Many moons ago, we moved to The Woodlands from the D.C. area (Annapolis, MD to be specific). We initially planned to land in Dallas or Kansas City (we have family in both places), but the job that I wanted had an opening in The Woodlands. We had one baby at the time, and my wife, Lauren, was pregnant again. We had heard great things and knew The Woodlands could be an excellent place for us.
I made an initial trip alone for my interview and to check it out. I loved it. Everything we had heard was confirmed. Plus, I grew up in Kansas, my wife went to school at Arkansas, we were moving from Maryland…The thought of not having a winter sounded amazing. Well, I got the job. So, Lauren and I took a day to visit The Woodlands together.
She hated it.
To be fair, several reasons justified this.
-She was very pregnant.
-We were in the middle of a move. Humans tend to hate everything during a move.
-Most importantly, this happened to be (what felt like) the hottest day in the history of the world.
…And it was mid-October! We legitimately thought something was wrong when we first stepped out of our car. We thought a bomb had gone off nearby-there is no way it should be this humid in October.
Fast forward to today, we love it. It’s been a great place to raise a family and build a career. And October can be hot at times, but that particular day happened to be one of the hottest in recent history.
This transition was also firsthand experience in changing 401k providers. Whenever you change companies or go through a merger, there are several financial decisions to make. For every Anadarko employee that continues with Oxy, you’re facing this now. Most people (justifiably) think every 401k is about the same. This would be logical, but in reality, it’s not the case. 401k’s and their rules and bylaws are largely determined by the H.R. department of the company you work for. So, it’s almost like there’s 10,000 different 401k’s, all with different rules and procedures.
What I want to do with this post is to tell you what you need to know about your new Oxy 401k. For many people, your 401k is going to be your largest source of wealth in your life. It’s worth taking a few minutes to arm yourself with the knowledge required to make sound decisions with it.
Your tax options
One great benefit of the Oxy 401k plan is the ability to make elective deferrals using Roth or pre-tax and use after-tax contributions above and beyond the IRS deferral limits ($19,000/$25,000 if over age 50). Many other 401k’s in the area have the same benefit, but it is important. Why? It gives you a tremendous amount of flexibility. You can decide whether your highest marginal tax rate will be higher today (probably choose pre-tax) or in retirement (probably choose Roth). If you’re ineligible for Roth IRA contributions, you can utilize Roth here (if it’s in your best interests to do so-some people get too excited about Roth and go all Roth when they should utilize pre-tax). After-tax can also be an enormous benefit. I’ve written on the subject before, but it’s also referred to as a mega-backdoor Roth.
Quick explanation: The IRS only allows you to get a tax benefit on the elective deferral portion ($19,000/$25,000). Most assume these are the limits for what can go into a 401k each year. Well, most are wrong. You can actually put $56,000 into the 401k each year ($19,000 + whatever your company match puts in + after-tax contributions). So, let’s say you contribute $19,000, and the company match gives you $15,000. You could put in an additional $22,000 as an after-tax contribution. You will not get a tax benefit upfront. This $22,000 grows tax-deferred. But, whenever you retire or change companies, you can roll this portion (the amount you contributed after-tax) into a Roth IRA, where it will then grow tax-free.
Quick Note: As is the case with all plans, the Oxy match can only go pre-tax (match cannot be Roth, even if your contribution is Roth).
Very cool feature. You can set your contributions to automatically increase by 1% at specific intervals (every January for example). This is a fantastic idea. Get in the habit of automatically upping your 401k until you are maxing it out.
Quick note on beneficiaries. If married, your spouse is the default option. If you want to name a different primary beneficiary (either sole or partial), the plan requires spousal consent to do so. I will take this paragraph as an opportunity to encourage you to get a formal estate plan. When I work with a family, I try to make sure that this is done in the first 60-90 days. I wrote about estate planning here.
As expected, loans are allowed. As is usual with most plans, there are restrictions (can’t borrow your entire balance), and paying the loan back can happen via after-tax directly from your paycheck. Be cautious with loans. Yes, you’re paying yourself back with interest, but it’s still something you don’t want to get in the habit of doing. This is something I may write more on later.
The Oxy plan, like most plans for larger companies, has a solid lineup of low-cost investment options. Vanguard is a name you will see frequently and that’s a great thing for your long-term wealth.
You’ve probably heard the phrase, “You get what you pay for.” Well, in investing, you can throw that out the window. It could not be further from the truth. As John Bogle (founder of Vanguard) so wisely put it, “In investing, you get what you don’t pay for.”
Why? We’re talking about public companies that you’re investing in. Every investor, every mutual fund, ETF, etc. has access to the exact same public stocks. The stock market is very efficient. I would argue the real estate market is not as efficient. That’s why HGTV has so many house-flipping shows. If you’re good, you can find 10 houses that are slightly undervalued. That is not the case, at all, with the stock market. There are not 50 stocks that are obviously undervalued and, if you simply buy those 50, you’re set. It doesn’t work that way.
Summary: the world of stocks will give you a certain return each year. Let’s say it’s 10% for example. You want to make sure you participate in that return. If you pay 1-2% in mutual fund fees/advisory fees, you should expect to trail the market by exactly that amount. Do not be fooled by thinking some advisor or mutual fund has some secret that allows them to make more than everyone else. They don’t.
Should you pay Financial Engines to manage it?
Financial Engines is an optional service that will manage your 401k for you. They’ll diversify it with the available funds, rebalance your portfolio as markets move over time, and gradually make your funds more conservative as you get closer to retirement age. The charge starts at .55% and tiers down to .3%. I lean towards no, you should not pay Financial Engines.
Why am I against paying Financial Engines to manage your portfolio? Two reasons:
If you want someone to make sure your invested properly, rebalance your asset mix, and help you lower risk as you age, just purchase a target date fund. The Oxy plan has Vanguard target date funds and they are doing exactly what I just described (diversify, rebalance, lower risk as you age). As I mention often in my writing, costs matter. I don’t see a reason why you should pay Financial Engines to do the work that a target date fund can do.
If you’re going to pay anything for financial advice, picking your portfolio is such a low value item to pay for. This is part of a greater conversation that’s beginning to happen on Wall Street, but asset management is somewhat of a commodity. And even though Financial Engines is on the cheaper side, why not pay a fee-only advisor to give you advice that actually helps merge your money with the life you want? Tax planning, estate planning, insurance, retirement planning, etc. plus ensure your 401k is invested properly. As New York Times columnist Carl Richards would say, “real financial planning.”
Does it cost to make changes to your portfolio?
One of the most interesting wrinkles with this particular 401k is the restriction on free portfolio changes. You are allowed to make 26 changes to your investments (i.e., switching one fund for another fund counts as one) for free every year. After 26, each portfolio change costs $10 (deducted from your 401k).
Oxy stock inside the 401k
Typically, this would not be a big deal at all, as you are almost assuredly not going to help your portfolio by trading often. However, the Oxy match portion of the 401k is automatically invested in the Oxy stock fund (which is Oxy stock). Through the plan documents and a call to the Oxy Retirement Service Center, I found that changing out of the Oxy match counts towards this 26. They also mentioned that you cannot change your election on the match portion. So, this means that every paycheck (26x per year) your 401k will have a contribution that invests in Oxy stock (your own contributions can be invested however you wish-Oxy’s match cannot). If you do not want to hold Oxy stock in your 401k, you will need to make a frequent manual change to diversify out of it. Solution: If you diversify out of Oxy stock monthly instead of every paycheck, this will save you from using all of your free trades.
Strategy around your employer stock
Should you hold your employer stock in your 401k? Well, that’s a personal question that depends on your unique circumstances. It also depends on the merits of your particular company that you’re investing in. A strong case can be made that you should be cautious before investing in your company. Ask the question, “where does my financial security come from?” and then ask that question for both today and 20 years from now. If the answer to that question both today (because of your employment and income) and 20 years from now (because you’re investing a lot of your retirement assets in their stock) is your company, that can be a red flag. Ultimately, that’s why Enron was so destructive. It wasn’t just the fact that people lost their jobs. They also lost their pension. And for many who were investing solely in Enron stock, they lost their investments.
Not to mention, we don’t have to use an extreme example like Enron. Take G.E. for instance. It’s one of the safest stocks in the world! So we thought. I’m sure long-time employees (who may have also been heavily invested in G.E. stock) didn’t expect it’s substantial fall a couple of years back. If you do insist on investing in your employer’s stock (or any individual company for that matter), try to keep it a reasonable percentage of your investable assets. Some people say 5%. Some say 10%. Just don’t overdo it.
Can you beat the market by picking a small number of stocks?
I will probably write an entire piece on the subject at some point. So, I’ll be brief here. But piling a large chunk of your assets into a few stocks is a reliable way to lower your portfolio returns. There’s a stark correlation between fund managers that invest in fewer stocks and underperformance. Plain English: Funds that invest in hundreds, or even thousands, of different stocks (and have a low expense ratio) have a much better chance of keeping up or beating their index than fund managers that try to pick 50 “winners.” No one knows who the winners will be. No one. And if it were a reliable way of managing your money, we wouldn’t have mountains of academic evidence that says the exact opposite.
I mentioned two really bad examples (Enron and G.E.). Take a more reasonable example like Exxon. We all probably know multiple people that own way too much XOM. Result? It hasn’t cratered, but over the last ten years, XOM has severely underperformed US Stocks.
NUA is allowed
Net unrealized appreciation (NUA) is a distribution opportunity inside of some 401Ks. Analyzing and advising on NUA distributions are a primary service my firm provides. I’ll start by saying you should consult your advisor for how an NUA distribution may or may not make sense for you. Make sure you’re working with an advisor that is well-versed in NUA distributions. You don’t want to mess this up.
Quick example: Let’s pretend that you have $500,000 in Oxy stock in your 401k. But you only spent $150,000 to purchase those shares over the last 20 years. At retirement, you could move the entire $500,000 out of the 401k and into a taxable brokerage account. Why would you do that? Well, 401k distributions are subject to income tax. Stock in brokerage accounts is subject to capital gains. IF tax law continues to allow lower rates for capital gains, getting your Oxy stock to a brokerage account can save you a tremendous amount. Plus, the IRS only taxes you on your cost basis to do it. So, your $150,000 cost basis would count as taxable income in the year you do it, but you’ve avoided income tax on the rest.
Does this apply to you? If you’re just now starting the Oxy 401k post-merger, no. NUA doesn’t make as much sense unless you have company stock that you bought for a fraction of its current value. So, if you’re coming from Anadarko and just now buying the stock fund, it’s not a major concern for you at this time.
That covers it. Hopefully this was far more interesting than the 41 page plan document that helped me write this! If you have specific questions on your 401k, your NUA distribution opportunity, or want more insight on how you should allocate your portfolio, schedule a free introduction call.