website. Today the Bogleheads have nearly 40,000 registered members, but millions more check into the site each month. (You don’t have to be member to read the posts but you must register to comment—it’s free.)
As you would expect given their name, the Bogleheads favor the investing principles advocated by Bogle and the Vanguard fund family: low costs, indexing (mostly), and buy-and-hold investing—though the members disagree on many details. The Bogleheads are led by a core group of active members, who have also published books, helped establish local chapters around the country, and put together an annual conference. Their ranks of regular commenters include respected financial pros such as Rick Ferri, Larry Swedroe, William Bernstein, Wade Pfau, and Michael Piper.
For investors who prefer their advice in a handy, non-virtual format, a new edition of “The Bogleheads’ Guide to Investing,” a best-seller originally published in 2006, is coming out this week. Below, Mel Lindauer, who co-wrote the book with fellow Bogleheads Taylor Larimore and Michael LeBoeuf, shares three of the most important moves that retirement investors need to make.
Choose the right risk level. Figuring out which asset allocation you can live with over the long term is essential—and that means knowing how much you can comfortably invest in stocks. Consider the 37% plunge in the stock market in 2008 during the financial crisis. Did you hold on your stock funds or sell? If you panicked, you should probably keep a smaller allocation to equities. Whatever your risk tolerance, it helps to tune out the market noise and stay focused on the long term. “That’s one of the main advantages of being a Boglehead—we remind people to stay the course,” says Lindauer.
Keep it simple with a target-date fund. These portfolios give you an asset mix that shifts to become more conservative as you near retirement. Some investing pros argue that a one-size-fits-all approaches has drawbacks, but Lindauer sees it differently, saying “These funds are an ideal way for investors to get a good asset mix in one fund.” He also likes the simplicity—having to track fewer funds makes it easier to monitor your portfolio and stay on track to your goals.
Another advantage of target-dates is that holding a diversified portfolio of stocks and bonds masks the ups and downs of the market. “If the stock market falls more than 10%, your fund may only fall 5%, which won’t make you panic and sell,” says Lindauer. But before you opt for a fund, check under hood and be sure the asset mix is geared to your risk level—not all target-date funds invest in the same way, with some holding more aggressive or more conservative asset mixes. If the fund with your retirement date doesn’t suit your taste for risk, choose one with a different retirement date.
Don’t overlook inflation protection. Given the low rates that investors have experienced for the past five years—the CPI is still hovering around 2%—inflation may seem remote right now. But rising prices remain one of the biggest threats to retirement investors, Lindauer points out. If you start out with a $1,000, and inflation averages 3% over the next 30 years, you would need $2,427 to buy the same basket of goods and services you could buy today.
That’s why Lindauer recommends that pre-retirees keep a stake in inflation-protected bonds, such as TIPs (Treasury Inflation-Protected Securities) and I Bonds, which provide a rate of return that tracks the CPI. Given that inflation is low, so are recent returns on these bonds. Still, I Bonds “are the best of a bad lot,” Lindauer says. Recently these bonds paid 1.94%, which beats the average 0.90% yield on one-year CDs. If rates rise, after one year you can redeem the I Bond; you’ll lose three months of interest, but you can then buy a higher-yielding bond, Lindauer notes. Consider them insurance against future spikes in inflation.
The suicide of comedian Robin Williams shows how tough it can be to overcome mental illness. The good news is that mental health care coverage is now more widely available, thanks to recent insurance rule changes.
The apparent suicide of comedian Robin Williams, who had reportedly suffered from depression, shows how tough it can be to overcome mental illness. His struggles are shared by millions of Americans—some one in four adults in a given year.
The good news is that mental health care coverage is now more widely available and at least somewhat more affordable, thanks to recent changes in federal law. And there’s reason to believe these rules can have an impact on suicide rates: Ken Duckworth, medical director of the National Alliance on Mental Illness, told USA Today that about 90% of people who commit suicide suffer from an untreated or under treated mental illness.
Here’s what you need to know:
1. If your health insurance covers mental illness, your benefits must be comparable to medical coverage.
If you’re covered under an employer health plan that offers mental health benefits—and some 85% of company plans do, according to the Society for Human Resource Management—you’re now entitled to coverage that is on par with coverage for physical illnesses. That’s the result of the Mental Health Parity and Addiction Equity Act of 2008—the final provisions of which just went into effect. (The parity act mainly addresses larger company plans.) Yet according to a study earlier this year by the American Psychological Association, more than 90% of Americans are unfamiliar with their rights under this law.
The mandate is even stronger for individuals buying coverage through the health insurance exchanges created under Obamacare. The Affordable Care Act included mental health care as one of 10 essential benefits that must be covered, expanding the parity rules to plans bought in the state exchanges.
“The parity act is a landmark law that creates a level playing field in insurance,” says Ron Honberg, national policy director for the National Alliance on Mental Illness.
2. Mental health care must have the same coverage limits as other medical care.
Before to the new rules kicked in, you would typically have had to get prior authorization for mental health or substance abuse treatment. And you would also have to cope with yearly limits and lifetime limits on treatments that were lower than for medical benefits.
“Now mental health care treatment rules have to be on par with medical care,” says Debbie Plotnick, senior director of state policy for Mental Health America.
That means you cannot be denied coverage for therapy visits or a stay in a treatment center, unless your plan also restricts coverage for comparable medical conditions. And you cannot be charged higher co-pays or co-insurance than you are for most medical and surgical services.
That doesn’t guarantee you’ll find treatment affordable. The sticking point for many people seeking counseling is that their provider may not be in their health plan’s network—far fewer mental health providers are part of an insurance network than other types of healthcare providers. If you’re in a plan that covers out-of-network treatment, you’ll still be reimbursed, albeit at lower rates than for in-network treatment. Note, though, that the entire bill may not be eligible since many providers charge more than insurers deem “reasonable and customary.”
3. Your insurance plan needs to disclose the medical criteria for denial of mental health care.
If you are denied reimbursement or coverage for mental health treatment, you will be entitled to the same appeal procedures as for medical care. The plan cannot simply refuse coverage without providing a detailed explanation that shows why the treatment is not deemed necessary, says Plotnick.
Over the past couple of years, many employer plans have already improved coverage of mental health. And there are early indications that more people are benefiting, particularly young adults who have remained on their parents’ health plans. (Adolescence and young adulthood is often when severe mental illness is diagnosed.) A recent study published in Health Affairs found that among people ages 19 to 25 receiving mental health treatment, uninsured visits declined by 12.4 percentage points, and visits paid by private insurance increased by 12.9 percentage points.
The new rules don’t cover everyone. Small plans may not be governed by these rules (depending on state laws). If you don’t have a large employer plan or one purchased on the exchanges, and if you don’t qualify for Medicaid, you may have to scramble. In many regions, and for many specialities, it may also be difficult to find a psychiatrist or therapist who takes your insurance. And if you go out of network, you will only be reimbursed for “reasonable and customary” costs that don’t cover your actual bills.
Still, for those suffering from mental illness, these new rules are major step forward. One more reason to, as late night talk show Jimmy Kimmel noted at the end of his Twitter tribute to Robin Williams: “If you’re sad, tell someone.”
Roth 401(k)s are showing up in more workplaces, but only about 10% of eligible workers saved in one last year. That's a big mistake.
Since they were launched in 2006, Roth 401(k)s have been typecast as the ideal plan for millennials. Paying taxes on your contributions in exchange for tax-free withdrawals, the reasoning goes, is best when your tax rate is lower than it’s likely to be in retirement. It turns out Roth 401(k)s may be the better option for Gen Xers and baby boomers too.
That’s the conclusion of a recent study by T. Rowe Price, which found that Roth 401(k)s leave just about all workers, regardless of age or tax bracket, with more money to spend in retirement than pretax plans do. “The Roth 401(k) should be considered the default investment,” says T. Rowe Price senior financial planner Stuart Ritter.
Yet few workers of any age invest in Roth 401(k)s, which let you set aside $17,500 in after-tax money this year ($23,000 if you’re 50 or older), no matter your income. Just as with a Roth IRA, withdrawals are tax-free, as long as the money has been invested for five years and you are at least 59½. Some 50% of employers now offer a Roth 401(k), up from just 11% in 2007, according to benefits consultant Aon Hewitt. But only 11% of workers with access to a Roth 401(k) saved in one last year. Big mistake. Here’s why:
Higher income. Every dollar you save in a Roth 401(k) is worth more than a dollar you put in a pretax account. That’s because you’ll eventually pay income taxes on those pretax dollars, while you get to keep every penny in a Roth. Granted, you get an upfront tax break by saving in a traditional 401(k), and you can invest that savings. Even so, a Roth almost always overcomes that headstart, the T. Rowe Price study found.
The fund company’s analysis looked at savers of different ages and tax brackets, both before and after retirement. As the graphic shows, a Roth 401(k) pays more even if you face a lower tax rate in retirement than you did during your career. The only group that would do significantly better with a pretax plan: investors 55 and older whose tax rate falls by 10 percentage points or more, which would mean up to 6% less income.
Greater flexibility. With a tax-free account, you can avoid required minimum withdrawals after age 70½ (as long as you roll over your Roth 401(k) to a Roth IRA). You can also pull out a large sum in an emergency, such as sudden medical bills, without fear of rising into a higher tax bracket.
Tax diversification. Having tax-free income can keep you from hitting costly cutoffs. For every dollar of income above upper levels, 50¢ or 85¢ of your Social Security benefits may be taxable. “Many retirees in the 15% bracket actually have a marginal tax rate of 22% or 27% when Social Security taxes are added in,” says CPA Michael Piper of ObliviousInvestor.com. And if you retire before you’re eligible for Medicare and buy your own health insurance, a lower taxable income makes it more likely you’ll qualify for a government subsidy. In short, when it comes to retirement, tax-free money is a valuable tool.