Approximately seven in ten Americans report that money is a significant source of stress (71 percent), according to the American Psychological Association. That is why I’m launching my Financial Health Series with Shawn Perkins, a personal financial advisor.
Chronic stress has been shown to cause chronic disease and wreaks havoc with your psychological and physical health. The Primal Power Method focuses on nutrition and exercise, but is also about pursuing a truly healthy and happy life. Financial stress affects all of us at some point, so this is a great series to get your finances in order, which will ultimately lessen your stress, and make you a healthier person inside and out.
Gary Collins: This is Gary Collins, best selling author and creator of the www.thesimplelifenow.com. We’re back here again with Shawn Perkins with Principal Shield Financial Services. That’s a little tongue twister. This is going to be episode three. We’re going to talk about how you choose to save for retirement in our series of the five ways that you lose money.
Thanks a lot, Shawn, for coming on. This is another great topic because it’s a hot topic for everyone. What is it right now, seven out of 10 Americans don’t have over a thousand dollars in their savings account and have no retirement? I think that’s some statistic. I may be off on that one.
Shawn Perkins: It’s pretty close, but you get the idea.
Gary: It’s going to be a problem, and it’s coming. We’re going to see it in the next 20, 25 years. People are not going to have anything in retirement to live on. They’re going to be solely relying on Social Security. For someone like you and me it’s coming up in roughly 15, 20 years.
I’m planning for it not to be there. That’s how I’m planning my retirement. I just plan not to have Social Security.
Shawn: Right, right.
Gary: Go ahead and tell people how they lose money depending on how they choose to save for retirement.
Shawn: I want to first talk about a couple things that you just mentioned. Number one, I don’t think there’s going to be a problem with Social Security being there. I think Social Security will have to be modified in some cases, and this younger Millennial generation is going to take care of that because they’re not going to want to pay for you and I to sit on the couch anymore.
What will happen is they’ll more than likely reduce the benefits and they’ll extend the retirement age. They should have done it all along. When Social Security came out, retirement age was 65 years old. That was put in place back in ’35. When President Roosevelt put that in place, the average life expectancy was about 61 years. People weren’t actually expected to live to 65.
If you did, Social Security was meant to be a supplemental retirement income. It was supposed to be in addition to what you’ve already done. Today, it’s really not a supplemental retirement income for people. It’s become more of the sole retirement income for people. Whether intentionally or unintentionally, that’s the way the statistics work.
In fact, something like 75 percent of people going on Social Security are starting their benefits at 62, which is the earliest you can begin benefits for a typical retiree. You’re supposed to wait until 65, 66 or 67, depending on where your birthday falls and the year you were born, but 75 percent of those going on Social Security, they’re taking it at 62 years old.
Shawn: I don’t remember where I saw the statistic, but something in the neighborhood of 80 percent of the people going on Social Security, it’s the only income they have. Those are pretty scary things. That was an aside to set some things straight.
But how people choose to save for retirement? The number one people save for retirement today is qualified plans. We referenced this, or alluded to it, in the last episode on how they pay their taxes. Qualified plans would be 401Ks, IRAs, 457 plans, 403Bs, TSPs, Keoghs, things like that.
Those are typically tax deferral plans. People like tax deferral plans, because they don’t have to pay the tax on the money today. It can come out of their paychecks pretax. They feel like they’re saving taxes. The truth is they’re deferring taxes.
I like to refer to it as “postponing taxes,” because the tax is due. The tax man will knock on your door and expect his money in some point in the future. More than likely, it’s going to be at a point in the future when you can least afford to pay it, because you’ll have no write‑offs. The kids are gone. It’s just you and your wife.
You have no mortgage deduction, because the mantra today is to pay off your mortgage, so you don’t have a mortgage payment recurring. Now, you have no write‑off for that. You’ll have literally no deductions other than the standard deduction and your own personal exemption. That means basically all of your income above $20,000, for a typical couple, is going to be taxable at your highest tax bracket.
That means that if rates go up, then you’re going to be paying that tax bracket at a higher rate than what you could have paid when you could have afforded to pay it. That’s going to hurt a lot of people. We mentioned that future tax rates are likely to go up for the reasons that I mentioned in the last episode, which is Social Security.
We have the largest group of people retiring, some 80 million baby boomers retiring. They’re going on Social Security. They’re exhausting that system. They’re going on Medicare. They’re exhausting that something. We have two wars that we fought and several other conflicts that we didn’t raise taxes for. They went on the credit card. We have an 18 and a half trillion dollar debt today.
We have unfunded liabilities in the way of government pensions, city, state, and government pensions. All kinds of other unfunded liabilities that make the numbers quite staggering. Taxes are going to go up. I don’t think people realize that the only way for you to save taxes in a qualified plan, is for you to take the money out when you’re in a lower tax bracket than you were in when you put the money in the plan in the first place.
If you’re in a 25 percent tax bracket today, you have to take the money out in a 15 percent tax bracket, or a 20 percent tax bracket for you to save money. What does that typically mean for you to be in a lower tax bracket?
Gary: You make less.
Shawn: You have to make less money. I don’t know about you, but when I retire, I don’t think I’m gong to be able to live on less than what I have to live on today.
Gary: That’s a common problem. Most people don’t realize that when they retire that they’re not going to have the income they had before, but they’ll have all this free time in which you spend more than you did before you retired. It’s like this whole catch…you’re screwed.
Shawn: What if your medical costs when you retire exceed the mortgage payment that you got rid of? You haven’t saved a dime. You’re still in the same place. Now instead of having a mortgage that you can write off the interest on you’re paying medical premiums that you don’t get to write off. [laughs]
Gary: This is a side question, but what would be the amount? I know when I was saving up in my 401K and my TSP through the government, which I got rid of. I cleaned it out because I was scared the government would eventually just take it anyway, but that’s a story for another time. [laughs]
I did the math, too. I saw what my amount was after putting in over 10 years in it. It wasn’t much, and it was definitely not enough to retire off. I had it pretty much maxed out. I went, “OK. I’ve got another 15 years of work. It’s not going to be anywhere close for me to retire off of.” What would be that magic number?
I’ve heard you have to have at least a million in your 401K for you to even be able to retire comfortably. Is there a magic number by any chance that you know of?
Shawn: Everybody’s situation is unique to them. Inflation will play a role, and inflation is different for everybody. A couple things to consider is, one, you’re a single individual with no kids. Your lifestyle is going to cost less than mine does. I’m married and I have two kids. There are other people that are married and have three, four, and five kids.
Their rate of inflation or their cost of living is higher than mine. We were talking on the phone yesterday. You told me that where you live the gas is $2 a gallon. Where I live it’s $3.50. There are expenses that are different for each one of us.
Another thing that comes into play is, what expenses could you have when you go to retire 15 or 20 years from now that you don’t pay today and you couldn’t actually envision paying today because they don’t exist?
Let me give you an example. Did you ever envision 20 years ago you’d be paying $150 a month for a cell phone plan?
Gary: Yeah, exactly.
Shawn: Or you’d be paying $150 a month for 200 cable channels? Or that you’d pay $50 to watch a USC fight or boxing or whatever?
Gary: Or 100 for boxing.
Shawn: Exactly. Did you imagine at that time paying fifteen or twenty dollars a month to be able to stream video to your TV or your computer for Netflix or whatever? What things exist today that didn’t exist 30 years ago that you’re paying for, and they represent a substantial amount of your budget? What things could exist in the future that don’t exist today?
Those are things that you can’t plan for today, so to have a magic number, it doesn’t really work that way. Everybody’s situation is rather unique. Another thing that comes into play with you picking the magic number is we don’t know what interest rates are going to be.
If you have that magic number, if interest rates are lower than what you expect them to be, then your magic number’s going to pay you less money on a monthly basis than it would be if interest rates were higher. In the old days, cash was king. Everybody thought in terms of the magic number.
The truth is today cash flow is king. What we need to have is a consistent, reliable cash flow. Cash is great to have, but it’s not going to solve all your problems. Example, case in point. Somebody has $2 million in an account. What are general interest rates today on, say, a CD or a savings account? Less than one percent.
You might be able to find them as high as one‑and‑a‑quarter. If you have a $2 million account with a one percent interest rate, that’s paying you $20,000 a year. You can’t live on that. Now fast‑forward to where I think rates are going in the future. Rates jump back up to maybe five or six, or 10 percent, but at five percent you’d be getting $100,000. That you can live on,
Interest rate fluctuations are going to affect that magic number. The higher the magic number the lower the interest rate you can get away with. If you have 10 million and it’s a one percent interest rate, then you’re still living on a hundred grand.
The lower the amount that you have in the account, the higher the interest rate has to be to give you the income you need to survive. There’s really no easy way to pick that magic number. That can be applied to everybody.
We talk about tax‑preferred accounts. You have to take the money out in a lower tax bracket than you were in when you put the money in to save money. If we believe the future tax rates are going to be higher, that’s not a good thing.
Gary: It’s not going to work.
Shawn: Especially when you consider that the government doesn’t just have to raise tax rates to affect you. The government can affect your taxes by way of tax thresholds. That means each income bracket that they describe for whatever the tax brackets are they can raise or lower the income brackets within the actual tax rates.
If before to qualify for a 25 percent tax bracket, you had to make $140,000, if they lower that tax threshold, the income threshold, to a $100,000, now you’re paying 25 percent on everything over $100,000. That’s going to hurt a lot of people, and it will be unexpected and you won’t know it until you do your taxes because they don’t announce that kind of stuff on the news.
They announce tax rate increases, but not thresholds. That can blindside a lot of people.
We’re getting into taxes when we mean to stay on the retirement bandwagon, but another way you can get hurt in taxes is elimination of deductions. They’re always looking to consolidate and lower deductions. The less deductions you have, the more income that you’re going to pay tax on.
Getting back into the retirement conversation, we’re talking about qualified plans or tax deferral. Tax deferral can be a good thing, but it has a bite you need to know about, and most people don’t know about that. You’re going to pay the tax at your ordinary income tax rate when you pull it out.
We talked about 59 and a half at the beginning of this video. That’s another thing, they lack liquidity. Qualified plans lack liquidity. What I mean by that is if you find yourself with your back against the wall financially, and you need access to your money, if it’s in a savings account, you go down to the bank, you pull the money out, problem averted.
If all of your money is tied up into a qualified plan, if you’re younger than 59 and a half, there are very, very few ways you can access that money without a 10 percent penalty. Most people are going to fall under the 10 percent penalty.
In 2012, I want to say, there were $57.5 billion in 10 percent early withdrawal penalties processed by the IRS. That’s how much free money the government got for people accessing their 401Ks. You had to pay $57.5 billion, America, in penalties to access your money before the government wanted you to access it. That’s a pretty big penalty.
Lack of liquidity means you can’t get at your money when you need it and you have to pay a penalty to get it. There are ways to get that money without the penalty. You can borrow against some of your qualified plans. You can’t borrow against an IRA, but you can borrow against a 401K.
Certain other types of vehicles, 403Bs and what not, will let you borrow. You can generally borrow up to $50,000, or 50 percent of your vested balance, whichever’s less.
Then you have to pay it back at a rate of interest. Now, people will say, “Yeah, but I’m paying myself back.” There is some truth to that statement, but you are paying the institution a fee for the money and you’re paying interest to yourself. You’re paying that money back with after tax dollars.
You referenced in the last episode that double taxation. If you’re paying back the loan with after tax dollars, and then the growth on the money that you put back in there, you have to pay tax on it when you take it out, you’re getting double taxed.
There’s a couple of boom, punches in the gut that you don’t expect to have happen with these plans. I ask people, “Whose retirement are you saving for, yours or the government’s?” Know about all these sucker punches that are coming from all these different directions, and you don’t know the rules, it’s usually the government’s retirement that you’re saving for, and you get to keep a little bit of it left.
Gary: It’s the old term, nickeled and dimed to death. You get a little here, a little there, and it all adds up in the end.
Shawn: Let me ask you this question. If you had $100,000 right now in a qualified plan, how much of that money is yours?
Gary: That’d be about right now.
Shawn: What’s the balance before? How much is yours? What’s that?
Gary: I could get to $50,000 of it.
Shawn: What most people would say when I ask them that question is $100,000. I put the $100,000 in, it’s my $100,000. No. You have a partner in crime, if you will. You have the IRS as your partner. All the money that you put in there, remember the tax that you didn’t pay? That money’s in there, too. You deposited the tax that you should have paid the IRS in there as well.
The IRS is along for the ride. Their money that you owe them is growing along with your money. That’s why the let you do it. They don’t mind letting you put money into your account so that you can give them a bigger chunk later.
If you have $100,000 in that account, you want to know how much of that’s yours, think of it in terms of if you withdraw the money out of the account tomorrow, how much do you actually get in your hands?
Take out the 10 percent penalty, because you’re not 59 and a half. Now your $100,000 becomes $90,000. Add the $100,000 to your W‑2 income, and pay the tax that you have to pay on the $100,000. It puts you in a new tax bracket.
Now you get to keep about $50,000. You were right. 10 percent comes off the top, which is $10,000. Then you’re going to owe 39.6, or you’re going to owe 35, or whatever your tax rate is. You’re going to get to keep $50,000 to $60,000, so you don’t have that whole $100,000 that a lot of people think they do.
Gary: That’s a good point.
Shawn: That’s another…
Gary: Me and many friends have discussed this many times. I’m not the only one to cash out my 401K. Others have, too. We always said, “You get half.” That’s what you’re going to get. You just plan on getting half. That’s a mistake that even I made. I didn’t understand that. It was added to my income for that year.
I thought, “Well, I’ve already paid into that, that’s just money that is considered separate, and it’s not. It goes right into your income. Not only that, but it jacks you into the highest tax bracket usually. You’re maxing everything out, state, federal. Then you’ve got to pay the 10 percent penalty on top of it. You’re going to get killed. That’s the thing most people don’t understand.
I have borrowed against my 401K as well. I did that early on when I bought a house when I was much younger. I learned that lesson, too. I thought, “Oh, I can borrow it, then I just pay it back,” not realizing there was a fee, and then there was a percentage that I had to pay back. I think it was four percent, roughly.
Shawn: They’re usually very low interest rates, three and four percent, so they’re very, very reasonable.
Gary: Very reasonable, but that was my money. [laughs]
Shawn: Here’s the thing. You borrow your money because you want to put a down payment on a house. When you take out a mortgage, the interest that you pay on the mortgage is tax deductible, correct?
Shawn: The money that you pull out of your 401K, you’re paying interest on that, so that you can buy a house. That interest is not tax deductible. In fact, you pay it back with after tax dollars. Again, another gut punch.
Something else to look at that I have concerns over the way people save for retirement is we talked about liquidity. If you do borrow that money, and then you wind up leaving your job voluntarily, or involuntarily, whether you’re terminated or you choose to leave for another job, do you know what happens to the balance in the account? The money that you borrowed, what happens to it?
Gary: No, I have never.
Shawn: If you don’t pay it back within 90 days, it can become a distribution. That means it’s a withdrawal and you have to pay the tax on it. You don’t get to just pay that back, I mean, over time. You have to pay it back in full after 90 days when you leave your employment. That’s something that most people don’t know and they find out about it going 65 miles an hour hitting a brick wall.
That can really surprise a lot of people.
A couple other ways that people lose money when they save for retirement is you have no down side protection, no principal protection from loss in those accounts. Your 401K, your IRA, whatever the account is in retirement, that’s in the market.
One, you have a very limited list of investment choices. Then, of those investments, most of them are going to be mutual funds of some kind, and you don’t have any down side protection. You can lose money.
We heard a lot of people in 2000 and 2002 that lost up to 46 percent. Then, in 2007, 2009, lost up to 59 percent of their account value on the cusp of retiring and now had to stay working for another three or four or five years trying to get back some of what they lost.
You have no downside protection. Add to that, how long is it going to take for you to recover when you lose 10, 20, 30, 40 percent?
Here’s something people don’t often understand. If you have money in a 401K and you lost 50 percent of your money, what return would you have to get next year to be back to what you were before you lost the money? Most people can’t answer that question.
Their first answer is 50 percent. “If I lost 50, I just have to gain 50 to get back to where I’m at.” I say, “OK, let’s do the math.” What’s that?
Gary: It’s more than that.
Shawn: Let’s do the math. You have a hundred thousand dollars in a 401K. Your account loses 50 percent. How much do you have in your 401K? $50,000. If you earn 50 percent that next year, you wouldn’t be back at a hundred. Your $50,000 earned 50 percent, which is $25,000. You’d have $75,000.
You had to actually earn 100 percent on your $50,000 to get back to a hundred. If you lose 50, you’ve got to gain 100 to get back to where you were before you lost anything. That can take a long time. We don’t know if that return’s going to be a hundred percent in one year or is it going to be eight percent compounded over the next eight years.
Let’s say it is eight percent compounded over the next eight years. Now you’re back to your hundred thousand dollars. But that’s where you were eight years ago. Eight years later you expect to be much further along the curve. We don’t have the time that it takes to recover from a loss.
When you don’t have downside or principal protection, you can be in a real world of hurt. Add to that, if you take your money, your everyday earnings, and put them in the stock market on your own in mutual funds and stocks, if you lose money you get to write those losses off against your gains so that you don’t have to pay tax on your gains.
If you don’t have any gains you simply get to write your losses off on your taxes. There’s a maximum that you can take, but you do get to write them off. If you lose money in your 401K and your IRA you don’t get to write that off. You lose the money, so it’s right there.
Gary: You’re actually making some really good points and that’s why I ended up cashing out my 401(k). It was so volatile and I tried everything in the world to make it work and I was switching around trying to time the market, which, not smart either. But I tried everything I could and I just thought it was a fool’s game at some point. Not to say, “Hey, 401(k)s are bad.”
Shawn: Not at all.
Gary: Not at all. Just for me I couldn’t see it working the way I wanted to and my attitude was, “I’m going into entrepreneurship and I’m an entrepreneur. I need that money now. I don’t need it 25 years from now to drain off.” My hope, and this is a gamble of being an entrepreneur, is that I can turn the money I was putting in to more money than I would ever have been able to take out.
Or I could lose it all too. That’s part of life.
Shawn: Sure. That’s the gamble. That’s the risk that we entrepreneurs take. Looking at that, we talked about provisional income in the last episode. 401(k), IRA…qualified‑plan money…counts in your provisional income, which can make your Social Security, up to 85 percent of it, taxable.
It can make your Medicare premiums higher. That’s the other side of the provisional income thing, is that Medicare is means‑tested. It’s not the same premium for everybody. The more money that you make the higher your Medicare premiums are going to be.
Here are ways that people lose money. We talked about the fact that it’s the opportunity cost of those lost dollars that kills you. Losing the dollars in and of themselves hurts bad enough, but losing what those dollars could have earned is a big kicker that compounds over time.
Another thing on IRAs and 401(k)s and qualified plans that can hurt you is they have high management fees. The problem with that is they’re high management fees but the bigger problem and the unseen problem is that those fees are hidden. They’re not currently forced to be disclosed on your statements.
When I ask the average 401(k) investor or typical 401(k) investor, “How much are you paying in management fees on your 401(k)s? He says, “Oh, there’s no fees. I don’t pay anything.” Wrong. You pay a lot of money in management fees to your 401(k) and things like that, but they’re not disclosed on your statements because they’re taken out of your investment accounts before you ever see it.
That’s changing in the coming years. The government is finally making 401(k) management companies: Principal Group, AG Edwards, whoever’s doing it, they’re making those companies begin to disclose their management fees on your statements and you’ll start to see where your money’s going, why you’re not earning very much.
High management fees can hurt you. Because you’re not…what are you getting management fees for? They’re not giving you advice on what to invest in. You’re looking at 10 or 12 limited investment choices. You’re looking at the one‑three‑six month, one year, three year, five year, 10‑year return histories and you’re picking that one or that one because of what it returned over that last period of time and that’s not necessarily going to tell you what the future’s going to bring.
Moving on to required minimum distributions, another thing in qualified plans is required minimum distributions. If you put money in a 401(k), IRA, things like that, qualified plans, you will have to take the money out when you turn 70 and a half. There’s a formula that calculates the minimum amount that you have to withdraw.
The minimum amount you have to withdraw is whether you need the money or not. It is the minimum. It’s because the government wants their taxes and they’ve decided that they’re going to get it at that point and no later.
If you don’t take your required minimum distribution the penalty is 50 percent of what you should have taken. If your required minimum distribution is $25,000 for the year and you don’t take it because you forgot, you didn’t know, you have to pay $12,500 in a penalty.
If you took $20,000 and you were supposed to take 25, you’ve got to pay 50 percent on the $5,000 that you didn’t take out. You’ve got to pay a 50 percent penalty on that, so it’s a $2,500 gamble. That’s a pretty hefty fee for a government that’s looking out for you, right?
Gary: Yeah, it’s insane.
Shawn: We’re going to set these qualified plans up to protect you so you have money for retirement but then if you don’t follow our rules, slap.
Gary: We’re going to take your money anyway.
Shawn: What’s that?
Gary: I said we’re going to take the money anyway anyway…
Gary: Whether you spend it or not. We’re going to get…
Shawn: It’s big. It’s what you don’t know that can hurt you, really what you don’t know that can hurt you. I ask most people, “Do you know what you’re investing your money in? Do you really know and understand what you’re investing your money in?” That’s far more important than what you’re investing your money in.
Knowing the goods and the bads and the ugliest of what you’re putting your money in is very, very critical these days and most people don’t know the first thing about any of the vehicles they put their money in.
Gary: That’s why I always recommend, again, that people go to a professional like yourself. With that, can you tell people how to reach you and how to contact you?
Shawn: Yeah. My blog address, because I write about a lot of these different things on my blog, is www.wiseandwealthyblog.com. My website, of course, is www.principalshield.com, with principal being spelled P‑R‑I‑N‑C‑I‑P‑A‑L, principalshield.com.
My email address is shawn, S‑H‑A‑W‑N, at principleshield.com. Then finally my phone number, my mobile number, is area code (619) 994‑1110.
Before we sign off, one last thing…we touched on this in the last episode…was, not all qualified plans are bad. I don’t want anybody to think that 401(k)s and IRAs are bad. 401(k)s can be a wonderful vehicle. It just should be one of the different vehicles in your retirement plan. There’s a lot of benefits to that, such as the employer match.
Employer matches are wonderful. It’s free money. Your employer is going to match a certain amount of your contribution. That’s free. You don’t have to do anything for it but participate in the plan. You should do that. I encourage people to do that. I just encourage people to not have that be the only arrow in their quiver, because it can come back to bite you.
Roth plans are very, very beneficial. Roth 401(k)s and Roth IRAs are very beneficial, but we talked about the limitation of a Roth IRA is that you can only contribute $5,500 per year into it. That’s not going to give you enough to retire on when you retire. Roth 401(k)s may be able to get you there, but the problem is not many employers have Roth 401(k)s in their mix, because it’s just too much to have to manage.
I don’t want to scare people away from traditional retirement vehicles. I just want them to reach out, like you said, and understand more about what their options are and about what they’re actually investing in and deciding if maybe there aren’t better options available.
Gary: With that, that’s some great information. If people want to reach me they can reach me at www.primalpowermethod.com and contact at primalpowermethod.com and be looking out for…we’ve got two more episodes left in this series.
It’s a five‑part series. But we will still be doing other financial services and talking about finances and how to better plan for your future in other future episodes, so it won’t just stop there. We hope to help people in many different financial avenues if we can.
Thanks again and I look forward to the next one.
Shawn: Thank you for the opportunity, Gary. I appreciate it.
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