Dear Successful Middle Manager: You Didn't Get the Memo? You're Part of the Super-Wealthy...

It's rant time at the Capitalist.  Let's focus on the story of Janet and Mike.

Janet and Mike are two middle managers in corporate America.  Janet and Mike did all the right things  from a career standpoint and now are in their late 30's.  One's white and one's not, so in addition to gender diversity, they're diverse in other ways as well. 

Both Janet and Mike did what they were supposed to do in America.  They went to college, graduated with good grades and got their first job.  Then, they did something they didn't have to do.  They outworked every other person who was their peer.  Just simply outworked them.  They sacrificed weekends, late nights after the kids were in bed, you name it.  Did it with a smile on their face, because they believed that was how you got ahead in America. 

Only after the work was performed and their merit proven did Janet and Mike get the rewards.  They got promoted and they got more money.  Their hours increased as well, but that was OK because they were taking care of their families.

After the promotions came, Janet and Mike made an interesting choice.  They chose not to expand their lifestyle, meaning they had more ability to save.  The first place they looked to maximize their savings rate? The tool that had been widely recommended to the bread and butter of any American's savings plan - the 401K.  Both Janet and Mike maxed their contribution rates to their 401k, making the most of the opportunity to minimize their taxable income and increase their savings rate as a percentage of income.

Then, they got the news.  The Fortune 500 they work for had failed its 401k testing, meaning that complex tests showed that the company's highly compensated employees took greater advantage of the company 401k than did the average employees.   Only the highly-compensated classification wasn't reserved for the C-level folks.  Janet and Mike were included in that.  They both make 110K.  They're classified as highly compensated even though they don't have a bonus plan and live in a market with an expensive cost of living.

Janet and Mike looked around for other options, only to find there were no tax-favorable options for them to turn to in order to save for retirement.  The Roth IRA (post tax money, but growth of the Roth account is tax free upon withdrawal) wasn't an option since both of their spouses also work and as a result, they don't qualify (made too much as joint filers).

Janet and Mike did all the right things to earn and provide and purposefully didn't fill their lives with empty spending when the promotions came as a result.  Unfortunately, it doesn't matter.  Regardless of merit, sacrifice, relative cost of living and simply outperforming their peer group, Janet and Mike aren't allowed the same opportunity to save for retirement in a tax-favored fashion as the rest of society because the company failed its 401k testing.

Middle managers who have outworked everyone else - didn't you get the memo?  You're part of the super-wealthy.  Thanks for your efforts.

(written by an anonymous HR professional who resents telling the Janet and Mike's of the world they don't have the savings opportunity as other employees).

See this link for Background...

Hey Macho (wo)Man - You Might Want to Reconsider Having Your 401K Allocated to Cash...

Here's some advice that will have you giving the "bird" to your computer screen when the past year has witnessed your 401k value chopped by 40%...

"Buy Low, Sell High". 

Giving the screen the "we're number one" salute yet?  It's a cliche', but it's true.  It's human nature to avoid things that are painful, especially shortly after you have experienced the pain - things like being invested in stocks when the market took the elevator down from 14,000 to 8,000 in one year.

I'm not an investment advisor, but take a look at the chart to the right (hat tip to Brett Billock).  It outlines the worst U.S. market declines in history, then illustrates how much the market recovers in 1, 3 and 5 years respectively.

Average rebound of the market one year after the end of a recession?  55.6%.

I know, I know.  The fundamentals are REALLY screwed up this time, and this time is different.  I hear you...

I wonder if they thought the same thing back in 1930?  You know the time, when they were taking the pictures of the dudes in suits standing in front of the soup kitchens?

Repeat - I'm not an investment advisor, and times sure suck.  Still, this chart would seem to be prime fodder for investors everywhere, including 401k participants. 

Buy Low!!

Employee Generated Videos - If You Want to Make a Hit, You've Got to Make it Quick...

We've been experimenting a good bit on our company-based social network (affectionately named "Sourceapolooza") and I'm becoming increasingly convinced that the killer app for any internal social network is video.  After all, YouTube rocks the casbah, and it's what people now expect/want in any web offering.

The only thing better than video on your internal flavor of Facebook?  EMPLOYEE generated videos.  When employees care enough to create their own videos, in my eyes that's pretty much the definition of engagement. 

Which is why the recent 401k contest sponsored by Best Buy is such a great idea.  More on the contest at BestBuy via HR Marketer:

"Last week one of our team members attended a Webinar about the power of Web 2.0 in talent management. One of the highlights was how Best Buy increased their 401k participation by 30%.

30%? How the heck did they do that?  With a contest. A video contest. They asked employees throughout the retail chain to submit motivating videos that would help increase overall 401k participation. They did just that and the winner is below."

You have to admit, that's pretty sweet, and if you're not the type of HR pro who has their wheels spinning as a result, then... well, you probably need to take a break and find your motivation or consider another career.

If I had to split hairs on the video, I'd say it's too long - if you want people to watch the whole thing, you have to bring a length no longer than a movie trailer - 2:30 tops. 

Still, that's mindless quibbling vs. the impact of employees caring enough to cut a video like this.  What can you do early in 2009 to give control to employees and empower them to get creative on video?

Signs of a Downturn (Google Perks Cutbacks), Signs of a Recession (Google Hiring Freeze)

So, the economy stinks.  That's pretty much a given, and most of us have stopped watching CNBC during the day and stopped opening our 401k statements.  It's like 1929, 1987 and 2000 all rolled into one, with the Dow falling from 14,000 to 8,000 in a year. 

Me?  I've got my own leading economic indicators, and they've got nothing to do with the "Money Quotes from Alan Greenspan" tear-away daily calendar on my desk.

I don't need Greenspan to figure this thing out.  Here's my leading economic indicator:

1.  We're officially in a slowdown when Google starts cutting perks.

2.  We're officially in a recession when Google does a hiring freeze.

3.  We might be in a depression if and when Google does layoffs.

Here's the rundown....

1.  It's definitely a slowdown. From the New York Post:

"Google is going on a diet when it comes to spending on a smorgasbord of food perks for employees living high on the hog in its New York office.  The online search giant issued a memo to its Big Apple workforce earlier this week noting slimmed-down cafeteria hours and food selection as part of an effort "to find areas where efficiency can be improved."

The advertising business is expected to be hit hard by the ongoing credit crunch and Google CEO Eric Schmidt said earlier this month that the company would be operating more carefully as ad budgets come under pressure.

Gone are exotic treats like afternoon tea on Tuesdays, which has been suspended indefinitely. However, the company said there still may be "occasional surprise 'snack attacks' in the future" - similar to what employees get in Google's Mountain View, Calif. offices."

2.  I lied before.  I'm still watching CNBC, and it's officially a recession. From CNBC's David Faber:

"Google, one of the nation's great growth engines for employment, has essentially stopped hiring for the last month, according to several executives at the company.

A spokesperson at the company says there has been no freeze on hiring, but several executives I have spoken with who have hiring responsibility said it was made clear to them one month ago they were to make no new hires, including at the secretarial level and they were

directed to fill all vacancies with internal candidates. In effect, they term it an unofficial hiring freeze.

The good news?  Nothing to report on the depression!  No layoffs at Google, at least yet.  If that happens, it trims 1,000 points off the Dow by itself.....

I know - I'm a ray of sunshine...

Is Congress Getting Ready to Eliminate the Tax Benefit of the 401(k)?

So, Washington is pretty much a Democratic town these days.  The name of this site is the  CAPITALIST, so you can probably guess that I'm leery of too much government in anything in my life.  Still, I'm willing to be open minded about most things and give ideas a chance.

But, history has a way of showing that whenever the Democrats or the Republicans hold both houses and the White House, over-reaching the mandate given by the people is usually right around the corner.

For example, would you believe that eliminating the 401k Tax Benefit for employees is under consideration in the newly blue Washington?

From the Philadelphia Bulletin:

"Congressional Democrats might enact legislation taxing 401(k) plans if they obtain a supermajority in Congress after the next election. They have shown an interest in revamping the current system and in eliminating the current tax exclusion from contributions.

During the past two weeks, U.S. Rep. George Miller, D-Calif., chairman of the House Education and Labor Committee and U.S. Rep. Jim McDermott, D-Wash., chairman of the House Ways and Means Committee's Subcommittee on Income Security and Family Support have entertained proposals that would tax 401(k) plans.

Both held hearings laying the groundwork for future legislation that could eliminate most of the $80 billion in annual tax breaks that investors receive by placing their money in the $3 trillion 401(k) system. The plan, which may serve as a model for this change, is by Prof. Teresa Ghilarducci, professor of economic-policy analysis at the New School for Social Research in New York. It is similar in ways to some European systems.

"Actually there are two plans, said Prof. Ghilarducci, "a short-term one and a long-term one. As part of the bailout, I would include a provision for individuals to be able to swap their 401(k)s at its August 2008 value for special issue government bonds paying 3 percent plus inflation."  Her long-term plan is to rethink the concept of 401(k)s and eliminate the tax deductibility of contributions to them. For example, she said, a person making $40,000 per year who contributes 5 percent of their income to a 401(k) currently receives a tax savings of $560.

For a person making $60,000, who contributes 5 percent of their income to a 401(k), they would have a tax savings of $900. She is proposing that the tax subsidy is eliminated completely. In its place everyone gets a $600 federal income tax credit. This would benefit those who make less.

But in the case of the aforementioned example, while people making $40,000 a year would see a net gain; people earning $60,000 per year would experience a net loss.  A tax increase by Democrats on those making $60,000 per year would not be in line with the  presidential nominee U.S. Sen. Barack Obama's pledge to only increase taxes on those making $250,000 per year."

Wow.  There are two things beyond increasing Federal payroll taxes on normal people that the Democrats could do to ensure Republicans take back seats in Congress in 2010 and 2012.  One is to eliminate or limit the tax benefit for interest payments on mortgages.  The other is workplace related, and that's to eliminate the tax benefit of the 401(k). 

The definition of over-reaching.  Surely that wouldn't happen, would it?  Wow.

Impact of Mutual Fund Fees in Your 401k to Employees....

Think the fees charged by the mutual funds in your 401k don't matter?  Think again.  Fees always matter, as evidenced by the following chart provided by Alliance Bernstein via the Retirement Plan Blog.  The skinny of the chart?  Lower fees by 1% (which increases return by 1%) translates into about $220,000 extra at retirement—and an extra 10 years of spending.

Curious about the methodology to arrive at the findings?  Here's the breakdown of the AB chart courtesy of the Retirement Plan Blog:

"For the mathematically inclined, following is the methodology Alliance Bernstein used to develop their chart:

Results are simulated. This is a hypothetical illustration only and its results are not indicative of any specific investment, including any AllianceBernstein mutual fund. The savings phase simulates a defined contribution participant salary of $45,000 at age 25, linearly increasing to $85,000 by age 65, making yearly contributions of 6% of salary at age 25 increasing by 0.5% per year to a maximum 10% with a 50% company matching contribution up to the first 6% of salary. In the spending phase, $63,750 (75% of final salary) is deducted at the beginning of each year. A yearly investment return of 9% is assumed at age 25, linearly decreasing to 6% at age 80 and remaining constant thereafter. In the “1% Greater Return Scenario” a yearly investment return of 10% is assumed at age 25, linearly decreasing to 7% at age 85 and remaining constant thereafter. Inflation is assumed to be a constant 3% and dollar values are expressed in real purchasing power terms."

So buck up and make sure your 401k fund selection includes some low-fee funds.  For me, fiduciary responsibility can be summed up in 2 words:  Index Funds, which typically feature low fees with returns beating 70-75% of actively managed funds. 

The Tony Soprano 401k Loan....

I saw a defaulted 401k loan from earlier this century (sounds cool to say that) and thought Paulie Walnuts was going to walk around the corner and start asking me for the weekly payment for "protection"...

More on that after the jump.  For now, let's review your role as a HR pro regarding 401k Loans.

Where's your head as a HR pro on the wisdom of 401k loans?  Do you talk to employees who are asking about the procedure about the downside of the 401k loan, or do you zip it and consider it none of  your business?    How does your responsibility as a fiduciary come into play?  Does that responsibility mean you speak up or shut up?

As with all things in life, balance is probably the best approach.  For some employees, taking out a loan against their 401k may be the only source of cash they have in an emergency.  That's hard to argue with.  Employees looking to finance the second waverunner may need a financial consultant. 

Here's your checklist of talking points if you want to advise a member of your tribe of the downside of a 401k loan, provided by the 401khelpcenter:

1. There are "opportunity" costs. According to the U.S. General Accounting Office, the interest rate paid on a plan loan is often less than the rate the plan funds would have otherwise earned.
2. Smaller contributions. Because you now have a loan payment, you may be tempted to reduce the amount you are contributing to the plan and thus reduce your long-term retirement account balance.
3. Loan defaults can be harmful to your financial health. If you quit working or change employers, the loan must be paid back right away. It's not uncommon for plans to require full repayment of a loan within 60 days of termination of employment. If you can't repay the loan, it is considered defaulted, and you will be taxed on the outstanding balance, including an early withdrawal penalty if you are not at least age 59 ½.
4. There may be fees involved.
5. Interest on the loan is not tax deductible, even if you borrow to purchase your primary home.
6. You have no flexibility in changing the payment terms of your loan.

That's a pretty strong list, especially the one saying that if an employee leaves the company, they must payback the loan in the short term.  If an employee is taking out a loan from the 401k in the first place, they probably don't have the means to do that, which likely means default.

So back to the loan that made me flinch from visions of Tony Soprano and Paulie.. Here are the specs of the loan from 2000, which was part of another plan, a long time ago, in a land far away (enough disclaimers?):

-Original Loan Amount - $8,600 and change...
-Interest Rate - 11.5% (ouch)
-Total Payments Needed to Retire Loan - 390 (15 years)
-Total $$ Needed to Retire Loan - $18,000 and change (Meaning over 9K in interest expense beyond the $8,600 principle)..

Again, some employees won't have access to any funds other than their 401k in emergencies.  That's OK.  But coach everyone who asks about the realities related to a 401k loan, especially if the loan must be paid back immediately after the employee leaves the company. 

Why Employees Don't Come to HR When 401k Balances Are Down 10%

If you follow the Business page or even the news in general, you know we have been in the midst of a downturn in the stock market.  Over the weekend, I thought about my email, phone and office traffic over the last 2-3 weeks while the market has been going crazy and corrected down around 10%.

My conclusion?  I hadn't had a single conversation with an employee who was freaking out about the value of their 401k.  I checked mine, and it was down about 8% overall for the three-week period ending last Friday. 

Is there any other area where employees take a 8% decrease and aren't hitting you hard to determine what's going on or how to get it back?  Could it be our employees are a bunch of savvy long-term investors, with the required understanding of the long-term horizon and the confidence that comes with that approach?

Or, are they just not watching their accounts?  And if they aren't watching their accounts and the related news during market corrections, is that the best investment approach they could have?    The Frontal Cortex recently rehashed some 1980's Harvard Research that suggests less news equals less action, which produces better results.  From the summary of the research:

"In the late 1980's, the Harvard psychologist Paul Andreassen conducted a simple experiment on MIT business students. First, he let the students select a portfolio of stock investments. Then he divided the students into two groups. The first group could only see the changes in the prices of their stocks. They had no idea why the share prices rose or fall, and had to make their trading decisions based on an extremely limited amount of data. In contrast, the second group was given access to a steady stream of financial information. This was supposed to be equivalent to watching CNBC, reading The Wall Street Journal and listening to experts analyze the latest market trends.

So which group did better? To Andreassen's surprise, the group with less information ended up earning significantly more money than the well-informed group. Being exposed to extra news was distracting. Instead of focusing on the important variables - the actual movement of share prices - the "high-information" students would become fixated on the latest rumors and insider gossip. (Herbert Simon said it best: "A wealth of information creates a poverty of attention.") As a result, these students engaged in far more buying and selling than the "low-information" group. They were confident that all their knowledge allowed them to anticipate the market. But they were wrong. Too much information can induce a state of ignorance."

Of course, this research probably assumes that the participants held valid investments with the proper amount of diversification, etc, which is not always the case.   Additionally, employees obviously have to be participating in their 401ks for the "buy and hold" approach to work as a long term investment strategy.

So, get your employees to participate in the 401k, educate on indexing and diversification, then bask in the knowledge that once properly invested, not following the news in downturns is probably a good thing.

Gecko would be proud....   

Money Never Sleeps - Why Mutual Funds May Be Hurting Your Employee 401k Returns...

Think all funds in 401k's are created equal?  Think again.  Under the premise that HR people are a lot like the general population, I've been meaning to get out a post to encourage all my HR peers who have anything to do with a 401k to push for more Index Funds and less Actively Managed funds.  You don't have to be Gordon Gecko to have a firm grasp of the impact.  First up, let's get a definition of what these types of mutual funds are:

Index Fund - A passively managed mutual fund that tries to mirror the performance of a specific index, such as the S&P 500. Since portfolio decisions are automatic and transactions are infrequent, expenses tend to be lower than those of actively managed funds.

Actively Managed Fund -Most mutual funds are "actively managed," meaning the mutual fund shareholders, through a yearly fee, pay a mutual fund manager to actively buy and sell stocks or bonds within the fund. Though you would think that mutual funds provide benefits to shareholders by hiring alleged "expert" stock pickers, the sad truth of the matter is that the vast majority of mutual funds under perform the average return of the stock market. Over time, because of their costs, approximately 80% of mutual funds will under perform the stock market's returns. Currently, most mutual funds do not make their fees very easy for shareholders to understand.

Expense Ratio - A mutual fund's total annual operating expenses (including management fees, distribution fees, and other expenses) revealed as a percentage of the fund's average net assets. High expense ratios decrease investors' returns. An example would be two funds that both earned an 10% return before fees. If the first fund has an expense ratio that is 2 percent higher than second fund, you lose an extra 20 percent of your expected returns each year when your money is in the first fund. High expense ratios doesn't mean better results.

So, with those definitions in mind, if your mutual fund selection doesn't include multiple index funds with expense ratios of .50% and below, you can likely do better for your employees.  The average expense ratio for mutual funds in company 401K is said to be in the 1.50% range.

How's that hurt employees?  Over time and with the magic of compounding, that seemingly small difference in expense ratios can end up hurting overall returns.  Here's a calculation I ran at Moneychip.com:

Scenario - Investing $100,000 for 20 years, Expected Annual Rate of Return - 10%

Fund A - Expense Ratio of .4%, Transaction Costs of .1
Fund B - Expense Ratio of 1.5%, Transaction Costs of .8

Results

Cost-Adjusted Return Rate - Fund A, 9.0%.  Fund B, 6.2%
Final Balance - Fund A - $560,441.  Fund B - $333,035
Difference - Index Fund outperforms Actively Managed Fund by $227,406 over 20 years...

All the more reason to rethink your 401k.  If you don't have at least 4 index funds in your 401K, you aren't providing all the tools available to enable employees to maximize their returns.

Like Gecko says - Money Never Sleeps.....

Legal Considerations - Before you start swapping funds in your plan, make sure you get full disclosure on expenses associated with employees moving money out of a fund with a high expense ratio.  Sales fees associated with funds with high expense ratios are common and a type of poison pill designed to discourage change...

When Choice Confuses Your Talent - 401k Options

Employee behavior often follows consumer behavior.  Roll out 55 versions of Tide, and what do many consumers do?  By the most basic version they can find or move to a simpler brand.  Employees make choices in similar ways, as highlighted by The Retirement Plan Blog, which recently highlighted a Workforce article on the light bulb going off at GM regarding a cluttered set of investment options:

General Motors is chopping the number of investment options in its 401(k) plans from more than 70 to fewer than 40 in a streamlining that the company hopes will improve employee participation in the plans.

Preston Crabill, director of employee benefits and human resource operations at GM, noted recent academic research that indicated having too many investment choices in a 401(k) plan can lead some participants to pick the most conservative investment option and discourage others from participating at all.

“We do believe that by reducing the fund lineup, we should see an increase in participation, an increase in the savings rate and also a better diversified portfolio on the part of our participants,” Crabill said.

70 Investment Options?  Are you kidding me?  We have 21 and I feel like that is a tidal wave of choice that is difficult to explain at times.  Additionally, if you dig into the article a little bit, you'll see that GM actually owned and managed some of the funds, never a great idea from a fiduciary responsibility perspective.

70 Funds....  I am sure that made a lot of folks just play lotto....