This week, I start fielding questions directly from readers. Here's one from a retired automotive industry manager, who wonders what he should do with his 401(k) account.
Question: I retired from Chrysler 18 months ago. As a middle-level manager I have a pension. My 401(k) is managed by Merrill Lynch and has lost approximately 30 percent of its value in the past 11 months. My financial adviser at (a big bank) wants me to empty the 401(k) and distribute it between two accounts: One claims to provide a minimum of 5 percent gain per year, regardless of market movement; the other is similar to a managed 401(k). Not sure what to do, but I believe the market will bounce back eventually. Stay or go?
-- R.K., Clarkston, Mich.
Answer: I would ask some pointed questions before moving this money, R.K.
There can be good reasons for a retiree to move money out of a 401(k) plan into another type of retirement plan, but you first need to understand the implications of what you're doing.
Most importantly, you want to know exactly what you're buying and what these moves are going to cost you, both in the short term and over the long term. Ask the bank adviser what expenses are associated with the accounts being suggested. And make sure you understand how they work before deciding anything.
It sounds to me like that first account suggested by the bank adviser might be a variable annuity featuring some type of guarantee benefit.
The guarantee sounds nice, particularly during times like these, but it can be quite expensive in many cases and, frankly, not worth the cost.
I've seen variable annuities that carry total annual expense ratios well in excess of 3 percent when you include mortality and expense risk charges, administrative fees, the costs of the underlying investment funds and special features like a guaranteed minimum withdrawal benefit.
Fees and Risks
Also, be sure to inquire about surrender charges. Many variable annuities restrict your ability to pull money out if you need it. Typically, if you try to withdraw more than 10 percent of the account balance within the first few years, you will be hit with a surrender charge. This charge might start at 7 percent in the first year and then decline 1 percentage point a year until it reaches zero.
Finally, ask the bank adviser how much he and the bank would earn if you moved a portion of your 401(k) money into this variable annuity. The commission payouts on variable annuities can be lucrative to the seller.
Find out what the total annual expenses are for the plan being offered to you, and then ask yourself whether you want to pay that much for a 5 percent guarantee. Remember, there are five-year CDs out there that pay nearly 5 percent a year at zero cost. Of course, the potential upside is limited with a bank CD.
To learn more about variable annuities, check out an Investor Alert on the topic published by the Financial Regulatory Authority at www.finra.org/investors.
If the combination of guaranteed income and growth potential appeals to you, I'd suggest you look at buying a fixed, immediate annuity now or in the future with a portion of your retirement savings and then keep the rest to invest.
The older you are when you buy an annuity, the bigger the monthly payment will be.
As I wrote a few weeks ago, I'm a big fan of immediate annuities for retirees who do not have a traditional pension. For someone like you with a guaranteed pension, it might not be necessary. Given your Chrysler pension, do you need additional guaranteed income to meet basic living expenses? Or are you better off investing for future growth?
As for the "managed 401(k)" you mentioned the bank adviser is suggesting, I'm not sure what type of account that is. What the adviser might be recommending is a rollover of your 401(k) account to a traditional IRA that he would invest and manage.
That's a common arrangement, but again, I would ask what that service is going to cost you and then compare it to other options. Ask yourself whether this is something you can do yourself or whether you need the help of a professional. There's no right answer to that one; every investor is different. Some need or want the outside help; others don't.
But if the total annual expense to you exceeds 2 percent of the account balance, that's a warning sign.
This work is the opinion of the columnist and in no way reflects the opinion of ABC News.
David McPherson is founder and principal of Four Ponds Financial Planning in Falmouth, Mass. He previously worked as a financial writer and editor for The Providence Journal in Rhode Island. He is a member of the Garrett Planning Network, whose members provide financial advice to clients on an hourly, as-needed basis. Contact McPherson at email@example.com.