Lump-sum 401(k) matching contribution

By Sonya Stinson • Bankrate.com

Companies offer benefits to attract and retain workers. But what happens when they restructure their benefits?
In the retirement benefits arena, a number of employers aiming to shave costs while incentivizing workers to stick around longer are switching from regular year-round contributions to a single annual lump-sum 401(k) matching contribution.
But by holding off until the end of the year to make their plan contributions, companies may be hindering their employees from saving enough for retirement.

How the controversy began

The issue became big news in February after AOL's CEO Tim Armstrong attempted to explain his company's decision to switch to a lump-sum annual match.
Armstrong bungled the message when he disclosed that high health insurance expenses relating to two distressed babies of AOL employees impacted the company's benefit costs. But in the wake of the resulting bad publicity, AOL decided to continue its year-round 401(k) matches after all.
On the other hand, IBM, JPMorgan Chase and Co., Charles Schwab Corp., Citigroup and a host of other major companies have decided to offer annual lump-sum 401(k) matching contributions.

Dollar-cost averaging disappears

By investing the full match all at once instead of periodically throughout the year, employers deny workers the benefits of compounding interest and dollar-cost averaging.
"If you're dripping money into a tax-deferred 401(k) account and you're doing it monthly, you're capturing the average cost of your mutual fund, ETF or stock over that time period," says Kris Venne, director of financial planning at Ritholtz Wealth Management in New York City.
The stock market has been trending up over the past 100 years, says Robert Gordon, a CFP professional in Coconut Grove, Florida.
"There are down years, but the up years outnumber them," Gordon says. "So you want to be getting the dollars in as soon as you can."
CFP professional Melissa Motz , president of Motz Wealth Management in Harleysville, Pennsylvania, notes that end-of-year matching means employees stand to lose up to 11 months' worth of potential market gains. "That definitely adds up over time," she says.

Frequent job changers miss out

Another disadvantage for employees at jobs paying end-of-year matches is they don't get the money if they leave before the match kicks in. If lump-sum matching continues to catch on even as workers continue to change jobs more frequently, retirement savings will likely take a hit, Gordon says.
"For the participant ... it just increases the (potential) that they'll miss an entire year's worth of contributions," Gordon says.

That risk figures into some employers' motivation for offering lump-sum matches: They're trying to give employees a reason to stay, says Alan Moore, founder of Serenity Financial Consulting in Milwaukee. Even workers planning to quit at year's end may change their minds when they discover the holiday season is not an ideal time for a job search.
"Finding and training employees is incredibly expensive, and they know that," Moore says. "The more turnover you have, the more expensive it's going to get."

Employers like holding onto cash

Venne suggests that some employers who view high turnover as inevitable may be using end-of-year matching to their financial benefit. They're betting that a portion of their workers will leave, reducing their obligation to pay into retirement accounts.
He sees lump-sum matching as a continuation of the employer cost-saving moves that began with the switch from pension funds to 401(k)s in the 1980s.
"They're coming up with ways not to shell out as much cash for their employees," Venne says.
Companies generally prefer to delay cash outlays for as long as they can, Moore says. "They pay bills at the last possible second because they need that money for working capital."
Another possible motive for year-end matching, in Moore's view, is the desire of employers to reduce their administration work.
"It would be kind of nice to only have to make one (annual) contribution ... and only have to do the paperwork once," he says.
Motz warns that putting off paying matches could even backfire for employers if they run into a financial crunch before the payments come due and they haven't planned for that scenario.

Making up for lost time

If your savings aren't growing as fast as they could due to annual lump-sum 401(k) matching contributions, look into whether you qualify to contribute to a separate Roth IRA, Venne suggests.



The annual contribution limit for either a Roth or traditional IRA is $5,500 in 2014 ($6,500 for those 50 and older).
Venne says that's not as high as limits on 401(k) contributions. "But if I had a client who was faced with this issue, that would be something I'd recommend."
Another idea might be to increase your employee contribution to the 401(k); in 2014, the limit is $17,500, or $23,000 for those age 50 and up. But Motz says to make up for delayed matching funds, you would have to start socking away extra savings early in the year.

Other ways to compensate

Those who don't have the cash to put into an extra retirement account might look at tweaking their asset allocation for better gains, Gordon says.
"Let's say they don't have the cash flow to open up an additional IRA," Gordon says. "They could tilt their portfolio to be a little more aggressive."
For example, a married couple with a moderate amount of debt might move from an allocation of 60 percent equities and 40 percent fixed income to one with 70 percent equities and 30 percent fixed income.
"They're taking a little bit additional risk, but the intention is to make up for what is lost," Gordon says.

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Americans need a financial wake-up call

Guest Contributor | Kathleen Burns Kingsbury | @KBKSpeaks

 

Thursday, 19 Jun 2014 | 8:00 AM ETCNBC.com

Let's face it: You know what steps to take to improve your finances, but you fail to take them. It's apparently the American way, at least when it comes to money management.
Despite the financial crisis, which should have been a wake-up call in 2008, and the multitude of financial gurus yelling at us daily to save more and spend less, we simply don't listen.

Tuomas Marttila | Maskot | Getty Images

 

The result? A nation that remains financially unprepared and illiterate. According to the National Financial Educators Council:

—60 percent of adults don't budget or keep close track of their spending.—41 percent of young adults, ages 18 to 21, fail to pay their bills on time every month.—69 percent of parents admit to feeling less prepared to give their teenagers guidance on investing than they do about sex. 

A large part of the problem is the myth that financial literacy is just about numbers. The truth is that to be truly financially savvy, you need to understand how you think and feel about money first. Then, armed with this insight, you can change the attitudes that contribute to unhealthy financial habits.
If you try to alter a behavior without understanding the underlying cause, you are likely to fail. And, collectively, we are failing as a nation.

In the field of financial psychology, individual thoughts about money are called money scripts. The collection of these scripts makes up your money mind-set.

This mind-set is developed between the ages of 5 and 15 and is primarily a result of watching your parents, caregivers and influential adults interact with money. Because these scripts are developed in childhood, they are often oversimplified and don't adequately factor in the complexity found in most financial matters.

Everyone has a money mind-set, but most of us are unaware that we do. The reason is that these beliefs often reside in the unconscious mind.


For example, if you had parents who fought about paying the bills every month, you might have developed a money scripts that says, "Talking about money is bad and leads to fighting."

In adulthood, you get married and find yourself avoiding financial conversations with your partner. If your partner has a different money script than you, you might—ironically—fight about money. You hope he or she will just stop badgering you. The real solution is talking more openly about money and uncovering the diverse scripts at the root of the issue.

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Our society does not help, as the taboo relative to openly discussing money matters persists. This "money silence" contributes to most of us not having a clue about our money scripts, let alone our partners.
The few who are aware of their money mind-sets often have faced a financial crisis that has forced them to look more deeply at their habits and behaviors. Or maybe they attended one of the few courses taught at the graduate school level on the psychology of financial planning. But there are not many of us.

"What can you do to improve your insight into your relationship with money and its connection to your financial habits?"

Most school systems don't teach young people about money mind-sets and literacy. So it is up to you as a parent or as an individual to tackle this task. What can you do to improve your insight into your relationship with money and its connection to your financial habits?


Here are three ways to get started:

1. Turn up the volume on your self-talk about money. Self-talk is the running dialogue in your head that occurs as you go about daily living. The next time you are running errands on a Saturday, make a conscious effort to listen to these thoughts as they relate to spending or saving money. Notice the type of messages you are sending to yourself, and then wonder about how this impacts your financial choices. By turning up the volume, you are gathering more information about your money scripts and mind-set.
   
   
2. Talk to your partner about your thoughts and feelings about money. Set aside 20 minutes to talk with your partner or a loved one about money. Don't ambush them with this conversation; instead, ask them if they would be willing to engage in a money talk so you two can learn more about each other. If they agree, set up a time where you will be uninterrupted by cell phones, kids and the doorbell.
   
   Begin the discussion with each of you taking five minutes to answer the question, "What is your greatest financial success, and what do you think contributed to this victory?" It is vital that you take turns talking and don't interrupt each other. This is a time to learn from each other, not defend your position. Stop after 20 minutes and schedule another time to engage in money chat. With practice you will master this skill.
   
   
3. Real change happens with the next generation. Take time to talk about money with your children and teach them about the basics of financial psychology. Help them develop insight into their actions around money, and teach them that you can change unhealthy financial habits if you want to. This lesson will go a long way toward breaking the money silence in our society (or at least in your family) and making sure that future generations are truly financial literate.

Kathleen Burns KingsburyCNBC contributor and founder of KBK Wealth Connecti

What women really want...from retirement

What women really want...from retirement
 

Kelley Holland | @KKelleyHolland

Thursday, 12 Jun 2014 | 7:17 AM ETCNBC.com

 

Thomas Barwick | Stone | Getty Images

 

If you're a woman looking forward to retiring after years in the workforce, brace yourself. You may have less company than you expect.
The share of older women remaining in the workforce has increased sharply over the past 20 years, much more quickly than for men. In 1992, just 23 percent of women ages 55 and older were working, or 59 percent of the share of men, according to BLS data. But by 2012, 35 percent of women in that age group were working, equivalent to 75 percent of the share of men. And the BLS expects women to account for 82 percent of the over-55 workforce by 2022.

"I think the women are going to be the leaders in this," said Ken Dychtwald, founder and chief executive of Age Wave, a company focused on the aging population.

 

The shift by women comes amid a broader trend toward work in what has been considered retirement years. Some of that is due to financial need—and certainly that is true for women, what with the pay gap and women's typically smaller retirement savings. But work later in life is also, in many cases, at least partly viewed as desirable.
A recent study by Merrill Lynch Global Wealth Management and Age Wave found that among respondents age 50 and above who are in retirement, 47 percent either plan to work, are already working in retirement, or have already done so. Some 73 percent of workers in that age group who are not retired expect to work at least part time in "retirement."
When asked about their reasons for working, retirees in the survey were more likely to cite social connections, mental stimulation, and the chance to stay mentally and physically active as top reasons to work. Less than a third—31 percent—of the respondents cited money as a top reason.
"People are beginning to realize that they may have a longevity bonus. They might live to 80 or 90. Then people are saying, 'Well, do I want to spend not five or six years but 20 or 25 or 30 years not working at all?'" said Dychtwald.

It's not as if the retirement years are all that golden for many people. According to Nielsen data, TV viewers over age 65 in the fourth quarter of 2013 spent more than 50 hours per week in front of the little screen.

 

But the presence of women in the older workforce is relatively new, and experts say it represents something else: Boomer women, once again, are different.
"It was the massive numbers of boomer women that really have made the changes" in the workplace over the past several decades, Dychtman said. Now, as they reach traditional retirement age, "not only do they have some history and some practice causing institutions to respect and change their policies for them, but they are also more skilled at this shifting."

Returnship for older workers: Proceed with caution

Boomer women also have timing issues that affect their retirement choices. For one thing, many in this generation of women backed away from big careers for a time to take care of children. Now, as their partners get ready to dial back, these women are ready to take the reins again, according to Kerry Hannon, author of "Great Jobs for Everyone 50+: Finding Work That Keeps You Happy and Healthy ... And Pays the Bills" and a career and retirement expert.
"I do think that women get this resurgence because they've been out of the workforce and it's really their time to come back in," she said.
A demographic shift may also be playing a role, according to April Wu, a research economist at Boston College's Center for Retirement Research. In 1900, husbands were 4.5 years older than their wives, on average, and that gap has been gradually narrowing. This may be affecting women's retirement rates, she explained, since spouses tend to retire within a year of each other.
For a man retiring at 65, "if the age difference is five years, the woman might retire at 60. But if there is two years' difference, she might retire at 63," Wu said.

 

Whatever the reason, the feminization of the older workforce has important implications for the shape of workplaces.
"We're going to see a shift in the face of some industries," said Hannon.
She expects many older women to work in health care—not just in nursing or direct caregiving, but also areas like physical therapy, occupational therapy and patient advocacy.
The nonprofit world also tends to be receptive to women, Hannon said.
The world of financial advisors could also see a change. Women are likely to manage the a large portion of the $59 trillion in wealth expected to be transferred to heirs, charities and taxes in the coming decades, but a Fidelity survey found that men are 58 percent more likely to be the primary contact when a couple uses a financial advisor. On top of that, one study found that 70 percent of recently widowed women leave their financial advisor within a year of losing their partner.

 

Plenty of women will chart other paths, as well, Hannon said. While many employers choosing between a young worker and an older, seasoned job hunter will opt for the less expensive, more energetic candidate, "employers do still want employees that don't wear hoodies," she said. And there will also be plenty of women working for themselves.
Hannon knows what she speaks of when it comes to boomer women in the workforce. She is a part of the tail end of that generation, and she is still going full tilt.

Giving to charity? Check this list

Jennifer Woods

Thursday, 22 May 2014 | 4:29 PM ETCNBC.com

Nothing is more rewarding than making a donation to a worthy cause—except, perhaps, donating to a worthy cause and getting a tax deduction for it.
While most donations stem from a desire to make a positive impact, there's no denying that tax deductions are a big incentive—especially among the wealthy.
In a study of high-net-worth philanthropy by Bank of America, about 33 percent of those surveyed said tax benefits were their motivation for giving, and nearly half said they would decrease their charitable giving if tax deductions were eliminated.

   

Fatido | E+ | Getty Images

 

However, because there are so many rules and requirements surrounding charitable giving, donors often miss out on the tax benefits they deserve. So before you make another donation, be sure you are up to date on the dos and don'ts of charitable giving to ensure your good intentions are paying off in every way.

The dos

Do make sure the organization is tax-exempt. One of the biggest mistakes people make is not making sure they're giving to a qualified organization, said certified financial planner Stephen Aucamp, senior advisor and executive director of the Ultra-High Net Worth Group at Convergent Wealth Advisors.
"I had a situation last year where a client gave several hundred thousand dollars to an organization that she thought was a charitable organization supporting a museum," he said.
Unfortunately, "the person she was donating to hadn't gone through the proper steps to become a qualified charity, so she lost the deduction," he explained.

The Internal Revenue Service has a complete list and searchable database of tax-exempt charities on its website.
 

Do have your paperwork in order. If you're planning to deduct a donation, you need proof, such as a receipt, canceled check or acknowledgment letter from the charity. For text-message donations, you'll need the phone bill with the organization's name, contribution amount and date; for donations deducted from your paycheck, you'll need your pay stub and donor pledge card showing proof of your gift.

If you are donating an item worth more than $5,000, you'll also need a letter from a qualified appraiser valuing the property.
 
For all deductions, you must file a Form 40 with the IRS and itemize your deductions on Schedule A. If your noncash donations exceed $500, or if you're donating items worth more than $5,000, you'll need to include IRS Form 8283, as well.

IRA charitable rollovers in limbo
Rolling over a portion of an individual retirement account to a charitable organization is another tack donors have taken, thanks to the various tax advantages.
Although the legal provision that allowed this expired last year, experts are advising clients not to worry, as that could change.
"If you want to roll over an IRA, first you should wait and see what's going on," said Carol Kroch, managing director for wealth and philanthropic planning with Wilmington Trust. "The rule may get reinstated shortly."
The provision has been reinstated and applied retroactively several times before, so there's a good chance it could happen again, particularly as it has received a lot of support from both donors and nonprofit organizations.
Under the IRA Charitable rollover provision, if you are at least 70 1/2 years old—the age at which you're required to begin taking and paying taxes on IRA distributions—you can choose to transfer up to $100,000 from your IRA into qualified charities.
There are several benefits to doing this: You can count the donation toward your required distribution, the withdrawal amount isn't recognized as income, the charity doesn't have to pay taxes on the withdrawal, and the donation doesn't count toward your charitable contribution deduction. It also removes the money from your estate, lessening the tax bite for your heirs.—J.W.

Do understand what counts as a donation. You're only making a donation if you're not getting anything of equal value in return. This is particularly relevant when it comes to charity dinners and auctions.
In the case of charity dinners, you can only deduct the difference between what you paid for the meal and its fair market value, according to Carol Kroch, managing director for wealth and philanthropic planning with Wilmington Trust.
If you paid $100 and the meal is valued at $100, you haven't actually made a donation.
The same is true with charitable auction items, she said. If you buy a $500 painting that's valued by the charity at $500, there is nothing to deduct. However, if the painting is valued at $300 and you pay $500, then you've made a $200 deductible gift. Raffle tickets are never tax-deductible.

   

Do run the numbers. "Before you make a contribution of something large, you want to have a plan," said Kroch, adding that your yearly tax savings will depend on a combination of factors, including your adjusted gross income, the type and value of your donations, whether you're subject to the alternative minimum tax and the type of charity to which you're donating.
Additionally, she said, a phaseout of itemized deductions was reinstated in 2013 for taxpayers with higher adjusted gross income. Depending on your income and other deductions, your charitable deductions may be reduced, which is why you need to have a plan that will allow you to optimize your deductions.

    

 

Some don'ts

Don't assume cash is best. While donating cash is easy, it's not always the most tax-advantageous way of giving.

"People often get an idea to donate but don't clearly think through a plan of what's the best asset to donate," said Donald Tharp, certified financial planner and president of Hudson Financial Advisors.
One common mistake, he said, is selling low cost-basis stocks and then donating the cash. When you sell the security, you have to pay capital gains taxes of 20 percent and the new 3.8 percent Medicare surtax on net investment income—depending on your adjusted gross income. After taxes, you're left with a smaller donation and a smaller deduction.
It's often better to donate the security, let the charity sell it tax-free, and get your full deduction. You can do this as long as you have held the security for at least one year.
If you have a piece of appreciated real estate, it's often advantageous to donate it rather than selling it and donating the cash.

"People often get an idea to donate but don't clearly think through a plan of what's the best asset to donate." -Donald Tharp, president of Hudson Financial Advisors

Don't assume all property is treated equally. Tax laws are incredibly complicated, particularly when it comes to giving big gifts. The rules differ, depending on what you're donating: There are special rules for clothing and household items, used motor vehicles, artwork and even taxidermy.
That's why it's important to know exactly what you're doing before attempting to make a donation.
Artwork, for instance, is particularly tricky. According to Aucamp, it's possible to benefit tax-wise by donating art, "but the regulations have gotten stricter and are pretty complex."
"You have to dot your i's and cross your t's or you'll lose your deduction," he added. "Often, clients will not get the outcome that they want unless they are willing to spend a lot of money to do it right. … So you really need a good advisor who can navigate the complexities."

Do you really need a private foundation?
Private foundations are often set up by individuals, families or corporations to disburse large donations to charitable causes.
While private foundations offer privacy and autonomy, experts say that, in many cases, they are actually unnecessary and more trouble than they're worth.
"People often get caught up in more complex vehicles because they hear about them and believe they need some complexities," said Stephen Aucamp of Convergent Wealth Advisors. In many cases, the associated administrative costs "don't justify the existence."
According to Aucamp, unless you're funding it with $5 million or more, you don't need a private foundation.
However, judging by the statistics, not everyone thinks so.
As of 2010, there were just fewer than 89,000 private foundations in the U.S. that had filed with the IRS in the previous two years. Of that group, more than 55,000 had total assets of less than $1 million.

Donald Tharp, certified financial planner and president of Hudson Financial Advisors, agrees that private foundations aren't always the way to go.
"Running a private foundation is not easy," he said. "People who have smaller private foundations tell us that it takes the joy out of giving [since] it is basically running another business."
In addition to higher administrative fees, there is a lot of management involved with private foundations, and they are subject to tough tax laws and regulations.
In many instances, Tharp said, the better alternative is a donor-advised fund, which acts as a middleman between you and the charitable organizations to which you want to donate.
With donor-advised funds, you make a donation to the fund and then advise it on how to distribute your money. The funds themselves are recognized as 501(c)(3) charitable organizations—their charitable purpose being to administer donations to other charities—so you get a tax deduction when you donate to the fund. But you also have the ability to take your time in determining how and when to disperse your money.
Donor-advised funds are more limiting than private foundations; for example, you can't donate illiquid assets. However, because they are easier to start up, the fees are significantly fewer, and the fund is responsible for the administrative hassles, they may be a better fit for many donors.—J.W.

Jennifer WoodsSpecial to CNBC.com

Million-dollar question: How much do you need to retire?

Sharon Epperson | @sharon_epperson

Thursday, 5 Jun 2014 | 8:05 AM ETCNBC.com

   

The good news is there are now more millionaires than ever. But when it comes to retirement, is a million dollars enough?
"If they want to be financially independent, retire at 65 and be able to have an income of $40,000 a year in retirement for 30 years, then it's likely that they're going to need a million dollars to retire to generate that lifestyle," said Bruce Allen, an independent wealth advisor.

Living comfortably on $40,000 a year in retirement, which would require a $1 million nest egg by the time you reach the retirement age, will depend on your expenses, investment returns and health-care costs. This figure does not factor in other benefits, like pensions and Social Security, which can greatly boost your retirement income.
For retirees Ralph and Karen Jones, making the most out of their money meant making a big move.
"I didn't think that we could maintain the lifestyle that we wanted if we stayed in New York after retiring. Coming to Myrtle Beach was just amazing, to see the difference in what your money would buy, how much you can get for your money," Karen Jones said.

The Joneses bought their new home in South Carolina and now pay a fraction of the property taxes they once did—freeing up funds to vacation frequently, and make big ticket purchases when they want.
The Joneses aren't your typical retirees. U.S. Census data show less than 8 percent of the U.S. population has a million dollars. Yet, many financial advisors warn even a seven-figure sum may not be enough.
Many retirees make it work with less. According to Census data, the median household income for those 65 and older is $34,000, but that's almost half the $66,000 for ages 55 to 64. In order to preserve that preretirement standard of living, financial experts say you'll need more than a million dollars.
"A million dollars could be enough, it might not be enough. It really depends upon ... what you anticipate your retirement to be and what you were earning before retirement," said Jeanne Thompson of Fidelity Investments.
That's the million dollar question.

Sharon EppersonCNBC Senior Commodities Correspondent and Personal Finance Correspondent

Heir tight: The dos and don'ts of creating rock-solid trusts

Jennifer Woods

Wednesday, 28 May 2014 | 8:00 AM ETCNBC.com

Imagine working for decades so that one day you could pass your assets on to your children or grandchildren.

Wouldn't you like to know that when the day comes, they won't lose it all on bad investments or to a gold-digging spouse—or simply because they have no idea how to properly manage large sums of money?
Whether you're bestowing assets during your lifetime or leaving them as an inheritance, creating trusts with well-thought-out terms can ensure your money lands in the right hands and isn't squandered.

Eelnosiva | iStock | Getty Images

 

"When you write a will and leave money outright to your heirs … once it's inherited, there are no controls on how that money is being handled, and you don't know what will happen," said certified financial planner Ian Weinberg, CEO of Family Wealth and Pension Management.
"Using trusts helps protect your heirs against future catastrophes—[such as] bankruptcies, money-hungry predators disguised as friends, family looking for loans or business bailouts and other financial challenges—and can also provide for certain special needs of your children or grandchildren," he said.
Many trusts make multiple payouts over time, the hope being that spacing out distributions will prevent the beneficiary from blowing it all in one shot.


Russ Weiss, a certified financial planner with Marshall Financial Group, said that when it comes to setting the distribution terms with clients, "the conversations become tricky."
In many cases, his clients use age-based payouts, in which a percentage of assets is distributed at various ages.

"The child doesn't get it all at once," he said. "If they are irresponsible with money, hopefully they can manage [with spread-out distributions]."

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Distribution options

Payouts at 25, 30 and 35 years of age have historically been common, though experts warn that in this day and age, 25 is too young to properly manage large sums of money.
Weiss also has clients who schedule periodic payouts after the benefactor dies, so beneficiaries may get a distribution, for example, every five years following the death.

While distribution schedules are common, others opt for more elaborate terms to allow for more contingencies.
For example, Weinberg has a client couple who planned to leave money outright to their children. However, after problems arose with one child, they created a trust that states certain conditions that must be met in order for the child to receive the inheritance.

There are various stipulations that can be dictated in a trust, depending on a given situation.

If an heir has a history of chemical dependency or mental health problems, Weinberg said, he or she might need to prove a consistent period of no drug use or have a report from a psychiatrist showing solid mental health before receiving a payout.

If work ethic is an issue, the trusts could require proof of employment or make income-matching distributions, where recipients get payouts equal to their salaries. In some trusts, distributions may even be contingent on whether the beneficiary is married or has children.

Though payout provisions are typically viewed as a simple solution, it's often better to avoid large distributions altogether, instead keeping the money in the trust, paying out any income generated and making distributions for certain expenditures.

"We like the idea of a trust remaining in effect for the child's lifetime," said John McManus, founding principal of McManus & Associates, a trusts and estates law firm. This is particularly beneficial when large sums are involved.

Who needs a trust?

• Trusts are not just for the ultrarich. If your heirs stand to inherit even a few hundred thousand dollars, a trust is worth considering.
• People with young children could benefit from a testamentary trust, established in a will and effective upon one's death. It dictates how assets will be distributed at later dates. The drawbacks? These trusts go through probate, delaying disbursements, and the records are public.
• Revocable trusts, or living trusts, are often a better option. You allocate, access and manage assets, and amend terms while you're alive. When you die, the trust can convert to an irrevocable trust with unchangeable terms. Other pluses: They're easy to set up, are flexible and protect privacy.—J.W.

Worst-case scenarios

Here's why: Say you set up a trust that finishes making distributions when your daughter reaches a certain age, by which point she's married with kids. If she dies, her husband is entitled to the money because it's now part of her estate. What happens if he remarries and then dies? The new spouse can take one-third of the assets—and can choose to redirect them to her own kids, depriving the true heirs.
Alternatively, he said, "the parents can direct that the inheritance pass in trust for the benefit of the daughter."
"The trust would provide for her on an as-needed basis during her lifetime and would require that any remaining assets pass to her children only upon her death."

One problem that can arise with perpetuating a trust is shackling the child to a trustee. That's why McManus often favors making the child the trustee.

In that case, the trust could include provisions limiting the beneficiary's access to the trust while allowing distributions to be made for expenses related to health, education, maintenance and support—referred to as the "HEMS standard." Some trusts also include a "5 by 5 clause" that provides $5,000, or 5 percent of the trust, per year in addition to HEMS.

"It's often effective to make children aware of the value and protection a trust can provide ... as they age." -Russ Weiss, certified financial planner at Marshall Financial Group

While you can dictate how you want your money distributed, things get tricky when the money is in a custodial account for your children.

Because these accounts are created for minors to pay for their expenditures, once the child reaches a certain age—18 or 21, depending on the state—they retain full control.

You can put custodial accounts into a trust, but if you want to set terms that restrict the child's access to the money, the child will have to sign off on it once they reach the legal age.
If this is a concern, Weiss said, "it's often effective to make children aware of the value and protection a trust can provide ... as they age and that it's in their best interest to protect themselves from future spouses or potential creditors."

Is your trustee trustworthy?
When creating a trust, choosing the right trustee to manage the funds over time may be one of the most important decisions you'll have to make.
While many people are inclined to choose a close friend, that's often not the best course of action.

"If you pick someone you can rely on but who doesn't have financial savvy, that can be a challenge when talking about larger sums of money," said certified financial planner Ian Weinberg, CEO of Family Wealth and Pension Management. "It's a big responsibility, [and] that person needs to be able to take on that role."
Ideally, Weinberg said, the person should have a good amount of experience in some or all of the following: investing, taxes and law and perhaps some experience running a business.
"The trustee needs to have the savvy and disciple and experience to know when requests are being made that are legitimate and when it could be to the detriment of the trust," he said.
Typically, trusts are set up to provide income and then capital at certain age intervals and for certain specific uses, such as buying a home, paying college tuition or funding a business. But there could also be requests for distributions that aren't clearly defined in the trust—in which case, the trustee would have to make the decision.
If you do pick a trustee who's a friend, you should, at a minimum, also have a co-trustee, he said.

Additionally, when young children are involved, it's best to choose different people to act as trustee and as guardian; divvying up these roles can avoid many potential conflicts in the future.
Russ Weiss, a certified financial planner with Marshall Financial Group, said it's also important to choose a "friendly trustee," or someone who can understand the parents' values.
He added that you should have good communication ahead of time with the trustee as well as the kids—provided they're old enough—to explain to them why certain language was included in the trust and why someone was chosen as trustee.—J.W.

Jennifer WoodsSpecial to CNBC.com

Which is better: An IRA or 401(k)?

By Chris Kissell • Bankrate.com

 

Which is better: An IRA or 401(k)?

Working Americans eyeing retirement typically look to their company's 401(k) plan as the best place to nurture a nest egg. These plans contained about $3.5 trillion in assets in 2012, up from $1.6 trillion in 2002, according to the Investment Company Institute.
For many people, a 401(k) plan is the best choice, especially if their employer matches employee contributions up to a given percentage of their pay. A 401(k) also is easy to set up and use, with contributions flowing directly from your paycheck. Many companies automatically enroll their employees, so workers don't have to do a thing.

However, another popular retirement vehicle -- the individual retirement account, or IRA -- offers some key advantages over a 401(k).
Following are five ways in which investing in an IRA may trump using a 401(k) plan.

Bigger and better selection of mutual funds

Most company 401(k) plans offer a limited number of investment choices. The average 401(k) plan offers participants a selection of just 19 funds, according to a recent study by the Plan Sponsor Council of America.
Those constraints disappear when you open an IRA with one of the nation's leading mutual fund companies. For example, T. Rowe Price sells more than 100 of its own mutual funds, Vanguard offers more than 150 and Fidelity has nearly 200.
In addition, these custodians allow you to purchase mutual funds from other companies. Fidelity says its customers can select from an array of more than 10,000 funds from hundreds of firms.
Having a wide variety of investment options can protect you from the mistake of putting too much of your nest egg into a single mutual fund, says Nathan Kubik, a Certified Investment Management Analyst at Carnick & Kubik, which has offices in Denver and Colorado Springs, Colo.
"There is no way to guarantee a (single) fund will perform well," he says.
Investing with a firm that offers a greater selection of funds allows an investor to build a diversified portfolio that matches his or her level of risk tolerance, Kubik says.

Lower expense ratios and other costs

A 401(k) plan is a great place to build your nest egg, but the price of admission can be high.
The average 401(k) investor paid 0.63 percent in expense ratios in 2012, according to a study by the Investment Company Institute. That represents a fee of $6.30 for every $1,000 invested.
While that might not be so bad, 401(k) investors often are subject to a host of other fees that can further eat into returns.
By contrast, IRA investors can eliminate many such charges simply by purchasing no-load mutual funds from companies that hold the line on costs.
"Fees are one of the few things that investors can control," says Joshua Itzoe, partner and managing director of the institutional client group at Greenspring, a wealth management firm based in Towson, Md. "The lowest-cost way to invest is through index funds or ETFs."
For example, someone who holds the investor class shares of Fidelity's Spartan Total Market Index Fund pays an annual expense ratio of just 0.1 percent -- or $1 in costs for every $1,000 invested.
If you have at least $10,000 to invest in the Fidelity fund, your expenses drop to 70 cents per $1,000 invested.

Option to invest in ETFs and individual stocks

In most 401(k) plans, you are limited to the mutual fund choices offered by your company. However, open an IRA and you have access to the world of exchange-traded funds, or ETFs, and stocks.
"Investing in ETFs or individual securities through an IRA can have many benefits," Kubik says.
For example, ETFs typically charge lower expense ratios than mutual funds. Also, if you are someone who trades frequently, an IRA's tax-deferred status can help keep your costs down, Kubik says.
"It is easier to have a very tactical portfolio," he says. "An investor can buy and sell securities without the concern of tax consequences."
Derek Tharp, a wealth manager with Mote Wealth Management in Cedar Rapids, Iowa, says that ETFs can be a wise choice in an IRA. However, he believes that portfolios of stocks are difficult to manage and are unlikely to provide enough diversification to protect investors over the long haul.
"The average investor should stay away from individual stocks," he says.

Easier access to Roth advantages

Investing in a 401(k) plan allows you to delay paying taxes to Uncle Sam for decades while your money grows.
But that big plus also comes with a drawback. Until you finally pay the tax, "the government still owns a portion of the investment," Tharp says.
Putting the money into a traditional IRA creates a similar dilemma. But choosing a Roth IRA allows you to pay the tax up front and then enjoy tax-free growth now and untaxed withdrawals later.
"Tax deferral is a nice benefit, but it is nowhere near the benefit of tax-free growth," Tharp says.
Some employers now offer a Roth 401(k) plan that mimics the benefits of a Roth IRA. However, such plans have not been universally adopted. For example, a Vanguard study found the Roth option was offered by 49 percent of the 401(k) plans for which it serves as the custodian.
Itzoe says a Roth makes the most sense for investors who expect their tax rate to be higher in retirement. However, it is hard to forecast that in advance.
"I wish I had a crystal ball and could tell you what tax rates will be in the future," he says.
Because of this uncertainty, he recommends splitting funds between tax-deferred and Roth accounts.

More options for withdrawing money penalty-free

In most cases, if you are younger than 59 1/2 years old and make a withdrawal from a retirement account -- either an IRA or a 401(k) -- you generally will have to pay taxes on the money, plus a 10 percent penalty.
But there are exceptions to the penalty rule, and some of them apply only to IRAs and not to 401(k) plans.
For example, first-time homeowners may tap their IRA for up to $10,000 to be applied toward a down payment for a house without paying a penalty.
You also can withdraw IRA cash penalty-free to fund higher education costs for yourself or immediate family members.
Try those maneuvers in a 401(k) and you will pay a 10 percent penalty.
Finally, if you open a Roth IRA, there are even fewer limitations to early withdrawals.
"You can always withdraw your contributions tax- and penalty-free," Itzoe says.
In addition, you can spend the money however you like. Keep in mind that this rule only applies to your contribution, and that any early withdrawal of investment earnings is subject to a 10 percent penalty.
So, which is better: an IRA or 401(k)? Both have much to recommend themselves, but some might argue that IRAs have several distinct advantages.

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