Why Your 401k Might Not Do The Job

June 05, 2015
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When was the last time you hired someone to do a job? We might not think of it this way, but we do it every day when we purchase goods and services in the market place.

Consider your cell phone service? You scan the available cell carriers, compare your needs and expectations with their rate plans, service areas, features and benefits and basically hire the best one to do the job. We make these types of buying decisions every day, some more significant than others. The decisions could range from a shop to service your automobile to a pest control or home security company. Hopefully those relationships go well, but if not, we fire them and switch to someone else who can do the job to our expectations.

Sometimes we engage in more significant longer-term projects. About 10 years ago Susan and I embarked on a complete makeover of our home. The home was built in 1961 and needed an entire renovation. The project was so significant that we were forced to move out for 12 months while the house was gutted, added on to and rebuilt. With four kids ranging from 8 to 17, it was a huge undertaking. A year before we began, we spent months drawing and redrawing plans to guide the project. This proved to be the most important step!

By the time the renovation was complete, we had engaged a range of sub-contractors. With each relationship we set expectations, gathered bids, selected vendors and materials, managed those expectations and inspected each final outcome. When a problem arose we found ourselves huddled around the plans to clarify expectations, managing the project back to our original design. The project was so significant we hired a general contractor to help us along the way. The endeavor was not without its twists and turns, disappointments and surprises. In retrospect, advanced planning and hiring the right people proved for a great result.

Building or renovating a home can be a rewarding experience, but so is preparing for one’s retirement. You could live in retirement for a third of your life! Most Americans spend more time preparing for a two-week vacation than preparing for their golden years. Since most American’s in the private sector “hire” a 401k, or IRA to do the job, I must inquire, “What job are you hiring that defined contribution plan to do?”

This probably sounds rather odd because you probably don’t even remember making a buying decision. Upon starting work, a person from human resources told you about the plan. You instinctively knew it was important to save, so you signed up. And besides, they said they would match part of your contribution, all of which would be pre-tax.

But, what job did you hire that 401k for? What’s its objective and how well can it do the job? When you stop working you are going to need income other than Social Security, right? And you want that income to last until you kick the bucket, right? The whole idea is to not run out of money, correct? But running out of money is only part of the expectation. Don’t you want a enough income to live the retirement lifestyle of your choice? We want optimal, don’t we?

So, will your 401k deliver? Can it do the job?

If you are like most Americans, their eyes glaze over at this point. It’s like that time I walked into the great room of my completely torn apart house to see my contactor and foreman looking up into the open attic with a puzzled look on their faces. I asked what was wrong and they said, “We are wondering how this roof is being held up, because none of this was done to code.” That was not a happy day!

USA Today recently reported (2/13/2014) that Fidelity Investments, the nation’s largest 401k provider, clocked the average 401k balance for pre-retirees over age 55 at $165,200. Let’s just assume at age 65 this balance is $300,000. It’s not, but I will give American’s the benefit of the doubt. Conventional wisdom used to say that you could withdrawal 4% of that asset for income each year with a reasonable expectation that you wouldn’t run out of money. Today, research suggests the percentage is closer to 3%. Read the Wharton Business School, Morning Star, Harvard Business Review and Wall Street Journal reports/articles in the Learning Center of my Website (TheEstateMD.com).

Let’s do the math. $300,000 times 3% means $9,000 a year in pre-tax annual income or $750 per month. Add the average Social Security check of $1,300 and you have a bank breaking $2,050 a month. Does this meet your “golden years” expectations? Is this getting the job done in your mind? My guess this falls way short of expectations!

But you aren’t average! You have accumulated $1,000,000. Congratulations! That means you can live on $30,000 a year in pre-tax income. This is still disappointing, isn’t it? What if you could learn how to potentially withdraw 7-13% per year without the fear of running out? And what if you could do that with potentially less risk and make the majority of the income contractually guaranteed? You do the math. That would be exciting, wouldn’t it?

To get started, you must get educated on the topics of longevity risk, sequencing of returns, withdrawal rate risk, the importance of actuarial science, anticipated cognitive decline and the confusion between constant vs. fluctuating interest rates. This may sound like alphabet soup, but these are important concepts to understand when considering whether your 401k plan will do the job or not.

With over 11,000 baby boomers retiring each day, many are beginning to realize that their defined contribution plans might not be up for the job. We work with pre-retirees every day to fix this problem. In short, keep the 401k, but combine it with actuarial science creating an integrated approach to retirement income results. Accomplish this with less risk and by staying on your current savings path. You will be amazed how this strategy gets the job done! Contact us for a no-cost or obligation one-hour consultation.