Still Believe Your 401k Is a Main Cog In Your Retirement Income Plan? Think Again
Let’s just get down to brass tacks. Your 401K/IRA is virtually guaranteed to let you down when it comes to the income on which you’re relying for retirement. You’ve been lead down the garden path. Ironically, these so-called ‘qualified plans’ are in reality very well designed future streams of income — for the Treasury Department — not you. This is especially true, often painfully so, for Boomers. It’s a classic bait ‘n switch play.
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The taxpayer, that’s us, is attracted to the bait of some cheap, but helpful (not much) tax savings — now. Let’s say you’re contributing $10,000 a year to your company’s 401k qualified plan. You’re pleased with the 20-30% or so in tax savings each year. (Depending upon your marginal rate and the state in which you reside.) We’ll say it’s the top of the range, 30%, or $3,000. This means from age 35 when you began, ’til 65 when you retired to make it work. During that 30 year period you saved (rounded up), $100,000 in taxes. If you made about 7.33% average annual return, you won’t, but we’ll say you did, your balance at 65 would be $1 million. Again you won’t do that, but we’ll say you did.
For as long as I can remember, Wall Street types have been tellin’ us to expect to live on a yield of around 4% of what we have at retirement. One wonders what they’re tellin’ those who retired recently? They’re not makin’ 4%. In fact, given that the yield on the 30 year bond is now at 3.04%, there is much disappointment out there. Imagine spending 30 years diligently putting in your $10,000, for the truly enviable privilege of making just over $30,000 a year upon retiring — before taxes that is. Oops. Wasn’t that $100,000 in tax savings over the last 30 years worth it?! Gimme a break.
Before you begin thinkin’ you’re the exception, and you may be, here’s what the average 58 year old American man has in his 401k: Less than $70,000. MegaOops.
But what if . . .
I speak to many in this situation, week in and week out. Let’s say they’re mid-40s and have been contributing to a 401k(s) since their mid-late 20s. So far, they’ve amassed around $385,000 in total 401k funds. If they were to take half out this year and half next month, the net after taxes/penalty(s) would probably be in the neighborhood of about $200,000. (But don’t believe me, believe your CPA.) Experience says it could be less, but unlikely to be much more. Add to that their savings in excess of cash reserves, and maybe some home equity, and they will have gathered roughly $280-295,000.
Yes, the tax/penalty hit was brutal. You wept. Better tears now, than at retirement, right? You bet.
You also ended up with four little income properties in a great region. You locked in historically low interest rates on all of ’em. Around 5%, maybe a tic less. Long before you retired, you’d combined the properties’ cash flow with disposable after tax income from your job(s).
20 years pass and you’re 65 — ready to retire
It took you about 15 years to pay them off. It could’ve been a lot sooner, but you were pretty conservative with your income. In the immediate five years before retiring, the cash flow from properties now debt free, accumulated at approximately $75,000 annually. Much of that was tax sheltered. In other words, in the immediate five years prior to retiring, you stockpiled $250-300,000 in cash — after tax.
Oh, and that income? It was projected to be the same in year 5, 10, 15, 20, and beyond as it was the day you acquired the units. The NOI is the same $75,000 it was 20 years earlier. They’re free ‘n clear of debt, so your net worth in these properties is a cool million bucks. We also assumed they’d never go up in value.
In order to equal that in your 401k, you’d first have to get your invested cash in the stock market up to $1 million or so. You can’t afford many, if any losing years. Good luck with that. Then you’d hafta earn 7.5% — year in and year out. Not freakin’ likely in both cases. You simply aren’t gonna get there.
OR . . .
You gather your available capital, follow the above real estate investment scenario, and make retirement income of $75,000 a year, while sporting $1 million in equity. If you think the projection of flat rents for two decades along with no appreciation in value for the same 20 years isn’t conservative enough, I don’t know what to tell ya. In no 20 year period in our lifetimes has real estate values failed to go up, net. Nor have rents been anything but higher over the same stretch.
Either way, the guy/gal who goes for the real estate is almost guaranteed to retire with a relatively highly secure income — with a million dollar equity available if life makes it necessary. Leave your 401k in the rearview mirror and give your retirement a fighting chance. Remaining in the qualified plan will doom you to a life sentence, not a retirement.
The numbers are against you. It was planned that way. Don’t take the bait. Do what they don’t want you to do.