If these products were so good for us why are so many people broke and working through retirement?
To write on this subject I called my friend Chase Chandler and owner of Chandler Advisors, LLC. He has dealt with these things first hand and seen how they work.
Please read Chase’s blog below written just for you as a FiscalBridge reader! You should feel special. 🙂
By: B. Chase Chandler, IBCAP, Best-Selling Author
Who collects our taxes?
What’s the quickest way to get from New York to LA?
These are simple questions that nearly any person can answer – all that’s needed is a little conventional wisdom.
When people think of retirement planning, there’s also quite a bit of conventional wisdom that floats about. The tool that many associate using for retirement is a 401(k), IRA, or some other qualified plan. In modern American these tools have become ‘obvious conventional wisdom.’ Financial pros, ‘gurus’ in the media, and authors everywhere endorse the 401(k). But here’s the question – why?
FiscalBridge.com is a financial education company. The research that Ms. Irmen has engaged in, and that I have been involved with, has pointed to the idea that QP’s may not be all that beneficial for us – the people. They are, however, excellent for the government and for Wall Street. The common reasoning for using 401(k)s is the idea that you’re saving tax dollars – you don’t pay taxes when you put money into a 401(k). But the reality is, as we’ll get to in a moment, you do not save tax dollars – you defer the tax to a later date.
Imagine this: a fancy dressed, slick haired investment professional comes to your house. He tells you that he is your 401(k) ‘advisor.’ He explains that you need to max our your 401(k) because the average rate of return of the market over the last 20 years has been 9.92%!* He also references this article, which is a well known financial guru touting an idea that the market has averaged 12% throughout history. Then he shows you these numbers, which illustrate an ‘average annual return’ of 9.92%:
But what this gentleman fails to point out is that this is not at all how long-term annual rates of return actually work. Notice the read box under the earnings rate column below. These are the actual years of the S&P with dividends from 1993 to 2012. You’ll notice that the average rate at the bottom is still 9.92%. You’ll also notice the ending value on the bottom right. In the second table the ending value is $314,400. In the first table, where 9.92% was run every year for 20 years, the average rate was still 9.92% – but the ending value was $623,876.
Mutual funds are almost always used in QP’s. Forbes ran an article a couple of years ago stating that the average mutual fund fees are 3.17% per year.** Most people have the idea that they’re not paying that much in their 401(k)s and that might be true. But typically they only reason they’re so confident they’re not paying 3% in fees per year is because their financial salesman told them that. We have yet to see a true mutual fund (not an index fund) with less than 2% per year in ‘all in’ fees – so for the purpose of this article, we used a conservative 2%. Above you’ll notice a ‘Misc. Fees’ column. This shows the 2% each year coming out of the overall balance of the account. After 20 years, one would have paid $65,451 in fees! That’s 20.82% of what the ending account value is. Seems a bit ridiculous right? It is.
The reality is that, because of market volatility and fees, the true annual rate of return was 4.13%. The overarching point here is that there is a MAJOR difference between the AVERAGE ROR and the ACTUAL ROR! Most advisors, 401(k) providers, and mutual funds completely ignore this fact. Or, if they disagree, like I’ve seen some do – its even worse – they are ignorant of how rates of return actually work.
And there’s one more point that’s vital – we haven’t yet considered taxes. When you consider the fact that you have to pay taxes when you take money from these plans then you also must consider its impact on your rate of return. That’s a topic for another day. The point is to understand you’re not actually getting what you think you’re getting. When we consider the tax equation, the fact that fees are usually much higher than 2%, and the fact that you can’t easily access your money until you’re 50 1/2 – QP’s come to light as one of the most efficient assets where one can put their money.
But, here’s the final question: if they’re not good for us, the people, then who are they good for. Answer: the government and Wall Street.
This all started in 1980, when 401(k) type plans were implemented (or allowed) by congress. This also happened to be soon after many politicians accepted the fact that social security and other entitlement programs would be severely underfunded into the 2000s. QP’s are sometimes advocated because they save us tax money. The fact is – they DO NOT SAVE TAX DOLLARS. They simply delay the paying of the tax to some date in the future. A date that we do not know what the tax rates will be, but congress will set them based on what they think they should be at that time. QP’s are essentially a Cadillac pension tax plan for the government.
Even with an employer match within a QP, the long-term rate of return is typically around 4-6% after considering all of the variables – fees, taxes, and market volatility. (This is a much more extensive explanation.) The reality is – you don’t have access to your money in a QP and the growth is going to be okay at best. Why would you want to fund an account with such an outlook?
Once you understand how these plan actually work, you won’t want to put you’re hard earned money into them.
B. Chase Chandler is the founder and CEO of Chandler Advisors, LLC. He is the author of the best-seller The Wealthy Physician and is the author of The Wealthy Family which is due out beginning of 2014. He holds a Certificate of Financial Management from Cornell University and is an IBC Authorized Practitioner. He is a recognized leader in financial and alternative strategy research and speaks around the country about economics, finance, and financial strategy for families and businesses.
*S&P 500 w/ dividends from 1993-2012