My son was recently hired into his first real job, with everything a real job has. It has a payroll, health plan, and a 401(k), in which he was automatically enrolled. So starts his journey. For the next 45 years or so, he will go to work, pay his bills and taxes and fund his 401(k), which his employer may or may not match. Most still do, but many do not. Twenty-five percent according to CNBC Online, (“No employer 401(k) match at the office? No problem,” 2/5/18). The match, after all, was a way to get rank and file workers to participate in the relatively new ERISA-based company retirement plans that required broad participation to remain compliant. Now that these plans are the standard to the extent that employees must opt out rather than opting in, it’s becoming less and less necessary to bribe employees to participate. How long do you expect matching will be the standard? Remember the pension? I didn’t think so.

So, assume he gets $15 an hour to start, and his earnings grow at the average of 3%, reflecting the rate of inflation only, i.e., no real growth. Also assume he contributes 10% of earnings every year for 45 years, tax brackets and calculations remain constant, his 401(k) grows at 6%, and he follows the 4% rule for withdrawals between ages 70 and 90. Without fees, when he retires he will have a balance of $1.56 million, and taxable income of around $83k, accounting for Social Security, his 401(k) withdrawals, and the current standard deduction of $24,000.

Fees

However, fees do exist, and have much more impact than you probably are aware of. According to the WSJ Online, March 1, 2010, “How much does it cost you to own a mutual fund? Probably more than you think. …”

“In selecting mutual funds, most investors know to check the expense ratio, the standard measure of how costly a fund is to own. U.S.-stock funds pay an average of 1.31% of assets each year to the portfolio manager and for other operating expenses…. According to Morningstar Inc…’there are other costs not reported in the expense ratio related to the buying and selling of securities in the portfolio and those expenses can make a fund two or three times as costly as advertised.'” To put that in perspective, for every $100,000 in your retirement fund that you hold for 10 years, you are paying anywhere from $10,000 to $40,000 in fees. And that doesn’t even count the additional money you pay your 401(k) administrator.”

If we use just a flat 2% fee, which would be at the low end including all the hidden sales expenses, expense ratios, and 401(k) admin fees, his balance would be $932k, and his taxable income would be $58k, including Social Security, his 401(k) withdrawals, and the current standard deduction of $24k. Two percent fees cost you 40% of your account balance, and 30% of income; Social Security is the same in both.

Tax Implications

During the entire 45 years he is contributing, he receives tax benefits of just under $30k, which averages out to $667 per year, using current tax rates. However, the amount of tax he will pay in his 20-year retirement is just over $92k, or an average of $4.3k per year. Six and a half times the amount his average annual savings. Worse, he’s moved all those taxes into his retirement years when presumably he is not as financially robust as when he was working.

An Answer

So, tax deferrals don’t make sense, fees drive down resources, and volatile markets restrict the income that can be received in retirement. What can be done?

One simple plan is what we call a Section 7702-IG. This is one of the oldest products in the world, is the source of some of the greatest wealth in the world and is one of the safest places to put your money. In fact, during the Great Depression, it was the only place people could get at their money, because while every other financial industry was bankrupt, the 7702 industry pumped the equivalent of $3 trillion in today’s dollars during the depression and grew its assets by about half that at the same time.

So how would a 7702-IG stack up to a 401(k)? Assume that all of the variables are the same as stated above, with one exception. This strategy is not tax-deferred, so we reduce the amount of contribution each year by the amount of tax deduction one would have gotten in a qualified plan. So, the same amount comes out of the paycheck.

At age 70, my son would have a tax-free income of $168,000, including his Social Security. That’s the equivalent of having a 401(k) with $2.9 million, rather than the estimated $932k in the 401(k). That’s without market risk, fees, or taxes, three of the big retirement killers. Should he die before age 70, his beneficiaries would receive over $1 million in tax-free death benefit. And, should he need it, he can always borrow against it any time without penalty or having to pay taxes. And, should conditions require, he would never have to pay it back, though the benefits of doing so are great.

If this sounds too good to be true, let us prove it to you. These are, like I said, very common and have been around forever. They are very safe, have a wonderful track record, and are backed by the strongest financial institutions in the world. I have illustration software that will provide you a quote from any of them, and I can’t wait to show you.

Stephen Kelley is a recognized leader in retirement income planning. Located in Nashua, he services Greater Boston and the New England areas. He is author of five books, including “Tell Me When You’re Going to Die,” which deals with the problem unknown lifespans create for retirement planning. It and his other books are available on Amazon.com. He can be heard every weekend on the “Free to Retire” radio show on WCAP and WFEA, and he conducts planning workshops at his New England Adult Learning Center, located in Nashua. Initial consultations are always free. You can reach Steve at 603-881-8811 or at www.FreeToRetireRadio.com.

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