There is a familiar parable about the wise man and the foolish man. The wise man built his house upon a rock. When the rain fell, the floods came, and the winds blew. The house did not fall because it was built upon a rock.
The foolish man built his house upon the sand. When the rain fell, the floods came, and the winds blew. The house built upon the sand fell.
Many Americans sticking to conventional wisdom are building their retirement on shaky foundations.
Tax-deferred money in 401(k)s, 403(b)s, IRAs, etc. can be a risky foundation because of:
- Where the money is invested
- Future taxes
Tax-Deferred Money Invested in the Market
Investors often invest money from tax-deferred plans in the stock market. Your hard-earned money is at risk for market loss!
The years from 2000 to 2010 are frequently called “The Lost Decade for Stocks.” If you had $1 million in the market in 2000 and rode the market for the next 10 years, you would have just under $1 million at the end of 2009. The S&P 500 annualized return over that decade was – 0.9%.
It wasn’t until mid-2012 that the market returned to its starting point of 01/01/2000.
Investors (people who had their money in the market) lost trillions of dollars. Not only that, they also lost the opportunity to earn money on that investment over those 12 years. It’s called Opportunity Cost.
For example, if in 2000, you invested $1 million into a guaranteed growth account at 5% per year for 12 years, you would have $1,819,848. That is an opportunity cost of $819,848.
During the 2008 financial crisis, the S&P 500 fell 48%.
As of August 2020, the S&P 500 index had lost 34 percent of its value due to the COVID-19 pandemic. While the 2020 stock market crash was dramatic, it didn’t last.
2022 saw significant market volatility; the S&P 500 closed out the year with an 18.11% loss, when you include the return from dividends.
Are you willing to chance your hard-earned retirement savings to the uncertainty of the market? Your spendable cash flow is dependent on the unpredictable nature of the stock market and is entirely out of your control.
Future Taxation of Tax-Deferred Money
Contributors do not pay taxes on the money they contribute to a 401(k), 403(b), IRA, etc. Many advisors (CPAs, financial professionals, HR Directors, tax preparers, etc.) will say you are “saving” taxes and encourage you to “max out” your annual contributions.
Let’s see how that plays out over time from a tax perspective.
The pre-tax investment has a larger balance after 30 years. It seems like a no-brainer, right? Take the tax-deferred plan with the bigger balance!
However, when you consider taxes, you will pay $16,940 per year with the pre-tax plan. In just two years, you will have paid more taxes than you did over 30 years in the after-tax plan.
Keep in mind, this example assumes taxes do not increase. Again, future tax rates are uncertain and out of our control.
For higher income earners, deferring taxes may be in your very best interest! If your annual income today is say $300,000, and you only need $150,000 to live on per year in retirement, delaying paying taxes may absolutely be your best decision.
Do the math. Consider the tax implications of the decisions you are making today on your lifetime wealth plan.
Fees on Tax-Deferred Investments
To add insult to injury, money in the market comes with fees. Many investors think the 1% fee they are paying to their advisor is the only fee they are paying. Not so! Depending on the investment, many accounts and funds are loaded with additional fees and charges.
Let’s see what a 1% difference in fees can have on your investment.
In this example, your account balance after 30 years with just a 1% additional fee is a whopping 24% less! That is significant when every dollar lost in fees is one less dollar to spend in retirement.
Find out exactly how fees are impacting your hard-earned invested money, especially if you have your money in an employer-sponsored retirement plan. Those plans often come along with additional plan fees of which you may not even be aware.
If Not Tax-Deferred Retirement Plans, Then What?
After-tax investment accounts face the same three risks to the safety of your money that tax-deferred plans do; however, they only tax the “growth” in the accounts at capital gains rates, not ordinary income tax rates.
There are a plethora of other ways to save money for retirement, many of which carry risks to the safety of your money.
Do the math. Peel back the skin on the onion. Discover exactly how the decisions you are making today will impact your future lifetime wealth strategies.
Safe Retirement Money Strategies
Unfortunately, there is great competition in the finance industry between the investment and insurance sides of the financial services equation. If structured properly, many insurance company strategies can be a very valuable addition to your lifetime wealth portfolio. Many of those strategies eliminate several risks to the safety of your money including market volatility, unknown future taxes, and investment fees.
Safe money strategies can be started shortly after birth all the way up through your early 70’s.
Dually Licensed Advisor
Strongly consider working with a dually licensed advisor; one who has the licenses to recommend and sell both life insurance products and securities. It is truly in your best interest, because your advisor can strive to address all your financial needs and ensure that all your financial pieces fit together. It also eliminates the need to seek the advice of multiple advisors leaving you to DIY your lifetime wealth management strategy.