The Bogleheads' Guide to Retirement Planning (48 page)

A red flag should arise if an adviser starts recommending investments you are not familiar with. There is a good commonsense rule of thumb about complex products: the more complex the product, the worse it is for you, and the better it is for the adviser. Hedge funds are particularly dangerous. Hedge funds have notoriously high fees and very little transparency. Also, some advisers may charge what appear to be low fees for complex, unusual investments, but there’s usually a catch. They charge low fees because their firm, or a related firm, owns the products being sold.

Finally, be very wary if the adviser asks you to write a check to them for an investment. Most advisers do not take custody of their clients’ money. A separate brokerage firm does that function. The only checks you should be writing to an adviser are for management fees.

There is a simple way to distinguish poor financial advisers from competent advisers. Ask the adviser what risk is. The adviser should have a good answer that you can understand clearly. Beware of advisers who claim that they can avoid risk entirely or who use past data exclusively when discussing risk. Avoid advisers who always talk about returns but not about the risk necessary to achieve such returns.

Advisers who are selling something that seems too good to be true are, indeed, selling something that’s too good to be true (anyone remember Bernie Madoff?). Remember, there is no such thing as a free lunch. Many investors in supposedly safe and conservative money market funds that were providing an unusually high yield learned the hard way that they were actually holding risky investments during the market turmoil of 2008. Risk and return are always related, regardless of what your adviser indicates.

If you have any doubts about your financial plan or planner, there are many good ways of getting a second opinion. You can use the expertise of the members of the Bogleheads Internet forum group. Post the details of your financial situation, and ask the Bogleheads to comment. You can also post your adviser’s financial plan and ask the Bogleheads’ forum members to comment on the plan. If you don’t understand something about the financial plan, feel free to ask the Bogleheads.

If you have an accountant or attorney, you might seek their opinion of the proposed financial plan. However, beware that many accountants and attorneys have conflicts of interest themselves. They are often tied in with insurance salespeople and brokerage firms and receive kickbacks from the products and services you buy through their referral network. You will be led astray if you show your plan to the wrong accountant or attorney. Know where these people stand before asking them for a review.

You could also ask another financial adviser to review the proposed plan. A financial plan from Vanguard is another option. Remember that there is no such thing as the perfect portfolio; there is only a portfolio that is perfect for you.

In a simple world, financial planners do financial planning, and investment managers take care of investment portfolios. Regrettably, the world is not simple. Many people who have a CFP designation call themselves financial planners, but they are actually investment managers or brokers. That is because their main compensation is derived from money management fees or commissions, not financial planning fees. You should ask potential advisers what their primary source of revenue is. If you are searching for a financial planner to do financial planning, you will want one who is paid from financial planning fees, not money management fees or commissions.

Many fine investment management firms do not do detailed financial planning. Those money management firms will not be part of the hourly fee-only Garrett network or have membership in NAPFA. Unfortunately, there is no one-stop shop where you can find someone to manage your portfolio. Finding a competent money manager who charges a reasonable fee and shares your beliefs can require some work on your part.

A good place to ask for help is
www.Bogleheads.org.
. The long-time members of the forum tend to know which advisers you should be talking with. Many money managers who follow a Boglehead philosophy write books and articles that you can often find online or at your library. All the investment advisers have web sites on the Internet, and they tend to publish research articles on those sites. You’ll want to read a few books or articles to see if an adviser’s investment ideas are aligned with yours.

Financial advisers come in two general types: financial planners and investment managers. Comprehensive financial planning covers many different fields, including savings strategies, taxation, diversification, investment selection, retirement, and estate planning. It is difficult for many people to gain the broad knowledge required for financial planning. If you lack the time, temperament, or experience to do your own plan, then consider the services of a financial planner. If you are seeking an investment manager to create and manage a portfolio for you, seek out a knowledgeable professional who has the same investment philosophy as you do.

Selecting the right financial advisers to assist you with planning and investing is, of course, extremely important. It’s not possible to describe a foolproof selection method that will work for everyone. Hopefully, the information in this chapter will point you in the right direction.

In the perfect world, everyone following the Bogleheads’ guidance in this book will have a happy and secure retirement. Unfortunately, the world is not perfect. In the real world, people lose jobs, good health turns bad, more than half of marriages end in divorce, and other setbacks occur that can ruin a good retirement plan. Few of us will get through life without one serious financial crisis along the way. This chapter discusses how life’s problems can impact your retirement plans and what to do about it. Surprisingly, retirement need not be a victim of things going wrong if you are informed about potentially ruinous events and can act to minimize the damage. This means knowing what happens in divorce courts and with creditors when an unpleasant event occurs. The rules may vary from state to state, so know your rights and consult an expert before taking any action.

Divorce is often a painful experience for everyone involved. Part of the pain is coming to a court-approved agreement about how assets will be divided. Divorce courts traditionally have sought to ensure that children are provided for, that spousal support is granted based on need when there was a long-term marriage, and that assets are divided equitably. Traditionally, pensions were future contingencies that were not divided or awarded by divorce courts. Only in the last 50 years have judges across the country sought to value and divide retirement plans.

Divorce is governed by the differing laws of the 50 states. The general rule is that property acquired during a marriage is split equally between the spouses at the time of divorce. Thus, a couple with no substantial property other than one spouse’s retirement plan should expect a divorce court to divide the plan equally. There are exceptions to this general rule.

The divorce court is not greatly concerned with which spouse was working and whose earnings funded the particular retirement plan. The plan belongs to both spouses in the eyes of a divorce court. This is in recognition of the fact that even if one spouse did not fund the retirement plan, he or she made other contributions to the marriage. The division of a plan between two spouses has no tax consequence.

A couple with two retirement plans of equal value and no other property should expect the court to award each their own retirement plan free of any claim from the other spouse. If one spouse was working and accruing retirement for a period prior to the marriage, the court might award one spouse more than the other in recognition that the portion of the plan acquired during the marriage is only a fraction of the money contributed to the plan.

There are exceptions to equal division of retirement plans. The percentage of a plan going to each spouse can be complicated by other property of the parties. That property, if acquired during the marriage, may affect the percentage division of retirement plans. An example of this is where a couple owned two homes of different value and one retirement plan. The court may give each person one home and then equalize the total division by giving the spouse who received the house of lesser value a greater portion of the retirement plan.

A retirement plan must be given a value before it can be divided. An individual retirement account (IRA) is easily valued. It is the sum of money in the account as shown in a statement. Defined contribution plans (DC) are valued the same way. The pension administrator can report to the court how much is in an employee’s account.

The value of a defined benefit plan (DB) is not so easily determined. Recall that those are plans where the benefit is a monthly amount from a pension fund that is not segregated into individual accounts. Perhaps the employee is entitled to $1,000 per month after 20 years of service. The $1,000 payment in the distant future is not going to be worth $1,000 at the time of the divorce. A present value of future benefits must be calculated.

There are numerous ways of calculating future value, and the resulting figures can vary considerably, depending on assumptions in the formula. For example, an assumption needs to be made for the expected rate of return, called a discount rate, along with an assumption about the future inflation rate. This is very difficult and often a point of contention. During a divorce, people can pay expert witnesses thousands of dollars to put a value on a plan. If the experts make different assumptions about inflation or length of service, the resulting figures will differ by a wide margin. Courts try to avoid valuing such plans. In the case of a wide disparity between parties, the judge will decide on a compromise.

Rather than go through a valuation, a common approach to dividing DB plans is to have the plan administrator divide the plan benefits as of the retirement date of the employee spouse. Thus, the divorce court would issue an order requiring the plan administrator to give the nonemployee spouse a fractional share, where the numerator would be the years of the marriage and the denominator the number of years of employment divided by two. For example, if a marriage lasted 10 years, and the employee spouse retired after 20 years, the benefit to the nonemployee spouse would be $250 per month ($1,000 per month x 10 years of marriage/20 years of service divided by 2 to get the nonemployee spouse’s share).

A nonemployee spouse might not want to be awarded a portion of a defined benefit plan. First, if there is a substantial age difference, the nonemployee spouse may need the income before the employee spouse would be expected to retire. Such a spouse would prefer to be awarded some asset that would produce income at an earlier time. Second, the spouse may prefer an asset that can be passed on by inheritance. Payments from defined benefit plans end with the death of the beneficiary. Note that if the beneficiary is the nonemployee spouse, payments will continue until the end of that spouse’s life. There usually is nothing to inherit except a death benefit, which usually is not large and may not be reserved for this particular spouse.

The divorce court divides a retirement plan by issuing a special order: a qualified domestic relations order (QDRO). A qualified plan is any DC or DB plan. There can be no division of a qualified retirement plan without that order. The order may be issued at the time of separation to prevent a retirement plan from being dissipated. There will be a QDRO at the time of divorce anytime a qualified retirement plan is being divided. A QDRO is not necessary to divide an IRA. In that case, the divorce decree must direct the division.

The QDRO order is a creature of federal law that is applicable in all 50 states. The law prevents divorce courts from modifying pension rights in ways that threaten the tax-free status of retirement funds. It prohibits divorce courts from changing benefits under the plan in ways that might violate retirement law. The plan administrator must approve the QDRO, or it will not have legal affect. Divorce courts do not have jurisdiction to order a plan administrator to do anything he or she does not agree with that the QDRO may require.

In practice, here’s how the law works. A divorce lawyer preparing a QDRO usually requests a fill-in-the-blank form from the plan administrator and turns that form into a draft QDRO. That draft is then sent to the administrator, and after the administrator agrees that the QDRO is in proper form, the lawyer sends it to the judge for entry. QDROs are a malpractice nightmare for lawyers. They can charge only a few hundred dollars to prepare the QDRO, and they take on hundreds of thousands of dollars of liability if, for some reason, the QDRO does not protect the client’s interest in the retirement plan.