Wednesday, February 12, 2014

The Trouble with IRA’s and 401(k)’s

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Individual retirement accounts seem like the answer to a lot of people’s prayers.

Every month, you deposit a set amount of money into your individual retirement account, whether it’s a 401(k), a regular IRA, a Roth-IRA, or any of the variants (403(b), most 457 plans, the Federal government’s Thrift Savings Plan, Obama’s new MyRA, etc.). That money that you contribute is discounted from your tax bill. So far, so good.

Once your money is in the account, it’s invested in stocks, bonds, or other paper assets. As it is invested in these paper assets, the amount of money in your retirement account grows as the paper assets rise in value and/or receive dividends or yields of whatever sort. Again, so far, so good.

By the time you retire, or so goes the idea, your individual retirement account will have grown in value so much that you will have a nice little nest egg. It will have grown from three sources: Number one, it will have grown from your monthly contributions; number two, it will have grown from the rise in the value of stocks or bonds in the account; and number three, it will have grown from the dividends or yields of those stocks and bonds.

This nest egg will be so big by the time you retire that you will have more than enough to receive a nice pension until the end of your days, and live your golden years worry-free.

Right?

Wrong. Oh so very, very wrong. Government-approved and IRS-compliant individual retirement plans work only in theory—but in practice they will not be enough to help you build a nest egg on which to retire. Far from it. Here’s why.

On its face, the current system makes perfect sense—and in a perfect world, it would be a good, workable idea. In a perfect world, an individual retirement account to which you dutifully contribute to every month would result in a nice nest egg by the time you retire. In a perfect world, that nest egg should be big enough that you can either buy an annuity that would give you a decent monthly income for life; or generate interest that would give you a decent monthly income for life; or be large enough that it would withstand a monthly slice off the principal. In a perfect world.

But unfortunately, our world is far from perfect.

Financial firms and government officials claim that the system does indeed work. But they have a vested interest in making it seem that it works. Financial firms want to encourage people to join these retirement plans—because they are the ones who receive and manage those retirement monies, and thus make their living off of fees and commissions from your account. And government officials score political points for seeming to be “doing something” for the retirement of the average John Q. Taxpayer by encouraging people to get into this system.

But the system does not work. No matter what you do, you will never manage to put together enough money in an IRA, Roth-IRA, 401(k), 403(b), 457 plans, the Federal government’s Thrift Savings Plan, Obama’s new MyRA, or any of the other government-approved, IRS-compliant schemes.

In order to understand why this system does not work, first we have to identify which steps in the process are the hidden booby traps that make the system fail. And then second, we have to figure out whether there is a way to correct these flaws when we are dealing with the system, or whether it’s smarter for us in the long run to bypass the system altogether, and solve your retirement funding problem in a different way.

Remember something crucial: Any and every retirement system is not an end in itself—rather, it is a means to solve a problem, the problem being how to fund your retirement and not end up in the poor house. Because that is the central problem here: Funding your retirement. Therefore, knowing the reasons the retirement system does not work means nothing unless it helps us figure out a way to solve that basic problem.

So in this presentation, first I’m going to identify each of the pitfalls that makes the current system not work. Then I'm going to weigh whether these problems make the system unworkable, and why. And then I’m going to present a solution that will allow you to have a solid nest-egg at the end of your career, and allow you to retire with a nest-egg that will provide steady income until the end of your days.

Ready?

The Pitfalls of The Current System

There are five pitfalls to the current system of private retirement accounts that severely limit how large your nest egg will turn out to be:
  • The realities of the job market
  • Caps on contributions
  • Fees and commissions
  • Low interest rates set by the Federal Reserve
  • Low capital gains taxes vs. high income taxes
Each of these factors severely limit the size of your potential retirement nest egg, if you follow one of the government-approved, IRS-compliant methods. Let’s look at each of them in turn.

1. The realities of the job market: If you finish college at 22 and retire at 67, you will have spent 45 years in the job market. That—in theory—is more than enough time to save a substantial nest egg.

But the reality is very different. First of all, most workers with a Bachelor’s degree or better see their income peak before the age of 45, those with professional degrees (doctors, lawyers) peaking at 37, as can be seen by the following chart based on a study conducted by Georgetown University in 2010:

Click to enlarge. Data is here


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9 comments:

  1. You missed the biggest pitfall of all that makes these accounts useless.
    Devalued currency.
    If you put $10,000 in your retirement account in, let's say 1999, that $10,000 now has the buying power of about $4,500 1999 dollars.
    So, You have lost over half of your money by putting it in your retirement account.
    The entire "retirement" account has been nothing but a scam from the beginning. It's just another way to keep you seperated from your money and therefore keep you controlled and working for the man.

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    Replies
    1. Yeah, that's the first thing I thought too. That's the 500 lb gorilla sitting on the back of an elephant in the room that the author failed to mention. You have to take great risk just to try to preserve the value of the money you have today. You're lucky if the value of the money you have in the future, including investment gains, is even close to the value of that money today. Your options are few, and typically a casino, with (even honest) insiders having a distinct advantage. And god forbid you invest in gold, because then you're fighting the Fed and its money printing machine it uses to squelch the price of gold, in an attempt to prop up its fiat money system. And I truly believe its only a matter of time before the government makes good on its attempts to turn everyone's 401K plan into a "guaranteed revenue stream" using T-Bills (i.e. Social Security 2 funded by blatant theft).

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  2. How about confiscation? The biggest pitfall of them all...

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  3. What's the alternative, eh? My wife and I both had IRAs and retired early; paid off our mortgage, and today we are living the good life. The IRA tax deferment worked great, and continues to work great, in effect we are paying virtually no tax.

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    Replies
    1. Works great!.. until it doesn't.

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  4. And when I retire, they'll say it was lost when the dollar crashed, it wasn't inflation-proof, or those great derivatives - nobody is honoring them anymore, so the money is gone. Sorry!

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  5. You also can not assume a low tax rate when you withdraw the money. When you die (without a spouse) the IRA etc. all falls into a single year's income, that could put you in a very high bracket. Also if you die too early, not only is all the money taxed as a single year income but early withdrawel penalty will be applied. My advise: save and invest all you can, but put a dollar smewhere you have complete control over it for every dollar you put in an IRA. Note: big matching contribution from employer would alter my formula.

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  6. Pres. Ronald Reagan foresaw the coming failure of Social Security and created the I.R.A. solution to counter Socialist programs doomed to fail. The success or failure of your IRA will be in locked step with your personal investing abilities. I've always had suspicion that the Gov't would snatch these investment A/C's someday. Commies are stupid and dangerous. They don't understand that if they even try confiscation it will tear apart America's foundations with far reaching implications. But perhaps they do understand and their intention is to topple everything.

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  7. In 1963 my farther was promised by "Old Mutual (Zimbabwe)" his pension pot would be worth millions!

    It Is!

    In Zim $ it is billions

    But in US$ it is worth $0.02 a month. I now support my 98year old grand mother and my farther.

    ReplyDelete

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