Posts

The Real Cost of Funding Your Retirement Entirely with a 401(k)

You work hard to save money on a tax-deferred basis so you will have more money after tax.  Then you go to retire and have to pay tax on 100 percent of the money you take out of the 401(k).  So if you thought paying taxes on your annual income was horrible, wait until retirement if all you’ve planned to retire on is a 401(k) or IRA!  Just because the amount you take out as income during retirement is smaller, doesn’t mean you will be in a lower tax bracket.

This illustration sums up the frustration of a tax-deferred retirement account. As you save money into a 401(k), the annual fees are large and loads for early withdrawals will cost even more money. In addition, the market risks cause losses 4 out of 7 years on average.  How is it possible to have enough money for retirement?    

Now, let’s assume that even with all the leaks that are possible with a tax-deferred account such as the fees, market risks, and penalties, you have been able to accumulate a good sum of money for retirement.  When you start taking income, this large sum is wholly taxed, 100 percent! Since you deferred your taxes, now you have a much larger number to pay taxes on. I ask: why would anyone fund their entire retirement using a 401(k) or IRA? It makes no sense. Of course, if your employer is willing to offer matching contributions, then a 401(k) can be one way to help build a retirement, but to rely solely on this kind of investment is foolish in my opinion.

Take a look at the above illustration one more time and ask yourself, “Does it make sense to defer my income taxes?” By deferring your income taxes, you subject all your money to fees, load, market risks and penalties over 40 years.  This cost can eat up all tax savings.  And when you turn on income, now you pay much more in taxes than ever before.  With few tax deductions, you might struggle to have enough retirement income to live on.  Please consider other options than the 401(k) or an IRA. I have loads of information to share with you on all the grand possibilities for retirement you should consider. Contact me today: peter@moneymastery.com  

Tax Rates May be Lowered… Think about Converting 401(k)s to Roths

If the Trump administration ends up getting taxes lowered, consider converting all IRA and 401(k) savings over to a Roth IRA.  The tax hit today will allow all future growth to be taken out as tax free!

Here are two observations about this advice: 

First, when you take income during retirement from a Roth IRA, you do not pay income tax on it. And this income does not force your Social Security benefits to be included for income tax purposes.  Withdrawals on 401(k) funds, on the other hand, usually force a Social Security benefits to be taxed with a potential $5,000 tax hit since 401(k) withdrawals count towards the earnings formula for Social Security.  Roth IRA withdrawals do not count in that equation so there’s no hit!

Second, when you pay the tax on the Roth IRA conversion today, you or your loved ones don’t have to pay tax on the withdrawals later. A 401(k) is tax-deferred so this means your spouse or kids will have to pay taxes on those withdrawals, or yourself, at a time when you’re on a fixed income, with not near so many deductions as you can take during your working years seeing as your house will probably be paid off and your kids will be grown.  To see what a huge burden  this can be, understand that the taxes you will pay in retirement on the  401(k) payout will be at least SIX times what you will pay in taxes on a Roth conversion now.

Example:  You  have $207,000 in an existing 401(k) and over the next 15 years between now and retirement you contribute  $6,000 a year into the account and it earns 5% interest, which will equal an additional $129,000; at retirement you have $337,000. Take this $337,000 and pay it out over 35 years for yourself or spouse or children and it will be worth $753,000.  Taxes on this total will equal $188,000.  If you converted this $207,000 to a Roth IRA instead and deposited the $6,000 a year into the Roth the tax you will pay is only $28,000.  Compare you paying $28,000 or $188,000, which do you think is better?  The multiplier in this case is 6.7 times!!

If the Trump administration gets taxes lowered, run, don’t walk to convert all tax-deferred accounts to a Roth.  More coming in the near future about how this will impact each of us.  But in short, lower taxes will indeed spur the economy and change millions of people’s lives so that they have surplus money to save.

Retirement Can be Like a Rose, Depending on How You Hold It

A rose is beautiful and we all enjoy them to celebrate special occasions.  But roses have thorns — sometimes we can prick ourselves if we aren’t careful.  Retirement is just the same.  We can enjoy retirement if we hold it just right, but if we refuse to prepare, the thorns we will experience in retirement can cause some real pain.

Here are some of those thorns to consider:

  • Of all people who filed bankruptcy in 1991, 21% were older than age 65. Today that number has grown to 28%.  This destroys credit and prevents ability to borrow money for needed items. If debt levels are really high before retirement age, this can be a real thorn to manage after age 65.
  • Some parents try to help their children with student loans by co-signing on federally insured loans. Later, if the child doesn’t get employment that earns enough money, the parents end up paying on the loan.  This can be a real thorn when it comes to retirement.
  • Another potential thorn in retirement is higher taxes. No doubt you have been taught to save money in a 401(k) or other tax-deferred savings program throughout your working years. Supposedly you will be in a lower tax bracket in retirement years so paying all those deferred taxes in retirement will be cheaper than paying them during working years. But it has been my experience working with thousands of clients that this simply isn’t the case. People in retirement usually pay much  higher income tax than when working because they don’t have any deductions!
  • Another thorn that can cause real pain in retirement is waiting too long to start saving for it.  If you started working at age 25 but did not form a habit of saving until age 55, this could potentially pain you every day of your life in retirement.
  • Having to work until age 80, because you don’t have enough money to retire, can be another real problem.  Maybe you like to work and you don’t mind it. But that’s different from being forced to work. And what if you don’t have the health to do so?
  • What about the fear of running out of money in retirement, which oddly enough, is a much greater fear than dying? I’m sure the reason is that it’s hard to cut spending down at a time we have more free time to spend.  Statistics show we spend more when we first retire than when working.  Apparently it takes a few years to adjust to the new income.
  • The thorn of inflation is real.  It has hurt so many retirement-aged people as their fixed expenses increase while their income does not.
  • The final thorn that can turn a beautiful retirement into a thorny nightmare is the need for dental, vision, hearing and for long-term or hospice care.  The huge prick here is that the costs can exceed your entire savings for retirement, and this might leave a surviving spouse destitute and on welfare.  A HealthView Services study in 2016 shows that the cost for all these elderly care service for a couple age 65+ will be $377,000 during their retirement.

To create a beautiful retirement with minimal thorns, get in touch with a financial coach who can teach you how to deal with each of the things I have discussed above. Contact me today: peter@moneymastery.com.

Are You Financially Playing More Offense or More Defense?

Take any sport and consider playing strategies and defense always seems to win in the end. Let’s take the NBA Playoffs for example. The highest scoring player of a game is held in high esteem, even paid the most money on the team. Crowds cheer when points are posted on the scoreboard. The high scorer gets to do the team interview at the end of game. But nobody posts defensive plays, no system keeps track of how many STOPS a player makes so the opponent cannot score, so why not? I believe the answer is the player that puts up big points is what sells tickets!

Now reference your 401(k) funds: are you on the offense, trying to score the best rate-of-return? Or, maybe you are playing defense and trying not to lose any money? A simple way to find out is to ask yourself, “Am I going for the best return I can get?” If so, you are on the offense. But history of all sports and all battles in war shows that a good defense wins most of the time, so why aren’t we all playing defense? I believe that defensive savings and investing isn’t as exciting as trying to get a higher rate of return, and doesn’t “sell tickets” so to speak.

So think of your mutual fund manager: Doesn’t he or she emphasize investments that have posted larger rates-of- returns to get you attention? If that is what you want, the best return, you buy into this, meaning you become the “sale.”

Defense definitely wins more games than offense. With a strong defense you shut down a hot offense, that is why you win most often. So when you invest your money, why not switch away from the mentality of always trying  to get the highest returns and play defense? Try playing defense with a small portion of your investment money. Go for the solid, never-lose investments so you don’t lose big and have to gain back better-than-average returns, especially if you have no time left in the “game” to recoup such losses.

Can you imagine how much more money you would have if you just had the money back that has been lost? I’m guessing it’s a huge number! Please consider going on defense with your investments and keep track of what happens. You may find that defense wins most often, just like in any sport. For more help on this subject email me:  peter@moneymastery.com.

Fixed Indexed Annuities Are a Good Tool If You’re Getting Close to Retirement

When you see an investment report on a 401(k), for example, it most often shows the average rate of return on funds over the last 40 years.  Averages do not show the impact on retirement of periodic drops in value.  Reports give averages over a long-range period of time, but fund managers never want you to focus on the big drops that happen during the shorter periods in between. For example, in 2000 the S&P 500 dipped by -10.14%, then again in 2001 by -13.04%, and then again in 2002 by -23.37%.  That is a total of 46.55% drop in values in three years.  If you took the average gain per year for just those three years it was negative, at -15.5% each year!  So what does that mean to you? Well, if you’ve got a lot of time to make up those losses, then maybe not too much. But it would take eight years at an 8% gain just to get back to where you were three years earlier. If you don’t have 40 years to make up these big dips in the market, then frankly you’re getting bamboozled.

This is a lot of math, but my point is that most people don’t know how to calculate the math.  They just look at a report showing a 40-year average and say, “Not bad.”  Not bad if you have lots of time, but what if you’re getting within 10 years of retirement?

Indexed annuities can be a great way to overcome market dips. When you invest in indexed annuities, you get only the gains and no downs — you are “sharing” the ups but not having to experience the downs.  Don’t know what an indexed annuity is? Contact me for more info: peter@moneymastery.com.

Do not confuse indexed annuities with variable annuities. Variable means you are in the market and must therefore be subject to the full ups and downs. Even if you placed your money in a strong New York Life variable annuity, remember, your money is in the market, not invested in New York Life, so it is subject to market ups and downs. Many people have made the mistake of assuming they were safe because of the financial strength of New York Life. But in my experience variable annuities can experience drops in value and then you still can’t get your money out during a bad drop because annuities aren’t all that liquid.

Now indexed annuities are even less liquid than variable annuities, so there is some disadvantage there. They may not work for you because they are not liquid enough for your needs.  But indexed annuities are guaranteed not to lose money and to share in the increases of the market.  And that’s a good thing.  If you are close to retirement and want a safe rate of return, and no downside risk in the market, these are great tools to use.

As a final note, there is one way to overcome to some degree the liquidity problem with indexed annuities and that’s by “laddering” them. You have probably heard about laddering CD’s and it works the same for indexed annuities. For example with a CD, let’s say you had $100,000 and wanted a good 5-year rate of interest on your safe money. You could split up the $100,000 into five $20,000 CDs.  Schedule each CD to mature one year apart, so $20,000 for a one-year CD until it matures, then place the next $20,000 in a CD that matures in two years, and so forth. Then in one year, the first CD matures, which if you need the money, you take it. But if not, it rolls over into a 5-year CD. In this manner, you have $20,000 maturing each year and in five years you will  have a five-year CD providing a top rate of return. To get the same impact for indexed annuities, you can “ladder” these annuities and provide better liquidity while getting the best possible rate of return.  

Contact me for more information on better ways to fund retirement than just dumping money into a 401(k) and hoping for the best: peter@moneymastery.com.

More Ideas on What to Do with “Old” 401(k) Money…

As noted in my last post, “How Old 401(k) Funds Can Get You Out of Debt Quicker,” many people change employment and still have money sitting in an “old” 401(k) they set up with their previous employer.  In my last post, I noted that this money can be used to pay off high-interest-rate debt, such as credit cards.

Here are some additional options to think about in terms of how to use this money instead of leaving it behind where is doing very little to benefit you today:

Option 1:  Roll this 401(k) money over into an IRA that you control.  Put it where you might get a good rate of return and have little or no risk.  Make sure you keep control of this account and can take the money out as needed.  Of course there will be a 10 percent penalty to pay if you do withdraw from an IRA before age 59.5, but that does not apply to the 72(t) tax rule. This ruling allows you to retire this plan (meaning you no longer contribute to it and only take the earnings from it over your life expectancy, usually age 84) without incurring a penalty. 

So, for example, if are say age 44 and have $100,000 in an account you retire, you will receive $3,365 per year without any penalty. CAUTION:  Once you select this option, you cannot change it  until age 59.5.  This example is simplified, so check with your tax adviser on how this best fits your circumstances.  There are places to put the $3,365 each year that can make you around 4 percent interest per year. Contact me for more details:  peter@moneymastery.com. So for this example, this means that when you reach age 59.5, all the money you started the account is still there, as you only took the earnings when you took the 72(t) option.

Option 2:  Roll the 401(k) money over into your own IRA that you control, then convert some portion of this amount once a year to a Roth IRA.  After five years, the principal amount you placed into the Roth IRA can be taken out without a penalty.  Check with your tax adviser first before taking this option to make sure you know all the rules associated with it, but in general this is another great way to get money out of an old 401(k) without paying a 10 percent penalty.

Option 3:  Roll the 401(k) money over into your own “self-directed” IRA.  There are extra fees you pay to the trustee of these kind of plans, but they allow you flexibility on where to invest and manage your money.

These ideas are for the purpose of giving your alternatives to leaving your money in an old 401(k) or IRA.  By being creative you can double the amount of money you might otherwise have if you just leave it where it is. For more information on these options feel free to email me: peter@moneymastery.com.

How “Old” 401(k) Funds Can Get You Out of Debt Quicker…

Are you one of those people who has changed employment and still has money sitting in an “old” 401(k)?  I want to give you options to think about in terms of how to use this money rather than just leaving it sitting there doing very little to benefit you. 

Take a look at the following illustration. It shows an employee putting money into a 401(k) “vault” of sorts:

The reason I call the 401(k) a vault is because money in this type of account is sort of locked up. It’s not liquid and can’t be used very easily. Basically you have very little control over this money. As you examine this illustration further, you’ll see that there are cracks in the vault, which represent the expenses of keeping your money in the 401(k) vault.  The vault does not offer protection from losing the money, as it is most likely invested in the market or mutual funds, which have volatility.  And notice when you retire and start drawing down on this 401(k) Uncle Sam is there, positioned to take a share of everything that you’ve put into the fund, plus any amount it has grown.

Now take a look at a couple I’ll call Mark and Joyce and their “Get Out of Debt” report, which is based onPower Down principles of quick debt elimination:

If Mark and Joyce will control spending so as not to keep getting into debt, they can have all debts paid off in less than 10 years.   It demonstrates how Powering Down your debt will get you debt-free in about 9 years, including your mortgage.

Now combine these two concepts of how the 401(k) locks up your money with the Power Down principle of getting out of ALL debt in less than 10 years. If Mark and Joyce were to consider taking all the money in an old 401(k) to pay off debts with higher interest rates, this could jump start their debt elimination considerably. Now of course, if they are younger than age 59.5 then they will have to pay a 10 percent penalty on top of the income tax due, but I don’t think you should be afraid of the 10 percent penalty because it’s less than those  high-interest rate debts you would use the 401(k) money to pay off.

Here’s how it could work:  

  1. Roll your 401(k) money into an IRA, so you have control.  Consider a credit union’s IRA savings account and remember earning interest is not the point. 
  2. Early in the year, like January or February, consider taking out a large chunk (in this example, I’ll use $10,000) and pay off credit card debt.  Taxes and penalty on this collapse of the 401(k) money are not due until April of the NEXT year. 
  3. Using this example, you would pay off $10,000 worth of high-interest debt (I’ll use a 22 percent credit card) and save that 22 percent for one year, which would equal $2,200.

Viola! You have just paid off a high-priced debt AND you are saving a ton of interest you would have had to pay to the credit card company. This suggestion would save you from paying interest of $6,500 on the credit card if you were to pay it off over a 5-year period, or much, much more if you never paid off the card at all!

So if you have an OLD 401(k) consider “using” it.  It does not have to stay in the “vault.” As it sits in the “vault” fees are being assessed, the market can decline, and in the meantime you owe $10,000 with a 22 percent interest expense on credit card debt — you’re basically going around and around in circles instead of getting on the road to total debt elimination.

While this is a great idea, I want to CAUTION you.  If you do not control your spending and therefore cannot save the monthly credit card payment of $275, in this example, you had better not touch the 401(k).  It makes no sense to pay off debt in this way where you will pay a bit of a price to do so if you are just going to get into more debt.  

Contact me with your debt information and I will prepare a Power Down report for you at no cost that will show you when you will be completely out of debt: peter@moneymastery.com.

What the Future Holds for Tax-deferred Accounts

Don’t you think it is better to have one bird in the hand, than two birds you can see in the bush?  Of course! Then why do so many people defer their taxes by using 401(k) plans, or others like it, when the future and the markets are so uncertain?  We all know the federal government is overspending.  We all know the feds cannot possibly pay out the Social Security and Medicare benefits it has already committed to.  Do you think taxes just might go UP?  Wouldn’t it be better to pay taxes now, and then never again? 

Since the average person reaching age 65 has less than $60,000 of total assets, why would you consider to deferring taxes until the worst possible time in your life, when you can least afford to pay them?

Consider this: When you start drawing money from these tax-deferred plans it can easily force your Social Security benefits to be included for income tax purposes also, meaning you will pay at a higher tax bracket.  So knowing this in advance, it’s time NOW to reconsider how you really want to fund retirement and how you want to pay your taxes. Don’t just go with what everyone else is doing, consider that there might be many other viable options for creating a predictable retirement you cannot outlive than throwing money into a 401(k). Contact me for these ideas:  peter@moneymastery.com.

Do You Need a Financial Parachute?

If you ever need a parachute, and don’t have one, you will never need one again.  Now apply this to your retirement.  If you don’t have a retirement, and you are arriving at that age in 5 years, you won’t have time to get one before it’s too late.

Here are national statistics to consider as you review your need for a financial parachute. 

First, the average amount of money saved in all 401(k)’s is $5,000.  ‘

Second, only 28% of employees who have access to a 401(k) actually deposit any money into it. 

Third, for those reaching retirement age of 65, they have assets totaling only $60,000. 

Fourth, 10,000 people each and every day are turning age 65 for the next 14 years.  

Okay, so what if you are nearing retirement age and you don’t have that “financial parachute?” Don’t panic, it’s not everlastingly too late, it’s just time to get serious… NOW! Everyone can improve their retirement income, no matter how late in the game, no matter how little the money.  Some things can be done to at least get a small parachute.  Please go to www.moneymastery.com and signup for the Select program, then complete the retirement worksheet. Then email your questions using the “ask a coach” feature within the online training.  This will be the best financial decision you make in your life.

Answers to Important Questions You Need to Know for Retirement…

What follows are 9 questions centered around my experience over four decades of helping people plan for retirement.  They are varied and don’t necessarily hook together, but they are quick and to the point.  See if they help you.  

  1. Are people shocked with taxes to be paid when they retire?  Yes, and no.  Some people have not accumulated very much money for retirement so taxes will not be an issue.  But for those who have saved all their money into a 401(k) plan, they will see taxes going from 15% to 25% when they add their Social Security benefits on top of earnings.
  2. What happens to people’s retirement funds when they reach age 70 Once a person reaches age 70.5 years old, they are required to take money out of all deferred accounts, like a 401(k).  This percent of balance grows as they get older so by age 80 it is close to 12% of the balance.
  3. Why should retired people stay below the 15% tax bracket?  Because this is the first level of tax, and it goes up to a higher bracket once a person reaches $75,000 annual income.  So if a person gets close to this level, it’s best to find a way to pay tax deductible items before the end of year so you don’t bump up into the 25% bracket.
  4. When should a person consider a Roth IRA?  Tax planning means to know where your level of income will be and convert funds from a deferred account into a Roth IRA years before you retire, and do it systematically so the amount you convert is low as you can get it, but still get the job done.
  5. Some folks have been able to save in a regular bank account, mutual funds and tax deferred accounts, like 401(k)s.  Where should they take their income at retirement from first?  It is best to even out your taxes over the years.  If all you do is defer everything, then at retirement and especially when age 70.5 arrives, the taxes will be much more than normal.  This really hurts to get to retirement and have to ask yourself, “Why didn’t anyone tell me about this before now?”
  6. What are some surprises most people find out at retirement People find they must have a spending plan (this is not a budget), or they will run out of money.  Up until retirement they could get along, wing-it a little because they might get a pay raise or a bonus or a large tax refund that gave them extra money to do fun things with.  But at retirement those extras go away unless you plan for them in your spending.
  7. What other surprises might someone find at retirement?  The biggest problem I see when people retire, then spend some money their first year, is that they find that within 7 years they will be totally out of money.  They kind of know this, but it hits them hard after the first year in retirement.
  8. What can a person do when they see they will run out of money in 7 years? They can slow their spending, get a part-time job making extra income, or sell an asset, and possibly get a reverse mortgage on their home to pull out extra money and turn this into income.  Many other ideas are available, but you will have to get creative. I suggest you contact me for some really great options that most other advisors will never tell you about:  peter@moneymastery.com. 
  9. Would you be willing to answer more questions that arise out of this retirement discussion Of course! It is hard for people to work at a job and learn all the rules about retirement.  They work hard and come home tired and the last thing they want to do is research tax code or call creditors. All I do is study various options surrounding the retirement decision so I can bring you lots of examples and ideas tailored to your specific situation so you won’t arrive at retirement broke, or run out of money in only a few years.  Call me or email:  (801) 292-1099, peter@moneymastery.com for a no-cost consultation.