There comes a time when retirement becomes very real. In my experience most people begin gettin’ that twitch in their get-along the closer they get to 50. It’s not much later when it dawns on ‘em that their 401K just ain’t gettin’ it done. In fact, if at 50, their $500,000 401K never had another losing year, AND averaged an annual yield of 8%, they’d not like the results. (Before continuing, here’s a sobering fact: The average American male of 58, has far less than $100,000 in their 401K.)
“Whoa there, cowboy, they end up with almost $1.6 million! How are they not ecstatic?”
I answer that question multiple times weekly. What’s the 10 year treasury yielding this week, roughly 1.7%? Wow! Turn the music up and let’s party! That’s when all the bond geniuses come outa the woodwork sayin’ how much they can get buyin’ corporate bonds and the like. OK, let’s do that. The guys runnin’ your plan at work have been tellin’ you all along that in retirement you’ll be wantin’ to keep your risk at a minimum, which I’ve found to be true. Duh. They say to realistically expect a 4% return. Let’s use 5% and create an example.
5% of $1.6 million is just short of triple the 10 year treasury yield. Of course, anything yielding 3-5% on Wall Street now, carries with it a relatively higher risk. But since you’re happy with that, and the plan’s advisor gives you the nod, you’re good to go. That 5% yield will generate a retirement income of approximately $80,000 annually. But before you start with the cartwheels, remember, that’s a before tax figure. Before we start figuring the tax hit, let’s take a look at your life at retirement age, in this example it’ll be at 65. As I recently cracked during a phone conversation this week, ‘There’s no deduction for grandkids.” As do most folks, you enter retirement with a free ‘n clear home. No payments are excellent, but no payments mean no tax shelter either. The point is that every April 15th the IRS finds you completely naked when it comes to any real tax shelter. If you live in a high income tax state like California and a few others, that $80,000 is gonna get pounded. Let’s be quick about it and say you were able to salvage $60,000 when the smoke cleared, counting state and fed taxes.
Before continuing, let’s review.
You spent 30-40 years building up your 401k to $1.6 million. (You’re not gonna, but we’ll say ya will.) Along the way you were happy to benefit from the tax savings, usually somewhere in the $500 to $5,000 range per year. Let’s say you opened your 401k in 1981, and will retire next week — about 31 years. Let’s say the tax savings over those years adds up to $100,000, give or take. There was a lotta sacrificing, as you gave up new cars for used, cheaper vacations for the ones you wanted to take, and the like. Your discipline was awesome. Yet after merely five years in retirement, you’ve already paid as much in taxes on your retirement income as you save in 31 years. Here’s the question I ask people about this fact of life.
Why would anyone do that to themselves on purpose?
Don’t get me wrong, as I’m not pooh-poohing an after tax retirement income of $60,000 a year. However, I’m not sure most would smile appreciatively at that figure, if they were initially told they’d managed to accumulate $1.6 million, do you? Here’s what the Wall Streeters won’t tell ya. The reason they advise against so-called ‘alternative’ investments (what a transparent crock that is), is simple: All the ‘alternative’ investments don’t reside on their shelves. Funny how that works, isn’t it? If they have it to sell, it’s prudent. If not? It’s (vampire music in background) ‘alternative’. I know what you’re thinkin’. “Fine, Jeff, you’ve knocked it down, we get your point. But what’s your solution?”
If you can — take control now.
There are Americans all over the country who’ve figured out that by taking the tax hit — which is freakin’ horrific — on their 401K today, it allows them to create a tax free retirement income for tomorrow. This isn’t true if your 401K is at your current employer. But 10s of thousands have old 401s they’ve allowed to sit and gather dust. Or they have IRAs. There are a few other entities you can mess with at your discretion. These people are deciding to do one of three things, sometimes a little of all three, simultaneously.
They ‘gut’ their traditional pre-tax contribution based 401/IRA and pay the taxes, and sometimes a 10% penalty to boot. Then they decide what strategy(s) they’ll embrace.
1. They then open up a Roth type plan. Which kind depends upon individual circumstances.
2. They get an EIUL started — using the money they previously earmarked for pre-tax contributions. (Search BP for EIUL)
3. They take all/some of the after tax money and invest in real estate.
This AIN’T one size fits all.
I’m gonna limit this post to concept for now. The concept is to create as much after tax, or better yet, tax free retirement income as you can. What so many are discovering too late, is what they always knew: We don’t spend pre-tax income — we spend what’s left. Income from investments inside a Roth ‘envelope’ come to you tax free in retirement. What this means in real life is beyond simple. But it boils down to two pivotal facts.
First, since you’re in control of what you choose as your Roth investment vehicle(s), you’ll probably be like the vast majority who’ve already learned they can easily out produce their ‘job’ related 401k without taking stoopid risks. In many instances they’re slaughtering the pathetic returns. Pathetic? How about the last 20 years? 3.5% is the average annual return generated by employer related 401k plans. Impressive, no? Um, no. Raise your hand if you think you can double that return using ‘alternative’ investments while napping.
Second, even beginning with 50-60% of your original balance — remember, you paid major league taxes when you bit the bullet to pull this off — you’ll be able to create a tax free income equal to, or likely higher than if you’d retained the status quo. But wait, there’s more.
The income inside your Roth and/or your EIUL is tax free. Here’s what that means. If you merely equaled the $80,000 earned by the aforementioned $1.6 million, it’s now all ‘after’ tax money. In other words, that tax free $80,000 is the rough equivalent of over $100,000 in taxable income. To create 100 grand a year in taxable income inside your current traditional 401K — using the generous 5% we used above — means you’d hafta have garnered $2 million, NOT a ‘mere’ $1.6 million.
Beginning to see a trend here?
Again, just concept today. I plan to talk seriously and publicly about this subject after the first of the year. But I will tell ya that there are literally thousands and thousands of Americans who, if they can take a step back to objectively analyze what’s really happening to their retirement, instead of for their retirement, a light will go on. The difference can, and often is ginormous in scope. How would you like, in addition to your personal real estate portfolio, to generate five figures monthly — tax free — in retirement? Is it easy? Gimme a break. Nothing’s easy in this world. Everything we do in the investment world carries with it commensurate risk. That’s why they call it risk capital. But I do it. I counsel my own kids to do it. They paid the taxes and never looked back.
Retirement is all about what’s left after Uncle is done with us. The rest is HappyTalk.
Photo: kirybabeYour Retirement Income -- News Flash! You'll Only Be Spending AFTER Tax Income by Jeff Brown