Considering Alternatives to the 401(k)

Boomers who have maxed out on their annual 401(k) contributions have other options to turn to that will help plan for retirement.

Experts contacted by National Underwriter say producers can offer clients a number of financial options for investing excess savings once theyve reached their annual 401(k) contribution and catch-up limits set for 2004. Contributions of up to $13,000 can be made per year. Participants aged 50 or older can make catch-up contributions of $3,000 in 2004. The most common of these vehicles include ROTH and traditional individual retirement accounts (IRAs), plus various types of annuities.

Angelo Robles, president of Northeast Wealth Advisors, Stamford, Conn., says boomers would do well to leverage these products even if they havent reached their 401(k) limits. Yes, he says, they should contribute to their 401(k) up to the maximum percentage that will secure matching corporate dollars. But alternative vehicles should be considered above these amounts because of favorable tax treatment.

“The 401(k) is not the be-all and end-all in terms of planning for retirement,” he says. “[Boomers] should consider having some long-term equity holdings outside of a qualified [401(k)] plan because they actually can get better tax leverage at retirement.”

That would be the case, he adds, for retirees who occupy high tax brackets. Holders of qualified plans, such as a 401(k), 403(b) or rollover IRA, can be expected to pay 28% on withdrawals from these pre-tax investments upon retirement if they occupy the 28% tax bracket. By contrast, holders of after-tax equity investments occupying the same tax bracket would pay just a 15% long-term capital gains rate.

But, says Robles, boomers who qualify should first look to placing after-tax dollars in a ROTH IRA. This vehicle lets clients grow and withdraw retirement money tax free. Funds available for investing in excess of the annual ROTH IRA contribution limit$3,000 currently and $4,000 starting in 2005can turn to other after-tax products, such as variable annuities, that benefit from the 15% long-term capital gains tax.

Even with phase-out IRA income limits of between $150,000-$160,000 for investors married and filing jointly and $95,000-$110,000 if single, a head of a household or married, filing separately and not living with a spouse, some argue that high-income boomers, might want to skip IRAs altogether.

“For the client making $60,000 annually, IRAs are certainly useful tools,” says David Bixler, president of Capital Strategies Inc., Indianapolis. “But for the 5% of income earners who make over $125,000, it probably makes more sense to put their excess savings into a variable annuity, which grows tax-deferred and has no contribution limits.”

Variable annuities offer another advantage over IRAs: the ability to borrow on deposited funds through a policy loan should the need arise. Such an “emergency fund,” adds Bixler, could be especially useful for clients who are “retirement rich but asset poor.”

These people, in other words, may have placed substantial sums in a 401(k) or IRA account. But they have few sizeable liquids assets upon which to draw. The typical “asset poor” individual, says Bixler, has a leased car, is overburdened with consumer debt or home equity loan, and has an employer-sponsored group life insurance policy with no cash value.

In a limited number of hardship situations, withdrawals also can be made from a 401(k) plan. For instance, a financial hardship withdrawal is allowed. However, if a participant is under 59-1/2, there is a 10% early withdrawal penalty, as well as applicable income taxes.

IRA rules also allow penalty-free withdrawals of up to $10,000 for qualified first home expenses and penalty-free withdrawals for qualified higher education expenses.

Asset questions aside, not all experts agree the variable annuity is the right vehicle for excess retirement savings. One reason is the high cost. And, other experts would argue that consumers should first focus on paying down debt.

Boomers can expect to pay sales commissions and management fees on the annuitys actively managed funds. Also, boomers close to retirement might not want to risk eroding their savings with a vehicle that is inherently volatile, its value subject to market swings.

Rick Meigs, president of 401khelpcenter.com LLC of Portland, Ore., advises that boomers purchase a straight or “fixed” annuity. This product, like the fast-fading company pension plan, can deliver a guaranteed monthly income stream well into retirement.

“The fixed annuity is a great substitute for the defined benefit plan,” he says. “Lets face it: The average person has a hard time keeping their hands off a pot of money. They need a guaranteed income as a foundation for retirement.”

Others say, however, that a fixed annuity becomes less appropriate the further the investor is from retirement. Individuals in their 40s and early 50s, because they can reasonably expect to work many years more, should have sufficient time to rebuild their savings following a market downturn. But with a fixed annuity, theyll have no opportunity to ride market gains that can substantially boost funds for retirement.

Boomers neednt invest in a variable annuity, however, to profit from such rises. Melody Juge, founder of the 401kChoice, Los Angeles, Calif., suggests they instead consider an equity indexed annuity fund. Because its value fluctuates automatically with a market index, such as the S&P 500 or Dow Jones industrial average, clients dont pay the fees common to actively managed funds.

Says Juge: “With an equity indexed fund, consumers only pay a flat commission to the insurance company. Its a wonderful product.”


Reproduced from National Underwriter Edition, April 23, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.