“The problem with retirement is you never get a day off.” – Abe Lemons
Retirement planning is a somewhat new fad. There was a time when people were just working… if you live, you work. In 1881 Otto Van Bismarck petitioned the Riechtstag to create a system of government that supported the elderly, and the German parliament gave birth to the “pensions” as we know them today (they cleverly fixed their retirement age at 70 years, nearly the same as life expectancy). ). America followed suit with the Social Security Act of 1935, creating a legal retirement age of 65 for us Yankees. Several generations of Americans planned for retirement by working and counting the days until they could collect Social Security and their pension. Then everything changed.
As demographics spiral wildly out of control — people work fewer, retire more, and live far longer, benefit plans have inevitably gone by the wayside. The Revenue Act of 1978 created the 401(k) and a modification in 1981 that allowed deduction contributions launched a new age of retirement {401(k) is for personal sector employees, government employees have an identical 457 option and non-profit employees have a 403(b) )}. There are now more than 30 million employer-sponsored retirement plans with total assets exceeding $7.7 trillion. It should be noted that IRAs (Individual Retirement Arrangements), which are often funded by legacy corporate retirement plans, also hold over $8.6 trillion. (https://www.ici.org/pdf/ppr_17_rec_survey_q3.pdf) So why is there approximately $17 trillion in the ridiculous plan? Let’s see.
- Tax
One of the main “benefits” marketed by 401(k) providers and accountants seeking a better current-year tax return is the ability to defer earnings. The word needs to be repeated, DEFER, because it’s usually confused with the word austerity. A quite common adage is, “Contribute $10,000 to a 401(k) at work, you don’t pay for it, Uncle Sam does.” Wrong! It’s true that somebody who earns a $100k salary and contributes $10k before taxes into their 401(k) has lowered their taxable income to $90k This years (without taking into consideration other deductions). However, the suspension creates a corresponding compound tax liability. Distributions that qualify in retirement will be subject to ordinary income tax on not just your contributions, but all your investment gains.
- But You’ll Retire in a Lower Tax Class
Or will you? Most of my clients want to maintain, if not enhance, their lifestyle in the Golden Years. This must be paid dearly. Wealthy individuals may find Social Security, pensions, and retirement distributions sending them into higher tax brackets than initially planned. Not to mention that many of your previous write-offs may no longer be available (i.e. dependents have moved out of the house, mortgage interest paid off, pre-tax retirement contributions, etc.). Also, today’s tax rates aren’t rigidly set. With more than $21 trillion in national debt, there’s little chance the tax rate could rise at some point. (http://www.usdebtclock.org/) Retirees are often surprised when the statements they’ve received for so long with high balances begin to spend much less.
- Then I’ll Keep Delaying
No, you will not. The IRS wants their tax revenue, so at age 70.5 you should start making Required Minimum Distributions. Failing to collect your RMD can result in a 50% tax penalty! (https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-required-minimum-distributions#1)
- This Money Is Only For Retirement
It is true. Unfortunately, life is not lived in a laboratory and sometimes the unforeseen happens. 401(k) participants are typically not allowed to access their funds before Age 59.5, it’s subject to a 10% penalty in addition to additional income tax. Your plan allows for hard withdrawals and waives your penalty (i.e. to buy your first home, pay medical bills that are not reimbursed, pay for college, etc.) Your employer’s plan may provide other options for taking out a 401(k) loan up to $50k or 50% of your plan balance (the lower of the two). Either way, be prepared to jump through some hoops or pay heavy fines if your household happens to need some extra cash.
- I Can Invest In Anything I Want
Not too. 401(k) plans have limited investment options, normally limited to mutual funds and sometimes ETFs (exchange traded funds).
- My Retirement Plan at Work Free
Nothing is for free. A 401(k) carries administrative and investment costs basically still retaining a cost of funds based on company and management activities. Some 403(b) for school systems even use a Variable Annuity chassis which can carry greater costs and limitations.
The 401(k) has absolutely found a place in today’s retirement planning environment, offering some smart incentives like automatic payroll deductions and sometimes invaluable employer matches. Some plans are also starting to offer a Roth option to address some of these tax issues. But as we have seen, there are quite a lot of strings that participants should know about. A smart investor should carefully consider market risk, current and future tax obligations and liquidity before making any investment decision.
BIOs:
Bryan M. Kuderna is a CERTIFIED FINANCIAL PLANNER™, a Life Underwriter Training Council Fellow, and an Investment Advisor Representative with the Kuderna Finance Team. He is a perennial qualifier for the industry’s prestigious Million Dollar Round Table®, Leaders Club, and Inner Circle. He is the author of the best-selling book, “MILLENNIAL MILLIONAIRE- A Guide to Become a Millionaire by 30”.
Bryan has a Bachelor of Science degree in Finance and Economics from The College of New Jersey. He also studied at The University of Tampa and The University of Economics in Prague, Czech Republic.
He is a featured speaker across the country at college campuses, teaching hospitals, government offices, syndicated talk radio shows, and major publications on the topics of Financial Literacy, Millennial Business, Networking, and Personal Development. Her work has appeared in Forbes, Business Insider, CNBC, Huffington Post, Broker World, Financial Planning Magazine, Entrepreneur, Think Advisor, Millennial Mag, Success and plenty of more.
In his spare time, Bryan enjoys hanging out with his wife, Anita, and their three kids. He has successfully completed The National Marathon in Washington DC, in addition to The Ironman of North America in Quebec, Canada. He proudly serves on the Board of Directors of The Community YMCA, The Colts Neck Business Association, The Asbury Park Rotary Club, Fellow of Lead New Jersey (LNJ)- Class of 2016, and The Monmouth Ocean Development Council (MODC).
You can find Bryan at www.kudernafinancial.com or www.thewhitebook.net.
