Maximizing Wealth as a Business Owner: Rethinking the 401k

Introduction

Are you a business owner contributing to a qualified retirement plan like a 401k? Then this article is for you. The topic of 401ks and their effectiveness as a retirement vehicle can be a contentious one, with differing opinions and mixed messages. In this post, we’ll dive into the numbers to help you make an educated decision about whether a 401k is the best use of capital for your business and your financial future.

The Misconceptions Around 401ks

As a business owner looking to create generational wealth, it’s crucial to be deliberate when considering retirement planning. While mainstream thinking suggests that contributing to a qualified plan like a 401k is the path to a comfortable retirement, we need to reframe this mindset. Our goal should not simply be retirement; it should be financial independence. Retirement is just one aspect of financial independence.

Understanding the Numbers

To evaluate the effectiveness of a 401k, let’s look at a scenario. We’ll start with a 30-year-old business owner who has just started their practice. Assuming a current qualified plan balance of $200,000, we’ll analyze the long-term projections.

Using a hypothetical scenario, we’ll assume an 8% annual growth rate on the invested dollars. For a business owner in the beginning stages, the maximum contribution limit of $66,000 can be utilized. However, it’s important to note that contribution limits may increase over time.

While the initial projections might catch your attention with the enticing $25 million figure, it’s crucial to dig beneath the surface and unravel the complete truth about the 401(k) as a retirement vehicle. The question often arises: “Why wouldn’t you opt for a 401(k)?” However, uncovering the full truth requires a thorough examination of all the considerations and costs involved. Let’s peel back the layers to reveal a comprehensive understanding.

Here are some key considerations:

1. Employee Costs: If you offer a qualified plan to yourself as a business owner, you must also extend this opportunity to your employees. Employee costs can include matching contributions or employer contributions. Depending on the participation level of your employees, this expense will impact your bottom line and the overall Internal Rate of Return (IRR).
2. Management Fees: Qualified plans come with administrative and management fees. As a business owner, you’ll encounter varying costs associated with different providers. It’s crucial to assess the value you’re receiving for the fees charged. A conservative estimate suggests an administrative fee of 1% of the asset value and an additional fee of 1–1.5% for money management. Though these can be much worse, so please be vigilant in understanding the fees associated with your account.
3. Tax Deferral and Taxes: One benefit of a 401k is tax deferral. Contributions are made with pre-tax income, providing an immediate tax break. However, it’s important to remember that taxes will be owed on the accumulated funds upon withdrawal. Including taxes in your analysis is essential to understand the true net return.
4. Earnings Rate: In the above projection, we employed a flat 8% earnings rate on our account. While some proponents, like Dave Ramsey, argue that 8% is conservative, it’s essential to acknowledge differing perspectives. Warren Buffett and much of the data indicate that a more realistic long-term rate of return hovers around 6–7%. However, this assumes a disciplined investment strategy without frequent jumping around. On the contrary, Dalbar’s data highlights the stark reality: the average investor achieves a meager 2.9% earning rate. Amidst the allure of projecting substantial numbers, it’s imperative to ground our expectations in the nuances of investment reality.

Evaluating the Numbers: By incorporating these factors into the analysis, the picture of a 401k as a retirement vehicle can change significantly.

In our hypothetical scenario for a 30-year-old business owner, we observed a notable decline in various aspects. The usable account value plummeted from $25 million to $5 million, and the internal rate of return (IRR) witnessed a dip from 9.29% to 3.14%. This discrepancy becomes even more pronounced when considering the stark reality of a Dalbar 2.9% earnings rate. The deviation between projected and actual outcomes serves as a stark reminder of the importance of a nuanced and realistic approach to deciding if qualified plans should or should not be apart of your plan.

Is a 401k the Best Fit for You?

The decision of whether to utilize a 401k ultimately depends on your individual circumstances and goals. While a 401k may still be a great choice for some business owners, it’s crucial not to follow the crowd blindly.

Analyzing the numbers forces us to ask the question:

“Am I okay with a net 3–5% return with the money that goes into my qualified plan?”

If the answer is yes then use it and find ways to maximize your return. Become educated in the self-directing space, see yourself as a professional investor not a professional guesser, and learn to create efficiency on every dollar you make by limiting taxes, reducing fees, and having a cash flow system.

However, if the response is no, it’s essential to recognize that financial independence is attainable without a qualified retirement account — it is NOT a mandatory prerequisite. This realization provides the opportunity to delve into alternative avenues and embrace personalized wealth-building strategies that go beyond the conventional. Whether it’s maximizing business valuation, exploring alternative investments, implementing efficient cash flow systems, transforming taxes into assets, reducing fees, minimizing interest payments, and much more — these avenues pave the way for making generational wealth a tangible reality rather than a distant dream.

Alternative Options to Consider

I understand that many of you utilize the 401k as a means to invest in your employees and retain top-tier players on your team. However, if you’re seeking to provide employee benefits without the associated costs of a 401k, there are alternative avenues to explore. Government tax credits can assist you in offering benefits like a wellness program, life insurance, disability insurance, and more, all without any out-of-pocket expense for you or your employees.

Conclusion

In conclusion, as a business owner, achieving maximum wealth demands a thoughtful examination of all available options. While a 401k might appear as the default choice, it’s crucial to meticulously scrutinize the numbers and assess whether it resonates with your overarching goals of financial independence and generational wealth.

Financial independence should stand as the ultimate objective, and the exploration of alternative strategies may serve as the linchpin to realizing it. Through data-driven decisions and a departure from conventional thinking, you can forge a path toward a flourishing financial future.

Remember, just because the majority follows a certain path doesn’t necessarily make it the best fit for you. In fact, challenging the norm is often worth exploring. Many people lack financial independence, yet there is a prevalent push for qualified plans. Take the time to evaluate your unique circumstances and select the trajectory that harmonizes best with your goals and aspirations. Your potential extends beyond mere financial prosperity; it encompasses generational wealth and, more importantly, generational impact. Don’t settle for middle-class results.

Data was processed, and graphs were generated using Truth Concepts Software. For those interested in exploring further, feel free to download the software at no cost by visiting www.truthconcepts.com

About the Author:

Justin Maxwell is a wealth and tax strategist with Big Life Financial. He helps professionals maximize their human life value, by helping get money in their life right and systematic so they can focus on things that actually matter. Beyond the mere act of saving a dollar, he specializes in empowering you to transform that saved dollar into a powerful catalyst for creating a life that truly reflects your deepest priorities and gives you permission to leave a generational impact. If you’re prepared to embark on a transformative experience, where you’ll be challenged, supported, and guided towards a bigger vision of what’s possible, click HERE to schedule a BIG LIFE consultation