Personal Finance Case Study 01: Should I roll over employer retirement accounts?

Intro: This is a series of blog posts in which I break down how to make better financial decisions. Each blog post in the series will tackle a case study or real life example. With some basic financial concepts I guide you through the “best” financial decision.

Note that I used the word “best”, but actually there is not A single best financial decision. The outcomes of a financial decision will depend on what is best for you and which assumptions you make. But by using a few concepts and frameworks, we take emotions and guessing out of the equation and let the numbers speak for themselves.

Should I roll over employer retirement accounts?

Should I roll over employer retirement accounts

I changed jobs in couple of months ago and a couple of weeks ago came the moment when the insurance company in charge of the retirement accounts at my previous employer sent me an e-mail requesting me to make any of these 4 choices with the 35 k euros (=37 k USD) I have on the account:

  • 1. Transfer the account balance to the standard insurance company plan
  • 2. Transfer the account balance to my current employers plan
  • 3a. Keep the account balance in the plan of my previous employer
  • 3b. Keep the account balance in the plan of my previous employer and add-on a life insurance on a portion of the balance. This would cut the estimated pay-out of that part at age 65 from 130 k€ to 110 k€.

Whenever making a financial decision I apply the following steps:

  1. Get all the necessary info.
  2. Analyze the information
  3. Eliminate bad options immediately
  4. Do the math on the selected few
  5. Take into account your personal goals and needs.

Here is how I cracked this case:

 

1. Get all the necessary info

Those few lines were literally all the information I received. They actually expect you to take a decision on 35 k euros with that little information. I was at least expecting a booklet or leaflet with some background info and data. Needless to say I wrote back to the insurance company and requested the following information:

  • Asset allocation of the current plan
  • Historical performance of the plan over 5 and 10 years
  • Cost structure of the plan
  • Terms of the life insurance

Wow, this caught them by surprise. Apparently I’m one of the very few who asks questions before deciding how to invest 35 k euro. Sounds craaaaazzzyyyy doesn’t it?

After two additional phone calls I got an e-mail response from a junior employee that compiled all the information. Well at least most of the info, because I did not manage to get cost structure and the very specific terms of the life insurance, despite asking repeatedly. Eventually I did not need this information, but we’ll come to that later.

This was such a bad customer experience. This is leagues away from what I read on the U.S. blogs. Do Belgians like being kept in ignorance about their finances? This is an industry waiting to be disrupted by a more efficient and honest offering. It boggles me that these guys are still in business. Major opportunity for anyone brave enough to venture into this field :-).

In order to compare I asked the same information on the standard plan of the provider and I reached out to my current employer’s to learn the details on their plan.

 

2. Analyze the information

I collected the following information:

 1. Insurance 2. Current employer plan3a. Previous employer plan3b. Previous employer plan with life insurance
Asset Allocation70% bonds / 30% stocks55% bonds / 40% stocks47% bonds / 38% stocks47% bonds / 38% stocks
5 year rate of return5,38%8,54%10,17%10,17%
10 year rate of return4,57%5,16%6,01%6,01%
Min guaranteed performance-1,75%3,75%3,75%
Cost structurs----
Life Insurance---Min 6% return guaranteed

 

3. Eliminate bad options immediatly

From the get go it is clear that option 1 is a terrible alternative: track record is worst of the three and no guaranteed minimum return.

Also n°2 flunked out rapidly after a brief chat with HR from my current employer. Basically it is a similar, poor product that does not match my current investment needs. As legislation on minimum returns changed in 2009 (I was with my previous employer since 2007), it only guarantees a 1,75% market return for a track record that is slightly below what the current retirement account is doing. Gee, I read in envy when I read discussions of U.S. bloggers about how they choose to allocate assets within their retirement accounts.

No need for any computations to see that both these alternatives are sub-optimal. Unless you like geeking out on the math, I simply disregard these options and pay them no more mind.

 

4. Do the math on the selected few ( Net present value, rate of return, pay-back period,…)

Time to get out a spreadsheet and do some number crunching on the last viable alternatives: 3a and 3b.

The subject of insurance policy struck a sensitive chord because as I changed companies, the plan my current employer is offering is markedly weaker on this front. Should I drop dead tomorrow, my partner and child would only receive 160 k euros (= 170 k USD) from the life insurance I have with my employer.  Or put differently, about 2,5 years in net salary. Completely insufficient and that is even before succession rights are paid. So I really wanted to get to the bottom of this choice.

First step was figuring out the cost of this option.

As the cost is expressed in the future (pay-out of 110 k€ instead of 130 k€ at the age of 65), I need to discount that 20 k€ for 31 years ( #years left until my legal retirement age) at an interest rate of 6% (market return I like to use). In this way I can express that future 20 k€ hit in a cost today. This is about 3 k€.

If you are interested in the Excel formula = PV(6%;31;0;20 000;0). Remember, as money has a different value through time. When comparing financial options it is important to bring back all sums to the exact same time in order to make a comparable decision. In this case I chose to bring all the sums to today’s equivalent.

Step two was to understand how both options are different.

In return of this cost I get a benefit, which in the case of the policy is a guaranteed 6% rate of return in case of decease before 65 (instead of the current 3,75%) on the 22,5 k€ (portion that is eligible for this added insurance). Now the difference between the guaranteed 3,75% and 6% may seem small, but is actually massive. If I were to pass away at 64, just before the policy expires, the expected pay-out to my partner and daughter would translate in a whopping 55 k€ differential between both options. Compare for yourself if you want to see how to do this calculation:

To calculate this I used the future value formula in excel and applied it from age 34 up until age 64.

So based on this figures I would be inclined to select the option 3b ( previous employer plan with added life insurance). Consider also that the guaranteed minimum returns are in both cases below the market returns over the last 5 and 10 year periods (including 2008 financial crash). It boils down to the future assumptions I am willing to make. If I think this retirement product is going to achieve less than 6% return in the long run, it makes financial sense to opt for the insurance. If I believe otherwise, I should just cross fingers and hope that if I should die before 65 the market is not experiencing a crash :-).

Considering the heavy weight of bonds in this investment, I do believe a 6% return in the long run might be a stretch, so from a financial point of view, I think opting for the life insurance would make sense.

 

5. Take into account your personal goals and needs

Final step before making that decision is taking into account what makes sense in your life. At this point we established that option 3b is mathematically sensible if I want to have extra life insurance. However, this mathematical point of view does not take into account my specific needs.

  • Yes, I want to maximize returns in the long run
  • Yes, I would like to increase the coverage of my life insurance to make sure that the needs of my family are covered in case something were to happen to me.

But what are the needs of my family?

Below find the graph that plots those needs over time as my daughter gets older. In red I indicated the amounts needed to make sure my income is replaced (and then some) until my daughter stands on her own two feet. I will make a detailed post on how to calculate your life insurance needs in the coming weeks. In green and blue are the sums that would be passed down to wife and kiddo. This is based on a worst case scenario.

The graph clearly highlights that I am severely under insured in the short-term. Moreover it highlights that choosing for the extra life insurance policy on this retirement account does not move the needle in the next critical 5 years. So, regardless of the financial return,  I would be “paying” 3 000 € for a product that does not help my financial goals.

 

Case study decision: should I roll over employer retirement accounts?

No! I stuck with option 3A and kept the capital built up under the plan of my previous employer.

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