Don’t Make These 457b Mistakes (Deferred Comp Plan)

deferred compensation 457b retirement

“Don’t worry; it will come back at some point.” This advice was given to a new client, who I will refer to as Mrs. Smith, by her former financial professional. Mrs. Smith was a county detective sergeant with minimal investment experience. This overly simplistic advice did not ease her concerns about the dwindling balance in her deferred compensation 457b plan.

Delaying Retirement Due To Bad Financial Planning

After a long career, Mrs. Smith was planning on retiring in the upcoming year. Instead of planning a retirement party, she was now contemplating working for another two to three years to make up for losses incurred during the recent market downturn caused by the Covid-19 pandemic.

She was planning to use the money in her 457b account, also commonly referred to as a “deferred comp plan,” to help fund her rising healthcare premiums in retirement.

But there was a problem.

Aggressive Investing And Retirement

I sat down with Mrs. Smith to review her 457b retirement portfolio and found several areas of concern. First, she was in an aggressively positioned variable annuity, which was primarily composed of equities.

Simply put, her money was invested into substantially risky mutual funds in a plan that carried high fees. The aggressive funds held within the variable annuity were sensitive to market fluctuation and not an appropriate fit if she wanted to retire in the near future.

In fact, she lost over thirty-five percent of her retirement assets in less than one month!

High Fees And Administrative Costs

Secondly, the variable annuity had high fees and administrative costs, which further hurt her portfolio in a down market. These fees totaled over three percent (3%) annually and are charged regardless of performance.

Essentially, she was paying someone to manage her account, whether she had a gain or loss for the year. “Well, that’s not cool,” you might be thinking, and you’re right.

Thirdly, after talking with Mrs. Smith for a while and doing a risk assessment with her, I found out that she considered herself a conservative investor and stated her primary concern is principal protection due to her upcoming retirement. Needless to say, the aggressive funds held within her 457b were not appropriate or suitable for her risk tolerance, investment goals, or time horizon.

Every Retirement Plan Is Different

retirement plan

After identifying the areas of concern, it was time to create a new plan for Mrs. Smith to get her retirement back on track. Mrs. Smith advised she would be receiving a state pension, and we found that her pension benefit would be equal to sixty-five percent (65%) of her final working year’s salary.

Like many other law enforcement officers, Mrs. Smith will not be eligible to collect Social Security benefits. Therefore, the primary goal for her 457b retirement savings was to supplement her pension income and pay for a portion of her health insurance premiums.

She again stated she considered herself a conservative investor, and large movements in her retirement fund were a constant source of stress for her.

Mrs. Smith also informed me that while she planned to retire within the year, she would not need to use the money from her 457b to supplement her pension for a few years, which would give the money time to recover and grow.

Knowing The Rules Of A 457b Plan

I explained to Mrs. Smith that once she retired, she would no longer be able to contribute to her 457b, which was another reason to focus on principal protection and recovering from her recent losses. I could see the look of stress and frustration on Mrs. Smith’s face as we reviewed her statements and broke down her recent losses and account fees that she had been unknowingly paying for almost twenty-five years.

So, what could we do at this point?

Since Mrs. Smith’s portfolio was in a 457b account, her investment options were limited to the offerings provided by her employer. These offerings included fixed annuities, fixed indexed annuities, and variable annuities.

Mrs. Smith made it clear she did not want her money in a variable annuity moving forward due to the possibility of the funds losing further value. This left the available options to Mrs. Smith of either a fixed annuity or fixed indexed annuity. 

The available fixed annuities were currently paying a one percent (1%) interest rate. I explained to Mrs. Smith that a one percent interest rate would most likely not keep pace with inflation, and she would effectively still be losing money. Mrs. Smith ultimately decided on a fixed indexed annuity, which offered principal protection while allowing for higher gains than a fixed rate.

We also eliminated the 3% fee that she was paying annually. This change gave Mrs. Smith some peace of mind and put her in a better position for recovery, while also leaving her with some more beneficial options in terms of what Mrs. Smith could do with her funds when she was officially retired.

Lessons Learned From 457b Mistakes

457b mistakes

There are several takeaways from the experience I had with Mrs. Smith. It is crucial to continually evaluate the positions held within your portfolio. Typically, the company representatives that initially set up your account will not be providing you with on-going investment advice throughout your career. This is because they work for commissions that depend upon enrolling new accounts.

Once they sign you up, they typically move on to the next. Granted, there are exceptions. However, this is what I have found to hold true the majority of the time. They are simply spread too thin and have the pressure of needing new enrollments.

This is why you should be working with an independent fiduciary.

Finding A Financial Advisor You Can Trust

A fiduciary is a financial advisor that is legally required to work in your best interest, not theirs. They typically work for a flat fee and give unbiased advice that is genuinely in your best interest.

Also, remember that marriage, having children, and approaching retirement are all reasons to re-evaluate investments and adjust accordingly. If Mrs. Smith were positioned correctly for her upcoming retirement, this entire event would not have occurred. Mrs. Smith would have fared much better if she had been working with an independent investment advisor much earlier in her career.

Creating A Personal Retirement Strategy With Your Deferred Compensation

I realize that this is a lot to take in at first glance. To recap, all of Mrs. Smith’s retirement investments were held within a 457b account. While there are significant pre-tax advantages to this account, there were also limited investment options offered by her employer.

Mrs. Smith could have also held funds within a Roth IRA account, which would have also provided favorable tax treatment at withdrawal and increased the number of investment options.

In fact, Mrs. Smith could have had both a 457b and Roth IRA to diversify and maximize tax efficiency and appropriate investment options.

Pay Attention To Fees

It is also vital to analyze fees and sales charges within an account. Mrs. Smith was paying over three percent per year in account maintenance fees and sales charges. These fees were being charged regardless of performance and had a compounding effect during negative years, and trust me, this is not the type of compounding you want in your account.

The negative compounding effect of these fees over twenty-five years drastically reduced Mrs. Smith’s overall rate of return to the tune of over $81,000! That is $81,000 Mrs. Smith could have spent in retirement.

Annual Retirement Reviews

Mrs. Smith should have had annual reviews for each of her accounts and for her overall retirement plan. These reviews could even have been brief telephonic meetings to ensure she was on track for her retirement goals. 

All too often, people hand their hard-earned money over to someone to manage or invest – and forget about it.  A quick ten-minute meeting in person or by phone with a trusted advisor can ensure everything is on track.

It is also vitally important to have these meetings as you approach retirement. A strategy meeting five years out from retirement should be the bare minimum and beginning of the development of a long-term plan. In addition, you should have annual meetings to ensure everything remains on track. 

I routinely see people retire who have not spoken with their financial professional for several years and frankly have no idea what to do next.

This is a recipe for failure and disaster in retirement.

Protect Your Investments And Your Future

protect retirement

The coronavirus pandemic proved how quickly the world could change in an instant. The economy felt the full negative force of this, and no sector was spared. The quick loss to Mrs. Smith’s account showed why it is essential to have a portion of accessible funds held in “safe” positions.

If a large portion of Mrs. Smith’s assets were not held in an aggressive fund, the recent downturn might not have drastically affected her retirement plans. It is crucial to remember that losses will have a much more significant impact than gains in any account.

Simply put, it takes much longer for investments to go up in value than it does for them to go down.

Therefore, if large market movements and volatility are a source of stress, then you may want to consider a more conservative and suitable investment approach. While tax-advantaged accounts have benefits, if there are no appropriate investment options, you may want to consider moving into a different type of tax-advantaged account.

It is also important to continually monitor your accounts and review them with a trusted investment advisor that will act as a fiduciary and do what is in YOUR best interests.

Finally, retirement should be a time to enjoy the fruits of your labor. Everyone looks forward to their retirement. I have seen countless retirement countdowns, and a common question in any police station is, “how much time do you have left?”

With that said, you don’t want to stress over money in retirement. Financial hardship will ruin your retirement years and cause you to forego the retirement of your dreams.

You only get one shot at retirement planning, so make sure you do it right.

If you’re concerned about retirement, click here to schedule a free call with Gary