Halbert Hargrove Global Advisors, LLC
Relationship Manager & Chair of Wealth Advisory Committee
In his advisory work with clients, Nick’s objective is to deliver an integrated strategy for their wealth. In addition to his investment expertise, Nick says he brings two key strengths to his client relationships. The first is educating them about their investments. “I make an effort to excel at this; it’s extremely important for clients’ peace of mind to understand that we invest with the intention of excelling in good markets and weathering challenging ones.”
Nick is also an excellent listener. “Through listening, I can suggest relevant solutions. I enjoy helping clients work towards goals, solve problems that arise, and uncover risks that they might not have considered.”
As Chair of Halbert Hargrove’s Wealth Advisory Committee, Nick leads the group in exploring financial planning issues that impact clients—and creating responsive solutions. Nick sees his role as “ensuring that we have a diverse set of ideas on the table to make the right decisions.” Nick is based in Halbert Hargrove’s Long Beach headquarters. He was named to his current management role in 2012; he joined the firm in 2005.
Nick holds an MBA from UC Irvine; he earned his B.S. degree in Management Science from University of California, San Diego, where he played college basketball and studied abroad in Florence, Italy. He was awarded the ACCREDITED INVESTMENT FIDUCIARY designation by the University of Pittsburgh-affiliated Center for Fiduciary Studies and is a CERTIFIED FINANCIAL PLANNER.
Nick and his wife Carrie love to travel; being part of close families, they also frequently head to central and northern California for visits. Ever hear of the Calaveras County Frog Jump? His extended family, aka the Gustine Frog Team, has participated in this event for over 50 years. Back home, Nick thinks a good start to the weekend is a morning run or hike in Rancho Palos Verdes.
BS, Management Science, University of California, San Diego
MBA, University of California, Irvine
Nothing contained in this publication is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.
The decision to start collecting Social Security should depend on your employment, tax situation, current expenses, and potential need for more income and survivor benefits if you are married.
Since you are currently working and plan to work until age 70, do you need the extra income to cover your living expenses? If the answer is yes, I would suggest decreasing your 401(k) contribution instead of starting Social Security benefits. You might be taxed heavily on the Social Security benefits you receive. And by electing to receive benefits now, you’d be giving up the 7-8% increase per year on these benefits available to you if you wait to start taking Social Security.
The Social Security Administration (SSA) penalizes recipients who start taking benefits before their full retirement age (age 66) if they make more than $16,920 in 2017 by reducing their Social Security benefit. Taking benefits early should be avoided if you are still working. I have included a link to the Social Security website that describes how the SSA deducts benefits from the earnings of those who haven’t reached full retirement age: https://www.ssa.gov/planners/retire/whileworking2.html.
If you wait to start your Social Security benefits, the monthly amount you ultimately receive will be increased by two factors. You’ll increase your earnings record and your benefit amount will also be subject to an 8% annual increase until you start taking benefits. If you continue to work until age 70, you could increase your benefits amount to approximately $1,874 a month, which would be almost double the amount you’d receive if you started your benefit now. This is a large incentive for you to wait to start receiving benefits.
More information on these calculations is available here on the SSA’s Early or Late Retirement? page: https://www.ssa.gov/oact/quickcalc/early_late.html.
If you are married, the other benefit of waiting until at least full retirement age is that waiting to receive benefits increases the survivor benefit. If you were to die prematurely, your spouse would be able to receive your benefit should your benefit be higher.
Potential drawbacks of waiting until full retirement age or later
The big drawback of waiting to receive benefits? If you die prematurely and are not able to use the funds. The breakeven point of benefitting from postponing benefits to full retirement age is 78 years old (not including the negative tax consequences of receiving benefits now). The breakeven point to postponing receiving benefits to age 70 is age 80, but again this does not include the negative tax consequences of receiving benefits now while you are working. If your health is of question, you might consider delaying receiving benefits for two to three years to increase your benefit amount. But in this case, it’s worth considering starting these benefits before full retirement age so that you can enjoy the funds you have contributed into the Social Security system. Although I would still recommend that you first decrease your retirement plan contributions before starting to receive Social Security benefits.
In summary, when to start taking benefits is a complex decision that should take into account many variables, including your health (life expectancy), income needs, and family situation. I would suggest that if you need extra funds to pay for your living expenses now, you consider decreasing your 401(k) contributions instead of starting to receive Social Security benefits right away. Delaying your benefits will allow your monthly benefit to grow by 8% a year—and you’d avoid having these benefits be subject to income tax before full retirement age. Delaying your benefits would also increase the Survivor benefit if you are married, which would provide a greater safety net for your family.
Mutual funds have become increasingly popular over the last 10-15 years. One powerful reason: the “Tech Bubble” crash during 2000-2002 and the more recent 2008 “Credit Bubble” crash. After losing significant assets during these market downturns, investors saw the need to become more diversified. They experienced how difficult it is to not only pick the right stocks, but to know when to sell them. Over the last 15 years, we have seen many more mutual fund options created. We’ve also seen the average costs of these mutual fund options decrease in terms of management fees.
During the late 1990s, the U.S. stock market was experiencing a strong bull run and investors were doing very well. As seen in the annual market returns shared below, the “Tech” sector—information technology—was booming. Employees working in tech were receiving stock options and avidly watching their net worth climb. Many investors were seemingly oblivious: Tech stocks, they believed, were an easy ticket to raking in high returns. Investors’ big fear was missing out on this opportunity. By contrast, holding a diversified portfolio was frequently viewed as hampering portfolio returns.
Annual Market Returns, S&P 500 vs. IT Sector, 1995 - 1999
1995: S&P 500: 37.20%, Information Technology Sector: 37.20%
1996: S&P 500: 22.68%, Information Technology Sector: 43.30%
1997: S&P 500: 33.10%, Information Technology Sector: 28.10%
1998: S&P 500: 28.34%, Information Technology Sector: 80.50%
1999: S&P 500: 20.89%, Information Technology Sector: 77.47%
Once the Tech Bubble had burst, many employees and investors watched the stocks they owned crash and burn. Many tech companies disappeared—and so did the value of their stock. Once the tech market collapsed, fortunes were lost because investors did not rebalance their portfolios—and they didn’t diversify. They frequently didn’t bank their gains even by selling a portion of the high-performing stocks they owned to diversify their holdings—as they experienced 100% and even 1000% returns in these stocks in the late 1990s.
Here’s the performance for the three years following the collapse of the Tech Sector:
Annual Market Returns, S&P 500 vs. IT Sector, 2000 - 2002
2000: S&P 500: -9.03%, Information Technology Sector: -38.46%
2001: S&P 500: -11.85% Information Technology Sector: -13.70%
2002: S&P 500: -21.97%, Information Technology Sector: -37.60%
A holistic view of risk
At Halbert Hargrove, we focus on mitigating risk in clients’ portfolios. These are the kinds of questions we continually ask with regard to individual holdings:
- If a client holds individual stocks either through a company stock plan or current stock holdings, what is the risk of that stock decreasing significantly?
- How would the client’s retirement plan and other goals be affected if the stock were to decrease significantly?
- What is the sell strategy to start a diversification plan?
A stock’s loss of value can be due to externals like geopolitical events or even simply being in a sector that’s fallen out of favor. Tanks in stock performance can also be placed directly at the door of the company in question: bad management, bankruptcy, fraud, for example. Notable examples of the latter are ENRON, WorldCom, General Motors, Lehman Brothers, and Washington Mutual, to name a few. The point is, clients’ portfolios should never be positioned such that their financial lives are potentially in danger. A clear advantage of diversification: If you own thousands of stocks in your portfolio and one stock experiences a significant loss in performance, the loss experienced by that one stock won’t keep you up at night.
Diversification: Spreading the risk
After the Tech Bubble, diversification became better known as a way to protect investors’ assets by spreading the risk between many different types of asset classes such as U.S. and international stocks and bonds, and REITs. To be truly diversified, an investor’s portfolio should hold a large number of stocks and bonds. This would be very costly for an individual investor to accomplish because of transaction costs; it would also be difficult to do. Purchasing mutual funds for the various stock and bond markets becomes a much better option for most investors: You’re leveraging the buying power of managers that have many millions, if not hundreds of millions of dollars, of investment capital to invest.
Over the last 15 years, we have seen an explosion in the creation of mutual funds that give investors more choices. There are more international mutual funds now available. Mutual fund companies have also launched funds targeted to discrete segments of the market, like company capitalization size (small, mid, and large cap), investment styles like Value and Growth, and sectors of the stock market like Health Care, energy, and information technology. All of these options give investors a vast amount of choices.
Critical to the concept of diversification is the risk protection it provides. If you place all your wealth in just a few stocks, the company you’re investing in can make bad management decisions (ENRON) or the industry can change (think Best Buy vs. Amazon)—and your stock (and your net worth) can go down and possibly never recover. Alternatively, take the example of investing in a mutual fund or ETF that tracks the U.S. Large Stock index, which accounts for the largest 1000 stocks listed in the U.S. stock market. During a recession, a good portion of these stocks will likely decrease in value, along with the value of your fund. But during an economic recovery, they should recover as a whole. Some of the companies will not recover as quickly, but others will recover more quickly and thrive in a new economic environment. As an investor, you know if you invest in a large amount of stocks you will be less likely to suffer extreme circumstances.
One decisive exception to this, of course, was the crash of late 2008. Diversification did not (immediately) help investors: All markets headed south, and the markets were rocky for an extended period of time. However, virtually all of those who remained in the market and followed the discipline of diversification eventually saw their holdings recover.
More funds, greater choices
There’s no question that losing one’s shirt in the markets due to overly concentrated stock positions—or even reading about this repeatedly in the media—can cultivate a heightened appreciation of diversifying options like mutual funds. Both the Tech Bubble (2000-2002) and Credit Bubble (2008) created an awareness of the need to invest in diversified vehicles. As investors poured into mutual funds, mutual funds options broadened.
Today, investors have more choices. This includes costs: As an investor, you can purchase actively managed mutual funds that will cost more than the average fund, or you can purchase a very low-cost option that will mimic a specific index like the S&P 500 or Russell 1000. A direct result of the popularity of mutual funds is more funds, greater choices, and enhanced flexibility for investors to create a portfolio targeted to their future goals that can more successfully manage risk.
You can have both a 401(k) and an IRA and contribute to both accounts during the same year. But each type of account has its own contribution rules and tax advantages—especially when you contribute to both accounts. If you are making 401(k) contributions, you might be better off making contributions to a Roth IRA instead of a traditional IRA. Another option would be to contribute additional savings into an after-tax investment account instead of contributing to an IRA.
Those who make pre-tax contributions into their 401(k)s are able to decrease their taxable income. If you do so, you would also be able to contribute to a traditional IRA (up to $5,500 for those under age 50 and $6,500 for those 50 and over in 2017)—but the IRA contribution would not be tax deductible (I’ve included more information on 401(k) rules / limits below). A secondary contribution to an IRA would be considered an after-tax contribution; you would need to inform your CPA / tax preparer about the contribution to ensure this information is included on your tax return (specifically, in section 8606 on your tax return). If your employer does not provide a 401(k), then you can make an IRA contribution and have it qualify as a pre-tax contribution to decrease your taxable income.
Already contributing to a 401(k)? Consider these alternatives to traditional IRAs
If you are making a 401(k) contribution and receiving a tax deduction for it, I would suggest that you consider either making a Roth IRA contribution (if you qualify) or that you make contributions into an after-tax investment account. A contribution into a Roth IRA is made with after-tax funds, grows tax free and distributions from it are tax free, but income restrictions apply. Roth IRA contributions are a very smart way to save for your retirement if your earnings are below the income restrictions. You can make a full Roth IRA contribution (same rules as IRA) if you make less than $118,000 if you are single and $186,000 if you are married filing jointly. You can make a partial contribution if you make between $118,000–$133,000 if you are single and $186,000–$196,000 if you are married.
An alternative to making an IRA or a Roth IRA contribution is contributing savings into an after-tax investment account. The main reason to invest in this account would be to save for a house, future large purchases, education, or retirement. An after-tax investment account provides a lot of flexibility—and there are no penalties for distributions.
When you change jobs or retire, you can either leave your 401(k) plan in place if you have more than a $5,000 balance, transfer your 401(k) funds to your new company’s 401(k) plan, or rollover your funds into a Rollover IRA. It’s possible to have more than one 401(k) and more than one IRA at the same time, but it is normally easier to have fewer accounts to manage and monitor. Once account holders retire, they would normally rollover their 401(k) into a Rollover IRA so they can manage the account and start taking distributions.
The best options depend on your future goals
In summary—yes, you can have a 401(k) and IRA at the same time and make contributions into a 401(k) plan and an IRA during the same year. But I would suggest other options for your future plans. If your goal is to increase your long-term retirement plan holdings, making a Roth IRA contribution is a better option than making an IRA contribution because of Roth IRAs’ tax-free growth and tax-free distributions after 59.5 years of age.
If your goal is to save for a downpayment on a house, a large purchase, or retirement and you want to maintain flexibility, then saving in an after-tax investment account is the better option.
Limits on contributions into a 401(k)
An eligible employee under 50 years old is able to make a 401(k) contribution of $18,000 in 2017. An employee who will turn 50 in 2017 or is above 50 is able to make a contribution of $24,000. The $6,000 of additional funds that those over 50 are able to contribute is called the “catch-up.” This is designed for those who might have gotten a late start in saving for retirement. Regular contributions into a 401(k) plan are “pre-tax” contributions, which means these contributions decrease your taxable income and thus decrease the income taxes you pay to the federal (and possibly) state government. The funds you have invested in the 401(k) plan can grow tax-deferred.
If your company offers a 401(k) plan, I highly recommend that you make contributions to this account to build your long-term retirement funding. Making consistent contributions over a long period of time into a 401(k) will give you a better chance to succeed in meeting your retirement goals.
IRA contribution rules
If you are younger than 50, you can make an IRA contribution of not more than $5,500 in 2017. At age 50 or older, you can contribute up to $6,500. In both cases, all contributions must come from your taxable compensation for the year. An IRA contribution can be tax deductible if you do not have a retirement plan through your employer or are not eligible to make a contribution through your employer’s retirement plan.
IRS web link: IRA Contribution Limits & Rules
IRS web link: IRA Deduction Limits
The #1 way to retirement success is contributing systematically to your retirement savings through either a 401k plan or a taxable investment account. I would suggest that you increase your 401k contribution rate to 15% to save for retirement—and decrease your overall income taxes. There are also a few steps I would recommend that you take. The first is to determine whether your current growth fund option is worth the fee. You should also explore investing in other U.S. equity funds that could help diversify your portfolio. An additional step you can take is to contact your HR person to request that low-cost options be made available within your employer’s 401k plan.
Research your fund’s performance and fees vs. its peers
First step: I would suggest reviewing all of the funds that are available to you. The 401k platform that you use should have a quarterly investment performance report available to view online. The report should list the investment options by asset class: All of the U.S. equity funds should be listed together, all of the international equity funds should be grouped together, etc.
Next: Compare how each of the U.S. equity funds have performed. You should compare each against its benchmark. I would suggest investing in both U.S. Large Cap and U.S. Small Cap funds, as well as in growth and value funds. Each different category can outperform the others for years at a time. I also like to invest in multiple managers in each category: If one manager underperforms for whatever reason, you could still have several other managers in any given asset class represented in your portfolio that turn in a better performance.
A growth fund with an expense ratio of 1.33 is a little high. Are they “earning” those fees? You can compare the fund with a U.S. growth index to determine if the fund manager is doing better than low-cost alternatives. In researching funds, I like to use Morningstar’s free online website to gather information. You can find out how each fund is invested, along with its performance and fees. In terms of performance, you’ll be able to see how a fund has performed by calendar year. Most performance reports only show performance by the most recent quarter, along with the most recent one-, three-, five- and 10-year periods. A bad performance year from four years ago can distort the five-year performance number, so I prefer to see performance by calendar year against a benchmark to give me a better perspective.
You can google the fund name and then include “Morningstar” after the name; google will provide the Morningstar page for that fund. For example, if I want to review how the Vanguard 500 Index Admiral Share fund has performed, I would type “Vanguard 500 Index Admiral Share fund Morningstar.” The fund is typically listed as the first search result, though that doesn’t happen 100% of the time. You need to look for Morningstar in the web link. After clicking the correct link, I suggest clicking on the performance, portfolio and fee tabs.
Once you do your Morningstar search for the growth fund, you have a decision to make. Do you compare this fund with a measure of the overall stock market like the S&P 500 or Russell 1000, or do you compare it with a Growth index? To become more knowledgeable, I’d suggest using both comparisons. But apples-to-apples is your key metric. Ask any investment advisor: You should compare a growth fund with a growth index.
Explore diversification options
Investing in value, growth and blended funds will help you diversify your portfolio so that, as an investor, you are not relying on just one investment style. You can conduct the same type of Morningstar analysis with retirement target date funds. It’s important to look at the underlying portfolio of a target date fund to see how it is invested in U.S stocks vs. international stocks. Some target date funds are heavily weighted to U.S. stocks; others have a more even distribution between the two asset classes. If you invest in the target date fund, the individual investments within the fund are designed to create a diversified portfolio.
At the outset, I suggested you contact your HR person to request that low-cost investment options be added to your 401k plan. Depending on how the retirement plan is organized and who is involved, this request may not be implemented right away. But you certainly have a strong case to make if the current active, higher-cost funds are underperforming.
In summary, increasing your contribution to 15% is a great move. This will help you on your path to retirement and decrease your taxes. You can research how each of the funds within your investment options perform against one other and against benchmarks. You can gather information about their portfolio compositions. You can determine which funds are managed well—and which merit the fees they charge. Using multiple funds within each category will help you create a well-rounded portfolio.
Having the proper diversity of types of investment and retirement accounts in retirement is very important in achieving the best possible outcome. Getting this right is dependent on your employment, retirement benefits, and when you plan to retire, as well as your goals and spending patterns. In general, I would recommend that investors maintain a balance among their allocations to tax-deferred accounts (401k, 403(b), IRA), their taxable accounts, and a Roth IRA. The objective is to have more flexibility in what accounts you ultimately make your withdrawals from in retirement, given the lower tax rates that taxable brokerage accounts and Roth IRAs are exposed to. Broadly, a balanced retirement savings allocation would be 50% in a Rollover IRA, 40%-50% in a taxable brokerage account and 0-10% in a Roth IRA.
If you’re not familiar with the tax considerations for each type of account, I have included a short description at the end of this article.
Do you own a business? Or do you work for a company and invest in their plan?
Your employment status is a key consideration. If you’re self-employed or own a business, you might need to reinvest most of your profits back into your company early on in your career. Thus, at the outset, you might not be able to contribute to a traditional 401k plan in a steady, consistent way. If this sounds like you, your path to retirement might be different. Your business can create a 401k or other type of retirement plan for you and your employees. If the business has significant profits, different retirement plan options can allow you to contribute more than the normal limit of $18,000 or $24,000 a year—you could work with a financial advisory and retirement plan consultant to tailor a plan for you.
Alternatively, if you’re employed by a company that offers access to a retirement plan such as a 401(k) or 403(b), you should contribute into the retirement plan as soon as you start working. Making contributions over a 30-40 year career will give you the best probability of success. If this is your situation, you could end up with a large percentage of your assets in your 401k plan when you retire because you started early. I highly recommend that employees contribute 10-15% of their monthly pay into a 401k (if available) to build their nest egg and decrease their income taxes as they make more money. When you’re able to max out your 401(k) contribution ($18,000 in 2017 for those under the age of 50; $24,000 for those over 50), I’d suggest that you add further savings into a taxable investment account. There is no limit to these types of contributions—and no distribution limits if you need the funds to buy a house, use it for college before retirement, or for other goals.
Will you receive a pension?
If you’re expecting to receive a pension when you retire, these pension payments will be fully taxable as income. In this case, it would be strategically important to build up your taxable portfolio as you approach retirement—instead of having a significant amount of your funds in a Rollover IRA. That’s because when you take distributions in retirement from a Rollover IRA, these would also be taxable as income. When you sell investments to make withdrawals from a taxable portfolio, these are subject to (typically lower) capital gains taxation. (If you sell a security within a taxable account after holding it for more than one year it will be taxed at the long-term capital gains rate.)
Should you allocate some of your retirement savings to a Roth IRA?
How much should you save in a Roth IRA? It depends. A key factor is the income limits for Roth IRA investors. The limits for Roth IRA contributions in 2017 are $133,000 for singles and $186,000 for married couples who file jointly. Also, not all company 401k plans offer a Roth 401k option. You should keep in mind that you do not receive a tax deduction for making a contribution into a Roth IRA. If you are able to make a contribution into your 401k and contribute to a Roth IRA, that would be ideal, but difficult to do.
If the option is available to you, you can currently contribute $5,500 a year into a Roth IRA, or you can contribute up to the max ($18,000) into a Roth 401k. If you’re able to save early in your career and make Roth IRA contributions and let the funds grow over the course of 30-40 years, this could be a smart financial move. Or, if you have a lot of personal deductions and making a normal 401k contribution does not have the same positive impact as it once did, then switching all or part of your contribution to a Roth 401k contribution could also benefit you.
What are your spending patterns?
Your spending patterns may play an important role in how you allocate your retirement funding. For example, if you like to pay for things like a car “in cash,” or you expect to remodel your home or have extensive retirement bucket-list trips planned in retirement, you may be facing significant financial outlays. In cases like these, you’d want to have a taxable investment account in place to pay for these types of expenses.
For example, if you plan to take a large distribution from an account to pay for a $35,000 car, how can you best decrease your overall tax bill? This of course depends on what securities you sell and how much of a gain you’ve realized for each position. If you were to take the funds from your IRA, the $35,000 will be treated as ordinary income, which means you will have to pay federal and state (since you hail from Illinois) income taxes on that distribution. In this case, the taxes you ultimately pay would be dependent on your tax bracket for that year. But you’d have to take these taxes into account in planning for your purchase—it will definitely cost more than the $35,000 for the car itself.
At what age do you plan to retire?
If you plan to retire before age 59 1/2, it will be wise to have a taxable investment account to pay for your expenses. If you only have IRA funds in place and no other source of income, your IRA distributions taken before you’re 59 1/2 will be taxed at ordinary income rates. Plus, a 10% penalty will be assessed on these distributions. The exception would be if you start a 72(t) distribution plan (you can Google this to determine if it might apply to your situation). Taxable investments do not have an age requirement for distributions and early distributions don’t incur penalties. Thus, they’re valuable if you retire before 59 1/2 and need to bridge the gap between when you start retirement and when you’re not penalized for taking distributions.
In summary, everyone has a different path to retirement. Achieving a balance between tax-deferred and taxable investment accounts will help you meet your unique goals and life situation. Planning for a 50% allocation into a 401k /IRA, 0-10% in your Roth IRA and 40%-50% in your taxable account will require year-by-year planning and adjustments as your life changes, but should help you minimize taxes and maximize your retirement funding. In addition, you should pursue an annual retirement savings goal of 15-20% of your future retirement funding needs to help ensure that you’ll enjoy a comfortable retirement that’s free of worries over funding shortfalls.
Tax impacts: A quick overview of the types of retirement accounts
The reason that diversification of retirement accounts is important is due to the differences between their tax implications:
401(k) / 403(b) / Qualified Retirement plans / IRAs / Rollover IRA – Distributions from these accounts are taxed at ordinary tax rates at the federal and state income tax levels in the year they are taken. Distributions are also subject to ERISA rules. For example, if you take a distribution from your IRA before you’re 59 1/2, you’re required to pay income taxes on the distribution—and to pay a 10% penalty for taking the distribution early.
Roth IRA accounts – Contributions into these accounts are made with after-tax money. There are annual contribution limits and the funds within the accounts grow tax-free and distributions are tax-free. Thus, these accounts can offer significant benefits when you need funds to pay for expenses in retirement but do not want to create a taxable event.
After-Tax Brokerage accounts – Contributions into these accounts are made with after-tax money. There are no limits to the amount of funds you can contribute to these accounts. A taxable event within these accounts is created when income is received from a security you own (stock, mutual fund, bond, etc.) or when a security is sold for a profit. If you held the security for more than one year, you are taxed at long-term capital gain rates, which are lower than income tax rates. This is the main reason to have an after-tax investment account. Distributions from this type of account do not create a taxable event, which is also an advantage. Long-term capital gain rates currently vary from 0% to 15% to 20%, depending on your taxable income level for the year.