Both Wall Street and Corporate America are very fond of retirement plans like 401K and SIMPLE and SEP. Have you ever asked yourself why? Being somewhat cynical, I have: and the answer I came up with was disturbing at best.
For financial institutions, the retirement plan permits them to charge much higher fees then they ever could collect under the old fashioned defined benefit plans. For corporations, retirement plans allow the employer to shift investment risk and funding cost to employees. Presto, two problems solved: Revenue generation and risk transfer.
As a professional and small business person, preparing for your own future, does the conventional wisdom of retirement plans really work for you?
Before we answer that question, let’s first talk about the 5 great risks of retirement plans: Savings Risk, Investment Risk, Longevity Risk, Government Rule Change Risk and Tax Risk.
Savings Risk is the risk that you will not be able to save enough in your retirement plan to provide an adequate retirement.
Investment Risk is the risk that even if you do save enough, you will choose the wrong investments and lose all or part of what you have saved.
Longevity Risk is the risk that even if you save enough and wisely invest, you will outlive your retirement plan value and be destitute in your final years.
You are in a partnership with the government and you are the minority partner. The government can change how much you can contribute, the tax treatment (now and in the future) and just about anything else any time they want. This is Government Rule Change Risk. Example: at one time there was a penalty for accumulating too much money in retirement plans: 15% excise tax on amounts over $750,000. By the way, that penalty has been suspended (not eliminated).
Tax risk is the risk that when you go to use the money you have saved, you may be in a higher tax bracket. Taking into account the situation in regards to Medicare, Medicaid, Social Security, not to mention the war in Iraq there are a few questions to ask yourself. Will taxes go up, down or stay about the same in the next 20 years? Will my retirement assets be positioned to take advantage of the tax situation at that time?
This is the part of the article that most experts would begin to tell you how to overcome each of the above risks. The problem with applying conventional wisdom to such issue is that it doesn’t always work. This goes back to my point of why corporations and financial institutions want you to buy into retirement plans – they have their own agenda. That agenda doesn’t necessarily work for your benefit.
You can use techniques to offset the individual risks, but sometimes, that very effort creates other risks and problems. Let’s use longevity risk as our example. You can offset longevity risk by using what’s called an immediate annuity. An insurance company agrees to take your retirement account value and promises to pay you an income for the rest of your life – no matter how long you live. Sounds good because you’ve offset the risk, but there is a cost. First, you lose control of that money. Once it’s in the hands of the insurance company, you can’t change the payment structure – even in the case of an emergency like illness. If you die after receiving a couple years of payments – your heirs loose all the money. Of course, you can set up the annuity to pay you for your life and include payments for a certain period or guarantee payments to a spouse, but you get much less income in those scenarios. PLUS, you pay a big fee to the insurance company when you purchase this product.
As business owners and professionals we must think about retirement planning as more than just accumulating money in a retirement plan. While we accumulate, we should be thinking about how that money will distribute to us when we need it and how it will be conserved as we reach the end of our lives.
- If a retirement plan builds wealth while we are working, but that is eroded by risks before retirement – is it really wealth?
- If taxes eat a large chunk of our retirement plan just when we need to use it – can we really count it as wealth?
- If we can’t pass on the money in our plan without paying multiple levels of tax – are we really building wealth?
The take away wisdom: The only way to make progress towards your goal of a comfortable retirement is to focus on how all the pieces work together to efficiently build wealth, allow you to spend it and pass it on. The “Micro-Economic” management of risks and benefits, when it comes to planning for retirement, just won’t get you any further ahead. If you take away only one idea from this article let it be that the better the phases accumulation, distribution and conservation integrate and coordinate together towards your goals, the better off you will be now and in the future.
Action Plan: I recommend that professionals and business owners thoroughly review their choices when it comes to retirement planning. Everything you have in your financial model can (and should) be used for your retirement. A comfortable retirement is about more than just starting a retirement plan or buying a hot investment. Retirement planning starts with coordinating and integrating the phases of your life while using the efficiency of money to build the most wealth you can (while controlling risk).
Joan Gilles is a Financial Coach. She helps business owners and professionals get really clear about what it is they want financially. Then, she gives them a model and tools to get it. Because. you deserve to have everything you desire. What makes her different is she does her work without taking money out of a business or personal pocket. She can be reached at 651/578-2961 or jmgilles@pressenter.com
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