| You may have heard of a 401k planner. An advisor | | | | bracket, your spendable income would be only |
| who helps set up 401k plans. These investment plans, | | | | $12,750 meaning that you've already paid back |
| disguised as appropriate retirement planning | | | | $2,250 in taxes. Now, if you plan on living more than |
| strategies, are nothing more than investments | | | | 7 years in retirement, then you would have paid |
| (stocks and bonds) wrapped up into other financial | | | | $15,750 in taxes - which is more than you've saved in |
| products (mutual funds), which are wrapped up under | | | | taxes over the course of 30 years! |
| an "umbrella product" (a 401(k) plan). | | | | But, I know what you're going to tell me: My |
| With all those wrappers, you have to believe that | | | | employer gives me a matching bonus on my |
| someone is getting paid for all that wrapping, right? | | | | contributions, so doesn't that make it worth it? My |
| Well, they are...and the fees can be enormous. But | | | | answer to that is: It depends. If you are in a |
| before we get to that, let's take on a few | | | | combined Federal and State (marginal) tax bracket |
| misconceptions about these investment plans. | | | | (rate) over 20%, probably not. |
| For many financial advisors, it is considered sound | | | | Suppose you invested $175 per month and your |
| financial advice to maximize your contributions into a | | | | employer kicked in another $175 for a total of $350 |
| qualified retirement account. For example: If your | | | | for 30 years in a 401(k) and you accumulated a little |
| annual salary is $40,000, and you contribute 5% of | | | | over $500,000 after fees and expenses charges. |
| your annual salary, or $2,000 to a 401(k) or IRA, and | | | | Let's say you withdraw 5% of that every year or |
| your marginal tax rate is 25%, then you are saving | | | | $25,000. You are going to pay taxes on that...and we |
| approximately $500 per year on income taxes. If you | | | | can probably assume that you are still in a 15% tax |
| plan on retiring in 30 years, you've saved $15,000 | | | | bracket, unless the U.S. tax system radically changes. |
| over the course of those 30 years. | | | | At 15% FEDERAL, you will pay $3,750. |
| If you did alright in your 401(k) or IRA investments | | | | Now, instead of using a 401(k), what if you chose an |
| and averaged 8% for those 30 years, you'd have | | | | after-tax contribution in exchange for tax-free |
| almost $245,000. The traditional approach to financial | | | | income at or during retirement? |
| planning would say that you've done very well for | | | | ...you would have to cough up a little more dough |
| yourself. | | | | initially because you didn't get a tax break upfront. |
| However, let's take a closer look at this situation. If | | | | You manage to accumulate only $450,000 after fees |
| you noticed, we've only just talked about the | | | | and expense charges. You draw the same 5% |
| accumulation phase - not the distribution phase. So, | | | | income, and that equals $22,500 - but that $22,500 is |
| let's take a look at the second half of this | | | | tax-free. It doesn't take a brain surgeon to figure out |
| "retirement equation". How much have you actually | | | | which was a better deal. |
| saved now as a result of pretax contributions? | | | | You have accumulated slightly less with your |
| A big mistake that individuals make is thinking that | | | | after-tax account, but who cares? You have more |
| they will be in a lower tax bracket in retirement than | | | | income. And...to get that lump sum out of your |
| when they were working. The truth is, many times, | | | | 401(k), you'll end up with FAR less that what's in |
| they are in the same or higher tax bracket. Let's | | | | your after-tax account. |
| assume that you want to withdraw just $15,000 | | | | Basically, the 401(k) looks good on paper, but when it |
| (6%) a year to supplement your retirement. If you | | | | comes time to use it, the taxes take away all of the |
| are like most people, you find yourself surprised by | | | | advantages. |
| the fact that you somehow wound up in the same | | | | When (or if) a "401k planner" approaches you, just |
| tax bracket as when you were working. You don't | | | | be aware of the idea that most individuals in the |
| think that would happen to you? | | | | financial planning industry are focused on product |
| Ok, let's take a look at what this means to you in | | | | sales and not financial advice backed up with |
| retirement even on a more conservative tax | | | | appropriate product sales. Even a "401k look-a-like" |
| assumption. Out of that $15,000, even in a 15% tax | | | | plan is not a comprehensive retirement plan. |