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Foreword
“I can’t change the direction of the wind, but I can adjust my sails to reach my destination.” – Jimmy Dean T his book is going to change the way you think and change the way you approach the future. In fact, it 's going to change the way you make decisions. I know it can, because I’ve seen it happen – to my clients and to my friends. I n fact, i t’s happening to savers across the country right now. And it will happen to you, too. We live in a world where rapid innovation has eliminated compromise from many areas of our lives. You don’t have to leave the beach early because it might rain; new weather apps can alert you when the rain will begin, down to the minute. You don’t have to rush home to catch your favorite TV show; you can watch it on demand, from your phone, anywhere. But when it comes to your retirement savings, I believe compromise is still the norm for many people. Nearly all of us are trying to decide how to give a little here to get a little there. What if it didn’t have to be this way? What if saving for the future didn’t feel like a series of trade-offs, but rather a strategy where you could get more of what you want, and reduce or even eliminate more of what you don’t?
Contents
Prologue.......................................................................................................... i Help From an Actuary............................................................................ i Putting Actuarial Expertise on Your Side .......................................ii Actuaries and Retirement .................................................................. iii Your Own Personal Actuary ..............................................................iv Why IRAs? Why Now?.........................................................................iv Three Conflicts in Your IRA....................................................................1 It Happened to Me ................................................................................. 2 Conflicts in Your IRA............................................................................ 4 Yes, I’m Talking to You......................................................................... 5 Outside-the-Box Thinking .................................................................. 6 Conflict No. 1: Growth vs. Security .....................................................7 The Conflict Inherent in Today’s Market .......................................8 Realities of a Volatile Market..............................................................9 The Impact of Volatility..................................................................... 12 Why It Hurts So Much When the Market Crashes ................... 14 The Flip Side of the Coin .................................................................. 14 The Challenge of Low Interest Rates............................................. 16
The Conflict of Growth vs. Security.............................................. 18 Conflict No. 2: Income vs. Legacy ...................................................... 21 My Conflicted IRA .............................................................................. 22 Finding the Balance ............................................................................ 24 Conflict No. 3: You vs. the IRS ............................................................ 27 Your Hidden Debt ............................................................................... 27 Your Silent Partner ............................................................................. 29 The Great American Savings Myth................................................ 29 This. Is. Important............................................................................... 30 Tax-Efficient Income Planning ....................................................... 30 The Tax Status of How You Save ................................................... 31 Which One is Best? ............................................................................. 33 Will Your Tax Rate be Lower in Retirement?............................. 33 The Million-Dollar Question........................................................... 35 Assuming That Risk............................................................................ 38 What Does It Mean in Dollars and Cents?................................... 39 Crunching Numbers........................................................................... 40 The Cost of Conversion .................................................................... 43 Which Path to Travel?........................................................................ 44
Your Three Conflicts.......................................................................... 45 From Compromise to Realize .............................................................. 47 How Do I Define Success? ................................................................ 48 7702 ......................................................................................................... 50 IUL ........................................................................................................... 52 Always Question What You Read ................................................... 54 Eliminating the Conflict of Growth vs. Security............................ 55 What’s the Worst That Can Happen? ............................................ 59 The Money Manager .......................................................................... 62 Eliminating the Conflict of Income vs. Legacy ............................... 63 The Four Big Needs in Retirement ................................................ 63 Getting Your Money .......................................................................... 64 Your Money, Undiscounted ............................................................. 65 Help for the Medical Cost of Aging ............................................... 66 Legacy for Your Heirs ........................................................................ 67 Eliminating the Conflict of You vs. the IRS .................................... 69 Kicking the IRS to the Curb ............................................................. 70 Brief and to the Point ......................................................................... 72 Putting My Money Where My Mouth Is......................................... 75 A Different Kind of Conversion...................................................... 76
How Much to Convert? ..................................................................... 76 Confidence in My Choice ................................................................. 77 Too Good to be True? ............................................................................ 79 Truthful Scale ....................................................................................... 80 That’s What Neil Thought ................................................................ 84 Final Thoughts.......................................................................................... 87 Fat-Free Frozen Yogurt..................................................................... 87 What the Future Holds ...................................................................... 88 Determine if IUL Might Be a Good Fit for You ............................. 91 Finding the Right Help ...................................................................... 91 How Can You Decide? ....................................................................... 92 How Much Should You Allocate to This Strategy? ................... 92 How Should My Advisor and I Evaluate My Current IRA / 401(k)? ........................................................................................... 93 How Can I Compare Results to an IUL Policy? ......................... 93 If I Choose to Use IUL, How Should I Handle My Taxes?..... 94 How Should My IUL Policy Be Structured? ............................... 94 Feel Good About Your Choice ........................................................ 95 Pay It Forward .......................................................................................... 97 New Rules for the Next Generation .............................................. 97
The New Rules of Retirement Saving................................................. A Crisis in America ................................................................................... C The Old Rules of Retirement Saving ............................................... E Three Rules for a Better Future..........................................................F Rule #1: Know Your Risks.........................................................................I Your Three Biggest Risks ......................................................................I
Prologue
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want to tell you my story. Most financial books you read tell someone else’s story. They look at the problems someone else faced, and how the author — our hero! — saved that person from financial doom. But not this book. This book is about me. And my friends. And my colleagues. It’s a book about how we chose to save for retirement … and what that choice means now that retirement is on the horizon. It’s a book about what comes next — for me, and likely for you, too.
Help from an Actuary
I’m an actuary. Yes, that’s right. You’re about to read a book written by an ac- tuary. Wait! Don’t shut the cover. There’s a good reason you should listen to what actuaries have to say about your retirement. Sure, I know the old stereotypes. What’s an actuary? A CPA without the personality. What’s a computer? An actuary with a heart. But the truth is, actuaries are experts in assessing and reducing risk. We use math, statistics, and complex analysis to determine the true risks in a situation, as well as how to minimize them.
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I’m here to tell you: Your IRA is full of risks. In fact, saving for the future is one of the most significant financial risks most of us take in our lifetime. So it makes sense to have an actuary like me to guide you through these risks. The problem is, most actuaries work for large financial and in- surance companies, where they sit in a tall corporate tower, far away from consumers like you. Most actuaries spend their careers helping institutions, not individuals. I’m here to change that. Putting Actuarial Expertise on Your Side Why am I so passionate about bringing actuarial expertise to savers? In 2000, over a cup of coffee, one of my closest friends asked me a question that would change my career. Until then, I had always worked on the side of institutions: I led product development, created a retail annuity business, and over- saw technology platforms for various insurance carriers. I had even served as CEO of an insurance and annuity company. But I had never served individual savers. None of the actuaries I knew did. My friend needed help, so he asked, “Do people like you ever help people like me plan for retirement?” It was an intriguing question. And, as I thought about it, I couldn’t believe the answer was “No.” I’ve always had an entrepreneurial streak; I love trying things no one has tried before. I realized I could use my actuarial exper- tise to help individuals instead of corporations. It became my mission and my passion. In 2001, I founded Stonewood Financial with the goal of bring- ing actuarial expertise to everyday savers. While I love helping
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savers one at a time, this book is my way of helping savers across the country. Many people have their own doctor, their own CPA, or even their own attorney. So why not have your own actuary to advise you? Through this book, you can.
Actuaries and Retirement An actuary is someone who uses math and statistics to analyze the financial consequences of risk. You’ll find our fingerprints on almost all insurance and financial products. Have you ever won- dered how your health insurance company determines your pre- mium each year? At some point in the process of designing the policy, an actuary had to calculate the cost of covering your risk of getting sick, getting injured or dying. If the insurance policy pro- tects your property, such as your home or car, an actuary had to crunch the numbers and predict the odds of your home burning to the ground or your car being involved in an accident. Wherever you find risk, you’ll find actuaries. Actuaries certainly have a stereotype: We’re the geeks of the math world. As one comedian put it: “Actuaries were invented so accountants would have somebody to make fun of.” In a way, we are geeks. Actuaries love numbers. The thing about numbers is they don’t lie. They are absolute. If Johnny has an apple stand and sells five apples a day for three days, he will have sold fifteen apples. Case closed. There is no way to spin that. Life may be complex and fraught with a multitude of problems and uncertainty, but logic is simple, and numbers are starkly pure. There is a rare, sweet harmony to math. The English words “actuary” and “actual” stem from the same Latin root, which connotes “a state of fact” or “that which is real.” When analyzed correctly, numbers can tell us much about life, es- pecially its financial side. Take Johnny and his apple stand, for
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instance. As a merchandiser of fruit, he is no superstar. This had better be a sideline business for the kid, because, at five apples a day, if he has any overhead at all, he is a bankruptcy candidate (of course that may depend on how much he gets per apple). Any fi- nancial undertaking held up to the light of analysis by applied ac- tuarial science will have a much better chance of succeeding than one without such benefit. This holds doubly true for retirement planning. Your Own Personal Actuary I believe people should have their own actuary the way they have their own doctor, lawyer, or accountant. Actuaries specialize in identifying and reducing risk. And just about everyone’s finan- cial portfolio could use help with that. One of the reasons I founded Stonewood Financial was so I could take the unique science of risk assessment and actuarial problem-solving out of the boardroom and bring it into the living room, so to speak. All of us deal with risk in our financial lives — risk that can be mitigated, or at least prepared for, through actu- arial analysis.
Why IRAs? Why Now? I told you this was a book about me. About my story.
A few years ago, I was helping my adult daughters figure out the best way to save for the future. Frustrated at the outdated ad- vice they were getting, I was moved to write a book: The New Rules of Retirement Saving . The book helped younger generations align their savings strategies with the realities of today’s market. One of the hallmarks of that book was a discussion on the pit- falls of traditional tax-deferred retirement accounts, like IRAs and
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401(k)s. While writing the book, I couldn’t help but feel I had fallen victim to these pitfalls as well. When my friends and I discuss our retirement plans, none of us do so with affection. We’re glad we’ve saved enough money for a comfortable retirement, but almost all of us feel anxiety about the way we’ve saved. Was it smart to defer so much in taxes? Do I have enough to live well and leave a legacy? How am I going to keep these funds growing? What if I lose it all in a crash? The concerns go on and on. Those concerns gave rise to this book. In January of 2016, I decided I was finished compromising in my IRA. I decided I didn’t have to accept the limitations of my current strategies. Most importantly, I decided to quantify the compromises in my IRA — and what they were costing me and my wife as we approach retirement. While I used my actuarial expertise to identify the impact of these consequences, you don’t have to be an actuary to understand the results. If you’ve ever felt frustrated with your retirement strategy, this book is for you. I want to show you how I uncovered the ways my IRA was failing me . . . and what I did about it.
CHAPTER ONE
Three Conflicts in Your IRA
e’re all part of a cultural movement when it comes to retirement saving. Most of us have bought into the prevailing ideas on saving for the future. Maybe we heard them from the talking heads on TV, or from a financial advisor or HR professional at work. But nearly all of us have joined this movement. Consider: Did you ever stop to think why you save for retirement in an IRA or 401(k)? Not why you chose the specific account you’re in, or why you’re invested the way you’re invested. I’m talking about why you chose to put the money you’re setting aside for the future into a qualified, tax-deferred retirement account. I’m guessing “chose” is a strong word. Most of us didn’t “choose.” Our companies, or a financial advisor, or the advice from CNBC chose for us. At some point, we began believing this was the American way to save. So, we did. You’re not alone. Most of my retirement funds are in 401(k) and IRA accounts. My financially sophisticated friends? You guessed it. They saved in IRAs and 401(k)s, too. For most American savers, qualified accounts are the norm. Let me be clear at the outset: This book is not here to bash IRAs and 401(k)s. They’re an important tool in the toolbox of saving. W
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But, like all choices in life, there are consequences when you choose to save for retirement in a qualified plan. And most of us have never been fully briefed on what those consequences — good and bad — might be. I wrote this book to talk about those consequences. Each of us has made compromises to save in a qualified plan. Now, we need to understand them. Only then can we reduce their impact on our retirement funds and, more importantly, our retirement plans. It Happened to Me Looking back at my savings experience, it’s probably pretty similar to your own. I graduated from Purdue University in 1972 with a degree in mathematics and physics. I was so eager to start my first job that I skipped my graduation ceremony altogether. While my classmates were tossing their hats in the air, I was settling into a new role as an actuarial student at Travelers Insurance in Hartford, Connecticut. At that point, saving for retirement was easy: I didn’t have to do it personally because my company did it for me. In the 1970s, Travelers had a defined-benefit pension plan, so each year I accrued a portion of my salary that would be paid to me at retirement for the rest of my life. Amazingly, I didn’t have to contribute a cent to this plan. It was up to my employer to fully fund it. If only it had stayed that easy. By the 1990s, I was CEO of an insurance company called Integrity Life, headquartered in Louisville, Kentucky. Here’s where my retirement savings got considerably more complex.
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At Integrity, we didn’t have a formal pension program. Instead, we saved in what was, at the time, the hot new savings product in America: the 401(k). Over the years, as I climbed the corporate ladder, I amassed a group of retirement assets that included a small pension and several rollover IRAs. Those IRAs are where my retirement funds have been growing, up and down with the market, as I march on toward retirement. I’m willing to bet your retirement accounts look similar. It’s an easy bet to make, because the majority of successful U.S. savers have most of their retirement funds in IRAs and 401(k)s. 1 But here’s something I didn’t realize as a twenty-five-year-old actuarial student, as a thirty-five-year-old head of insurance product development, or as a forty-five-year-old CEO: I was making a lot of compromises to save in my IRA. And you have, too. What does that mean? This book will show you. This book will teach you the three biggest compromises in your IRA, and how you can overcome them to live a happier retirement. Together, we’ll transform your thinking around retirement saving, and create a strategy free from compromises. A word of caution before we begin: As you read this book, you may get a sinking feeling, realizing perhaps you’ve made some errors while saving. I’m here to tell you not to worry. While you can’t go back and make different choices in your past, you do have the power to choose what comes next. Together, we’ll make sure it’s the right choice.
1 Sarah Holden and Daniel Schrass. ICI Research Perspective. December 2017. “The Role of IRAs in US Households’ Saving for Retirement, 2017.” https: // www.ici.org / pdf / per23-10.pdf.
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Conflicts in Your IRA At its core, this is a book about conflict.
What do I mean by conflict? Two needs pulling you in opposite directions. Two goals that are not compatible, where making gains in one area means losing ground in another. I want to eat cake and I want to lose weight. The more cake I eat, the less weight I lose. The more weight I lose, the less cake I can eat. But I can’t eat more cake and lose more weight, because there’s a conflict inherent in my goals. Likewise, conflicts have forced you to compromise in your IRA, as you try to balance competing interests. As innovative Americans, we have figured out how to eliminate conflict from many areas of our lives. What if I want to sleep in but I also want my coffee brewed? No problem. We’ve created programmable coffee makers so a hot cup is waiting when I get downstairs. How about when I want to join an important meeting in a distant city, but I don’t have time to fly across the country to do so? Great! We’ve created video conferences so I can join in from the comfort of my home office. When it comes to finances, however, we’re still battling a lot of conflicts that have gone unresolved. Your IRA is home to three major conflicts that act as hurdles to your retirement goals. • Growth vs. Protection : The desire for your funds to grow so you have enough income in retirement, and the desire for your funds to stay protected so they won’t be wiped out in the next market crash. • Income vs. Legacy : The desire to use your funds for living expenses in retirement, and the desire to leave your funds as a legacy to your children, grandchildren, or favorite charity.
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• You vs. the IRS : The desire to use your retirement account as income, and the government’s desire to get its portion of the account through taxes. That’s it. Three conflicts. These three conflicts in your IRA have a bigger impact on your living standards in retirement than almost anything else. Yet, most of us have never tried to overcome them. We assume it’s necessary to accommodate them, to plan around them. I’m here to tell you: It’s not. Yes, I’m Talking to You I know it’s easy to say, “This book isn’t for me. I’ve done a decent job of saving. I’m smart with my money. My account is diversified. I’ll be fine.” But the truth is, you are battling these conflicts, too. I’ll show you why it matters so much. Take my client, Andrew. Andrew is a CPA, and he knows numbers. He also knows how to evaluate risk. After one of our meetings, he remarked to me, “You know, when I first met you, I always assumed you were talking about other people. I figured I was smart enough to know what to do with my savings. Heck, I advise my clients on some of the same strategies you’re dismissing. But you know what? I needed help, too. I was relying too much on the talking heads and not enough on the level heads.” So, before we begin, let me say: I am talking to you. In the pages ahead, you’ll see why these three conflicts in your IRA may be the biggest challenge you face in retirement.
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Outside-the-Box Thinking I have one request as we embark on this book’s journey together: open your mind and think outside the box. I’m going to give you a different lens through which to view your finances. It’s going to feel different from what you’ve done before. That’s good! Because we’re here to perform a savings check-up: to make sure conflicts aren’t standing in the way of your happy retirement. When people ask me what I mean by “thinking outside the box,” I’m reminded of a story from the early 1900s, where the automobile was just being introduced. A spokesman for Daimler Benz was asked about the future of cars: just how scalable was this new invention? The spokesman thought inside the box. Here was his answer: “There will never be a mass market for motorcars, because there is a limit on the number of chauffeurs available.” He was stuck in the box where every car needed a chauffeur. He couldn’t see outside the box, where individuals would enjoy driving themselves. He couldn’t see the personal automobile. The same is true with saving today. Too many of us are saying, “I accept the limitations of these strategies, because these strategies are the way people save. It’s just the reality of saving.” But, as you’ve probably guessed by now, we’re not going to approach your future inside the box. We’re going to take a step back, evaluate where you are today, determine where you want to be, and build a path from one to the other. Let’s get started. A quick note: Throughout this book, you’ll see me using the terms “401(k),” “IRA,” “qualified account” and “tax-deferred account” somewhat interchangeably. Regardless of the term, what we’re discussing is retirement savings accounts where your funds and earnings grow tax- deferred. So, call them what you like — now you’ll know what we’re talking about in the pages ahead.
CHAPTER TWO
Conflict No. 1: Growth vs. Security
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ver watch CNBC and get overwhelmed with the advice you hear? Or you read USA Today and have trouble sorting out what it all means? Financial planning can be confusing. It’s even harder when the “experts” can’t agree. Here’s what we face when we turn on the TV, or read the paper: “Baby boomers should generally have [up to] 70% of their port- folio in equities.” – USA Today 2 So you think: Great. I’ll put more of my savings in stocks. But wait! “Baby boomers have too much retirement savings in stocks.” – CNN Money 3 Hmm. Okay, so, less in stocks. But wait again! 2 Jeff Reeves. USA Today. Nov. 9, 2015. “The 60 / 40 stock-and-bond portfolio mix is dead in 2016.” https: // www.usatoday.com / story / money / personalfinance / 2015 / 11 / 09 / 60-40-stock- bond-portfolio-mix-dead-2016 / 75042316 / . 3 Katie Lobosco. CNN Money. Aug. 14, 2015. “Baby Boomers have too much retirement savings in stocks.” http: // money.cnn.com / 2015 / 08 / 14 / retirement / retirement-baby-boomers-stocks / in- dex.html.
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“Subtract your age from 100 – that’s the percent of your port- folio to keep in stocks.” – CNN Money 4 This is getting confusing, you think. I’ll just fall back on the old tried-and-true advice to keep 60 percent of my portfolio in stocks, and around 40 percent in bonds. “The 60 / 40 stock-and-bond portfolio mix is dead.” – Motley Fool 5 Oh . . . See what I mean? No wonder so many savers are confused at best, and fed-up at worst. The Conflict Inherent in Today’s Market Part of the problem is today’s market is filled with conflicts of its own, and that makes allocating your funds very difficult. Take my client Eddie. Eddie is sixty-six years old and recently retired from one of the largest construction companies in our state. He’s done a pretty good job of saving in his company’s 401(k) program, but he’ll be the first to admit he underestimated just how much income he and his wife need in retirement. He once quipped to me, “I’ve got grandkids stretching from California to South Carolina. We’ll burn through our retirement funds in airfare alone!” Eddie is faced with a very common problem, one I suspect you struggle with, too. First, Eddie wants his retirement funds to grow. 4 CNN Money. 2018. “Ultimate Guide to Retirement.” http: // money.cnn.com / retire- ment / guide / investing_basics.moneymag / index7.htm. 5 Selena Maranjian. The Motley Fool. Dec. 29, 2016. “5 Facts About Stocks Every Baby Boomer Should Know.” https: // www.fool.com / retirement / 2016 / 12 / 29 / 5-facts-about- stocks-every-baby-boomer-should-know.aspx.
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Second, Eddie wants his retirement funds to stay safe. While he’s saved well, he can’t afford the retirement he wants if his 401(k) never grows. Yet, while he needs his account to grow, he can’t afford the retirement he wants if his account is wiped out by a stock market crash. This creates a conflict for Eddie, and for you and me as well. While Eddie was saving, his account grew by contributions and investment earnings; he had two ways to boost his retirement funds. But now that he’s retired, his account can only grow by in- vestment earnings: it can only grow by what it earns in the market. He can’t ignore growth while he’s retired. Where can he find that growth? Let’s take a look at Eddie’s challenge. Realities of a Volatile Market Do you have some of your retirement funds in mutual funds? Target date funds? Stocks? If so, congratulations. You’re depend- ing on the stock market for growth. Traditionally, the stock market is where we’ve turned for growth. There’s nothing wrong with that approach but, as savers, we need to understand what today’s market is, and what it is not. Remember the 1990s? There are a lot of things I don’t miss from the 90s. Flip phones that could barely text. Beanie Babies that somehow convinced millions of adults to buy stuffed animals. Windows 95. But there’s one thing I miss from the 90s every day: the stock market. The 1990s were booming days in the market. You might re- member something called “Dart Funds” — these were funds you could invest in where a stockbroker literally threw a dart at a sheet of stocks and invested in whichever ones the dart hit. You know
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what? Dart funds were making good money! Everything was mak- ing good money. The market was going up, up, up. We all know what happened after the feel-good years of the 90s: the dot-com bubble burst. If you’re like me and the majority of Americans, for the last two decades, you’ve been riding the mar- ket roller coaster as we recover and then crash again. The 2000s started low: From March of 2000 to October of 2002, the NASDAQ lost 78 percent of its value. The S&P 500®, which is an index that economists often use to measure the overall health of the stock market, fell by nearly 40 percent. In a series of months, many people’s retirement accounts were severely de- pleted. A running joke at the time was that 401(k)s had been re- duced to 201(k)s. 6, 7 The good news is, the market didn’t stay down. From 2002 to 2008, the market recovered. Those were okay years. Most of us were trying to earn back what we had lost in our retirement ac- counts. The market was helping us along. Then the real estate bubble burst in 2008 and sent the market crashing again. Today, the market has recovered. In fact, the S&P 500® is hov- ering around all-time highs. And, as any financial advisor will tell you, if you rode the wave, you’ve come out on top. If you didn’t get scared and sell when the market was down, if you didn’t panic and buy when the market was high, if you just stayed the course, you slowly recovered. Recently, we've watched volatility return to the market. Most experts, including myself, believe the next big crash isn't a ques- tion of if but when. But I’m not here to scare you with talks of the next great crash. Instead, I’m here to help you evaluate what a
6 Multpl.com. March 13, 2018. “S&P 500 Historical Prices by Year.” http: // www.multpl.com / s-p-500-historical-prices / table / by-year. 7 Investing.com. March 13, 2018. “NASDAQ Composite Historical Data.” https: // www.investing.com / indices / nasdaq-composite-historical-data.
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volatile market means for the equities-exposed portion of your re- tirement account. Here’s what many people don’t realize: So far this century — from 2000 to the end of 2019 — the stock market has seen two bear markets (crashes) and two bull markets (growth periods). That’s a LOT of volatility. If you stayed the course and didn’t panic, you’ve done well. You’re reaped the benefits of all-time highs in the market. Right? Well, not quite. From 2000 to 2019, the S&P 500® (a measurement of the 500 largest stocks on the exchange, which is what people usually mean when they say “the market”) returned an average of 6.06 percent. All that risk — riding the roller coaster through booms and busts — netted you around 6 percent a year. Remember, that’s your growth before you pay the fees inside your 401(k) or IRA, and of course before the IRS takes out its portion for taxes.
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The Impact of Volatility Imagine you had to save during the worst decade in modern U.S. market history. A market so bad you would, on average, lose money every year. A market that saw not just one but TWO crashes that wiped out more than a third of your savings’ value. We feel for our parents and grandparents who lived through that kind of market with the Great Depression. But here’s a sur- prise: their generation isn’t the only one that had to work and save during one of the worst markets in history. You did, too. The years 2000 through 2009 are estimated to be the single worst decade in S&P 500® history. You might have heard it called the “lost decade of investing,” because the market that decade ended lower than it started. How bad was it? For those number geeks like me, this next sec- tion will be very exciting. If you’re not a numbers person, don’t worry — I’ll explain what all the numbers mean. If you had a 401(k) with $100,000 in it, completely invested in the S&P 500®, what would have happened over the first decade of this century? Well, look at the line on the preceding chart marked, “Annual Total Return of the S&P 500®.” This represents your ac- count value. The market crashes from 2000 to 2002. It takes you four years to earn back what you’ve lost, and finally by 2006, you’re above water. Then, in 2008, you lose it all again. You saw some good years. The market was up 28 percent in 2003 and 26 percent in 2009. But you used those big gains to earn back the money you lost when the market dropped. So those gains
really didn’t reflect forward progress, did they? In fact, it’s even less progress than you think.
Guess what your 401(k) earned, on average, from 2000 through 2009, if it was invested wholly in “the market”? Four percent? Three percent?
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The answer may surprise you. It’s negative 1 percent. That’s right. For the entire decade, you lost about 1 percent on average per year.
That’s frightening data when you’re trying to grow and protect your retirement savings. As I mentioned, the experience over the rest of the century hasn’t been much better. Remember, from 2000 through the end of 2019, the S&P 500® has returned an average of 6 percent per year. Not terrible (at least you didn’t lose money), but also perhaps not enough to grow your account value in a meaningful way. And, remember, that’s your growth before you pay the fees inside your 401(k) or IRA and before you pay taxes. No one is going to successfully retire on an account that’s growing in the very low single digits. You need meaningful growth to fuel your account.
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Why It Hurts So Much When the Market Crashes Here’s a very concrete example of why most savers weren’t cel- ebrating when the market rose 28 percent in 2003. Below is a chart of the growth needed for recovery when the market drops:
That’s right. If the market drops 50 percent, your account needs to grow by 100 percent to make up that loss. So, when the market dropped 22 percent in 2002, and went up 28 percent in 2003, many savers were still under water: They hadn’t earned back eve- rything they had lost. Let’s put it another way. You have $10. You lose 50 percent of it. Now you have $5. You grow that money by 50 percent. Now you have $7.50. You’re still $2.50 short of where you started.
The Flip Side of the Coin Right now, you’re probably thinking, “Okay, Marty. I get it. The market is volatile. That’s why my account is diversified. So what?” Here’s what.
THE NO-COMPROMISE RETIREMENT PLAN • 15
In today’s market, to get diversification, you have to give up a lot of growth. That’s a core conflict of your IRA. My friends and I saved with a mistaken belief: we assumed once we hit age sixty-five, we could put our funds into safer instru- ments and be done with it. Sure, they wouldn’t grow as much in CDs as they did in stocks, but we could still get meaningful growth on our funds while keeping them protected. Think back to the 1970s and 80s. Perhaps you were like me. When I was in my thirties, I opened a checking account at the local bank in Louisville, Kentucky. It was a basic checking account, a place to deposit my checks (remember when you had to drive to the bank to deposit a check?) and pay my bills (remember when you had to write a check to pay a bill?). From this account, I was very careful about when I paid my bills. I always waited until the last day possible, and then wrote a check and put it in the mail. This odd behavior wasn’t because I was broke; I had enough money to cover my bills. Can you guess why I did this? In 1980, my checking account was earning an interest rate of around 18 percent. Eighteen percent! I wanted to keep my money in the bank and earning that interest as long as I could. It’s hard to remember back when money could achieve mean- ingful growth in secure vehicles. It’s just not a reality anymore. Most checking accounts today earn around 0.10 percent. When was the last time you saw a checking account earning interest on the left side of the decimal point? It doesn’t happen anymore.
16 • MARTIN H. RUBY
The Challenge of Low Interest Rates Low interest rates have been a boon for borrowers. Auto loans? Less than 2 percent. Mortgage loans? Less than 6 percent. But the same low interest rates that make it easy to buy a car or finance a home have made it very challenging to grow wealth safely. My father owned a children’s clothing store in New Albany, In- diana. As a small business owner, he didn’t have a pension or cor- porate plan, so, in retirement he and my mother lived off what he had managed to save and grow on his own. They spent frugally and did what so many retirees of my parent’s generation did: largely lived off the interest from CDs. I used to think I’d live off CD interest in retirement, too. But that’s not an attractive option for today’s savers. Even five-year CDs are returning just over 1 percent. It’s not enough. If you don’t want the volatility of the market, you’re stuck with low growth. That’s because most safe alternatives to the stock market rely on interest rates. And low interest rates are here to stay . . . at least in the near term. Generally, interest rates have been falling steadily since the mid-1980s and are currently near historic lows. These low rates have helped companies afford to hire workers, and workers afford to buy bread, milk, cars, and clothes at prices that aren’t pumped up by inflation. Recently, rates have begun to rise — but only modestly. No one is suggesting we go back to rates we saw in the 80s and 90s any- time soon. Here’s one reason why.
THE NO-COMPROMISE RETIREMENT PLAN • 17
The government wants — and needs — low interest rates. The U.S. government has a big incentive to help keep interest rates low: It reduces the federal government’s debt payments. An increasingly large portion of our federal budget each year goes to paying interest on the U.S. debt. In 2010, 6 percent of our federal budget was dedicated to debt service, or around $209 billion. By 2035, the Congressional Budget Office projects debt service will grow to 25 percent of the budget, or around $2.27 trillion. As this book is written, the federal government is borrowing and repay- ing money at very low interest rates. If those rates rise, so does our national debt. Consider: Between 2011 and 2013, the gross federal debt rose more than $3 trillion. If interest rates had been just 1 percent higher during that time, the government would owe an additional $30 billion in interest each year. On June 1, 2005, the total national debt was $7,775,753,817,632.01. Ten years later, June 1, 2015, it was
18 • MARTIN H. RUBY
$18,152,841,401,259.20 — more than double. 8 Politicians like to talk about slowing the growth of our national debt, but few hope to reverse the trend altogether. And this suggests interest rates are going to stay relatively low for the foreseeable future.
So, what does this mean for your retirement account? It’s going to be hard to grow your savings significantly in safer vehicles — likely for many years to come.
The Conflict of Growth vs. Security Here’s the first big conflict in your IRA. You can choose growth potential in the market and assume a lot of risk and volatility to
8 Treasury Direct. “The Debt to the Penny and Who Holds It.” http: // www.treasurydirect.gov / NP / debt / current
THE NO-COMPROMISE RETIREMENT PLAN • 19
do so. Or you can choose security in CDs and money market funds and give up any kind of meaningful growth. But you can’t have growth AND security.
This is often called the “Saver’s Dilemma,” and it’s impacting your IRA today. You have to compromise because of this conflict: give up some growth to get protection; give up some protection to get growth. That compromise means your account is growing slower than it could be, and at the same time, your account is less protected than it should be. This is one of your IRA’s key conflicts, and probably the one that sounds most familiar to you. But there are two other conflicts you need to consider as you head to retirement.
CHAPTER THREE
Conflict No. 2: Income vs. Legacy
I
n the last chapter, we focused on how you might be growing your retirement funds. In this chapter, I want to focus on how you might use your retirement funds. Not surprisingly, there are conflicts in your IRA here, too. I have good friends, James and Lynda. They’ve been blessed with two children and more importantly — as anyone my age will tell you — four beautiful grandchildren. James and Lynda are planning to retire in two years, when they reach seventy. When we get together for dinner at their house, one of their favorite things to do is update my wife and me on their plans for retirement. They’re building a swimming pool in their backyard for when the grandkids visit in the summer. They’re planning to spend two months every winter out in Phoenix, where their son and his wife live. The point is, James and Lynda are going to need a good amount of income to make their retirement plans a reality. Thankfully, they’re in a good place: they’ve saved well. But over dinner one night, the conversation turned to inher- itances. Unwittingly, during the course of the discussion, James uncovered a big conflict in his retirement account.
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22 • MARTIN H. RUBY
James’ family grew up at the lower end of the middle class. When his dad passed away, there wasn’t much need for a will, be- cause there wasn’t much to pass on to his kids. His dad had sold his house to help cover his nursing home care and had gone through most of his savings in pursuit of the same. But James built a good career as an attorney in Louisville. While he never expected an inheritance from his dad, he wanted to leave one to his kids. The reality James faces — the same reality I face and one I bet you do, too — is that we have one pot of money. We’ve saved, and now it’s a question of how that money will be distributed. Do I use it while I’m living, as income? Or does it go to my kids once I’m no longer here, as an inheritance? This creates a big conflict in your IRA. My Conflicted IRA When I think about my IRA, I know I’m going to need it for four things: First, and most obviously, I’ll need to use it for income to cover everyday expenses. While my wife will tell you I’ll never retire (I’m not sure she wants me puttering around our house, anyway), at some point, I’m going to either work less or stop working altogether. So, when my income drops or disappears, I’m going to need money every month to buy groceries and pay our cable bill. This is why most of us started an IRA or 401(k) in the first place: for retirement income in the future. But there are three other ways I’ll likely use my IRA. One is for the medical costs associated with aging. After all, ex- pensive medical bills aren’t factored into our budgets, but they’re a reality for many of us in retirement.
THE NO-COMPROMISE RETIREMENT PLAN • 23
It may surprise you to learn a healthy sixty-five-year-old cou- ple could spend nearly $400,000 out of pocket on medical ex- penses in retirement. 9 We’re not talking about spare change. My IRA will have to help cover costs as my wife and I age: in-home nurses, medical procedures, physical therapy, medicines. It adds up — potentially to the tune of $400,000. Next, I will likely have unplanned expenses. My house needs a new roof. My wife needs a new car. The basement floods. We all have emergency needs eventually, needs we can’t predict and don’t necessarily budget for in our annual income. My IRA will have to support some of those as well. These first three demands on my IRA — income, medical ex- penses, emergencies — are all money I’ll be spending. But if you’re like me and my friend James, you’ll also want to leave a legacy for your children, grandchildren, or charity. That means your IRA also has to cover your legacy needs. I have two adult daughters and four grandchildren. While I’ve worked with my daughters throughout their lives to be good sav- ers and plan for their own futures, I’d still like to leave something to them when I’m no longer here. My wife and I have also made commitments to charities that are important to us: religious insti- tutions, educational institutions, hunger organizations. If you want to leave a legacy, your IRA is pulling double duty. And there’s a big conflict embedded in that.
9 HealthView Insights. July 2019. "Retirement Health Care Cost Data Report." http: // www.hvsfinancial.com / white-papers /
24 • MARTIN H. RUBY
Finding the Balance My IRA may end up being used like this:
But here’s what I realized: my IRA — and your IRA, too — is a zero-sum game. That means the more money I use as income, the less money I have as inheritance for my kids. And the more inheritance I want to leave my kids, the less of my IRA I can spend as income. As an actuary, I’m trained on life expectancy and risk. When I counsel people on saving, I emphasize an important reality: The risk to your loved ones is dying too soon, but the risk to your sav- ings is living too long. Medical advances are helping people live longer and fuller lives — many of us will live well into our nineties or even beyond. Life expectancy is nearly ten years longer today than it was when I started saving in the 1970s. That means we’re going to use
THE NO-COMPROMISE RETIREMENT PLAN • 25
a lot more income while we’re living, and potentially have less to pass on as inheritance. No matter how long you live or how much you spend, your IRA is still a zero-sum game. It’s one pot of money, and you face con- flicts on how to divide it up. So, conflict No. 2 pits you against your heirs: How much will you spend, and how much will you be able to pass on? Of course, whether you plan to use your funds as income or legacy, there’s still a big chunk of that money you won’t get to keep, and that brings us to conflict No. 3.
CHAPTER FOUR
Conflict No. 3: You vs. the IRS
Y
ou’ve probably heard of Dave Ramsey before. He’s an au- thor, radio host, TV star, and popular purveyor of financial advice. If you’ve ever listened to his show, you know his most famous mantra: get out of debt! Ramsey encourages Americans to pay off their credit card debt, car loans, medical bills – even their mortgages. In general, it’s good advice. Americans could use a lot less debt. But I’m always alarmed Ramsey overlooks one of the biggest debts nearly every American carries. Your Hidden Debt I call this your hidden debt, since so few of us realize we carry it. You may have paid off your mortgage. Student loans may be decades in your past. You may own your car and pay off your credit card bill each month. But if you’ve saved for retirement in a 401(k) or IRA, you are NOT debt free. So, what’s your hidden debt? The taxes you owe in your qualified account. My client Dave never considered his hidden debt.
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28 • MARTIN H. RUBY
Dave has $760,000 in a 401(k). When I first met him, he was laser-focused on income: he and wife needed $100,000 a year in income for the retirement lifestyle they desired. He wanted to know the best way to manage and protect his $760,000 so that, along with Social Security and his wife’s pension, they could meet their income goal. But Dave forgot about his hidden debt. He believed his IRA was worth $760,000. It wasn’t. Dave’s tax liability is around 25 percent. So, when he with- draws $50,000 from his IRA, he only gets to keep $37,500. The other $12,500? That’s the taxes he owes. That’s his debt payment to the IRS. Put another way, Dave is indebted to the IRS (and its state and local partners) for around 25 percent of Dave’s retirement funds. While he was saving, Dave got a tax deduction on his 401(k) con- tribution every year. It was like a loan he didn’t have to repay an- ytime soon. But now, as Dave gets ready to retire, he’ll start to repay that loan. Why don’t most of us think about our hidden debt? Because it doesn’t impact us now. When you buy a house on mortgage, you live in the house every day and make your mortgage payments each month. But with your IRA, you’re not using the money until years in the future, and the debt isn’t immediately clear. It’s about to become clear. Like Dave, when you begin accessing funds from your IRA or 401(k), you begin paying back your debt to the IRS. And it gets worse. Because in truth, you’re paying back that debt with interest. After all, you deferred taxes only on your IRA contributions. Now, you’ll be paying taxes on your IRA contribu- tions AND all the growth that’s occurred in your account. The IRS is taking its cut of your principle and your earnings.
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