The Retirement Planning Conundrum

The Three Stages of Truth

Years ago, the German philosopher Arthur Schopenhauer stated that all truth passes through three stages before it is recognized as self-evident. In the first stage, it is ridiculed; in the second stage, it is violently opposed; and in the third stage, it is regarded as self-evident. Many great advances in science and knowledge have come through this gauntlet of trial.

Evolution of Disease Treatment

Consider the evolution of disease and its treatment. For centuries, disease was based not on science, but on religion, superstition, and myth. As we began the 19th century, a step forward was made suggesting that disease was associated with environmental factors such as imbalances in diet and personal behavior. Louis Pasteur, a young microbiologist, proposed the theory that germs were the cause of many diseases. His colleagues ridiculed him, but as he persisted and proved his theory, his claims were eventually regarded as self-evident.

The Retirement Planning Conundrum

In finance, and more particularly in retirement planning circles, we have a similar conundrum. We must first understand the difference between a qualified retirement plan and a non-qualified retirement plan. We have been trained to advocate for qualified plans, which offer tax deductions for contributions and deferred taxes until distribution in retirement.

Qualified Retirement Plans

The advantages of qualified plans include:

1. Tax-deductible contributions.
2. Tax-deferred growth.
3. Potential employer matching funds.

However, there are significant disadvantages:

1. Distributions are fully taxable.
2. Early withdrawals incur penalties.
3. Loan proceeds from plans become taxable distributions if not repaid.
4. Employers must avoid discrimination in favoring certain employees.
5. Limited access to funds.
6. Employers face lawsuits over plan performance and investment choices.
7. High administrative costs for employers.
8. Strict federal laws and penalties.
9. Limited investment choices.

Government Incentives and the Shift in Retirement Plans

The rationale for government-promoted qualified retirement plans is rooted in shifting the burden from employers to employees. This shift was embraced by the financial community, creating a new product to market and a revenue source for the government through deferred taxes.

The Wilsons' Retirement Scenario

To help the reader understand the dynamics of this concept please refer to the illustration provided. You are encouraged to form your own opinion by taking the time to answer the questions concerning the Wilson’s Retirement Scenario. Credit goes to Dougles R. Andrew for this illustration.? See the chart below to follow along:

Wilson Retirement Plan

Annual IRA 401(k) Contribution = $6,000 x 35 years = $210,000 Total Contribution

Tax Bracket =33.3%

Tax Savings: $6,000 x 33.3% = $2,000 x 35 years = $70,000 Total Tax Savings

$6,000 Per Year at 7.5% return for 35 Years =$1,000,000

$1,000,000

??????? X 7.5%

??????????????????????????????????????? $75,000?? ????Interest Income

??????????????????????????????? ???????? X 33.3%???? Tax Bracket

??????????????????????????????? $25,000????????Annual Tax

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?????????????????????????????Therefore:??? $75,000?? Supplemental Retirement

?????????????????????????????Creates:???????? (25,000)? Potential Annual Tax

?????????????????????????????Results:??????? $50,000? Net Spendable Income

?

Facts:? a 30-year-old couple - the Wilsons - are each contributing $250.00 a month to a qualified retirement plan.? That is a total of $500.00 per month or $6,000 a year.? They are in a 33.3% tax bracket, so they are saving $2,000 in taxes per year. ($6,000 X 33.3%) Over a 30-year period that is a total tax savings of $70,000 ($2,000 X 35 years) $210,000 is the total contributions made by the Wilsons.

Assumptions: If the contributions earn an average return? of? 7.5% a year,? the plan will have a value of? $1,000,000 at? retirement.?? Wilson’s tax bracket is still 33.3%.?

Distribution:? If the Wilsons take out 7.5% of the plan per year that would equal $75,000.

If we subtract their tax liability of $25,000, they will have $50,000 a year for retirement.

Conclusion: On the surface this seems like a very fair proposition.? You the reader can determine the fairness of this proposal by answering the questions below.

Questions:

1. How much in taxes do the Wilsons pay over the first 10 years of their retirement?
2. How much in taxes did the Wilsons save during the accumulation period?
3. How much in taxes will the Wilsons pay over 20 years of retirement?
4. After 20 years, how much more have the Wilsons paid in taxes than they saved during the accumulation phase?

Whose retirement were they planning? Theirs or Uncle Sam’s? If one is not getting this then think of the following: Would the farmer be better off having the government tax the seed he buys or the harvest he sells?

Non-Qualified Plans

Main Disadvantage:

1. Contributions are not tax-deductible.

Benefits:

1. More investment choices.
2. No contribution limits.
3. Access to funds at any time.
4. Employers can select key people.
5. Possibility of tax-deferred growth.
6. Potential for tax-free distributions.
7. Fewer government rules and oversight.
8. Businesses can borrow money to fund their plans.
9. No discrimination rules.
10. Much less expensive to administrate

Conclusion

This article is not the final word on retirement planning. We have not covered the benefits of the Roth IRA, self-directed plans, or converting to a regular IRA. Hopefully, this article will encourage you to think outside the box. Keep in mind that large companies offer limited options and if a plan is not profitable to them, you will never hear about it even if it is in your best interest.?