The New Rules of Retirement Saving

THE RISKS NO ONE IS TELLING YOU ABOUT . . . AND HOW TO FIX THEM

Martin H. Ruby, FSA With Neil Wilding and Becky Ruby Swansburg

Stonewood Financial LOUISVILLE, KY

Copyright © 202 3 by Martin H. Ruby. All rights reserved. No part of this publication may be reproduced, distributed or transmitted in any form or by any means, including photocopying, recording, or other electronic or mechanical methods, without the prior written permission of the publisher, except in the case of brief quotations embodied in critical reviews and certain other noncommercial uses permitted by copyright law. Stonewood Financial 100 Mallard Creek Road Suite 200 Louisville, KY 40207 502-588-7155 StonewoodFinancial.com

The New Rules of Retirement Saving/ Martin H. Ruby. — 6 th ed.

Contents

Prologue......................................................................................................... v The New Rules of Retirement Saving...................................................1 Three Rules for a Better Future..........................................................6 Rule #1: Know Your Risks..................................................................... 11 Structural Risk .......................................................................................... 15 The Three-Legged Stool.................................................................... 16 Market Risk ............................................................................................... 29 Tax Risk ...................................................................................................... 41 What Happens If… .............................................................................. 48 Which Should You Choose? ............................................................. 49 Now You’re In the Know .................................................................. 56 So, Fix It Already ................................................................................. 57 RULE #2: Choose a Strategy That Addresses Your Risks............ 59 Choosing How You Save ....................................................................... 63 7702 Plans.............................................................................................. 68 IUL ........................................................................................................... 69 Eliminating Structural Risk .................................................................. 71 A Self-Completing Plan ..................................................................... 72 Eliminating Market Risk ....................................................................... 75 Eliminating Tax Risk .............................................................................. 83 Too Good to Be True.............................................................................. 87 Truthful Scale ....................................................................................... 88 Rule #3: Take Action Now .................................................................... 95 Final Thoughts ........................................................................................ 101 How Much Do I Need to Retire?....................................................... 105 Longevity Risk.................................................................................... 106

iii

iv • MARTIN H. RUBY

Addressing Longevity Risk............................................................. 111 Give Me a Dollar Amount............................................................... 113

Prologue

ou’re about to read a book written by an actuary. Wait, don’t close the cover. I know the old stereotypes. What’s an actuary? A Certi- fied Public Accountant without the personality. What’s a com- puter? An actuary with a heart. But the truth is, an actuary is someone who uses math and sta- tistics to assess and minimize risk. And, whether or not you know it, risk is all around you as you save for the future. So what’s an actuary doing writing a book on saving? In 1998, I was talking to one of my oldest friends as he began getting his assets in order for retirement. At the time, I was chief executive officer of an annuity company, but on the side I was al- ways giving advice to friends and family who needed help figuring out complex financial decisions. As an actuary, I knew how to get deep into financial products and figure out their benefits, so giving my friends some informal advice became a hobby. On that afternoon in 1998, over a cup of coffee at my office, my friend asked me a question that would change my life: “Do people like you ever help people like me plan for retirement? I want an actuary to be my advisor.” It was an intriguing question. But I had to answer: “No.” It’s a funny thing. Actuaries are uniquely positioned to help you think about saving. Our specialty is discovering risks and figuring out how to eliminate (or at least minimize) them. But the vast ma- jority of actuaries work for large financial or insurance companies in steel and glass towers, where they seldom come into contact with the public. Actuaries spend their time helping institutions, not individuals.

vi • MARTIN H. RUBY

But my friend’s question kept ruminating in my head. Could actuaries help individuals? That simple question was an awakening for me. My “a-ha mo- ment,” so to speak. I’ve always had an entrepreneurial streak to my personality. I love trying things no one has tried before. I realized I could use my actuarial expertise 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. And while I love helping savers one at a time, this book is my way of helping savers well beyond my clients and friends. Many people have their own doctor, their own CPA, or even their own attorney. Why not have your very own actuary? Well, now you can. Help from an Actuary? 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 protects 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. Actuaries love numbers. And 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

THE NEW RULES OF RETIREMENT SAVING • vii

be complex and fraught with a multitude of problems and uncer- tainty, but logic is simple and numbers are starkly pure. There is a rare, sweet harmony to math not found in the other sciences. 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 in- stance. As a merchandiser of fruit, he is no superstar. This had better be a sideline 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 financial undertaking held up to the light of analysis by applied actuarial science will have a much better chance of succeeding than one without such benefit. 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 financial risk is what keeps many of us up at night. Will the stock market rise or fall? Will in- terest rates go up or down? Have I saved money in the right vehi- cles, with the right tax status, at the right time? It's enough to give anyone insomnia. Just about everyone's financial portfolio could use help mitigating risk. 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. So let this book be your own personal actuary. I promise it will be more interesting, insightful, and enlightening than our stereo- type would lead you to believe.

CHAPTER ONE

The New Rules of Retirement Saving

“Invest in the future because that is where you are going to spend the rest of your life.” ~ Habeeb Akande

did it wrong. That’s not easy for a person like me to admit. I’m an actuary. And actuaries are mathematical experts at managing risk. Yet I was blind to some of the biggest financial risks I’d ever face. There’s a good chance you’re doing it wrong, too. This book is an attempt to fix that. What is the “it” I’m referencing? Saving for your future. I know. Not the sexiest topic (except to actuaries like me). But it may be the most important thing you change this year. So what did I do wrong? I saved for the future in the wrong way. It wasn’t my fault. Not completely, anyway. I had a lot of people — experts among them — encouraging me to save this way. Now, at age sixty-five, I can see the tremendous mistakes I made. Here’s how I got into this predicament. 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

2 • MARTIN H. RUBY

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 Traveler’s Insurance in Hartford, Connect- icut. 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 ac- crued a portion of my salary that would be paid to me at retire- ment 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 In- tegrity Life, headquartered in Louisville, Kentucky. And here’s where my savings plans went astray. 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). If you’re reading this book, chances are you’re saving in a 401(k), too. And chances are, if you don’t make a change today, you’re going to be facing the same risks I am in the future. It doesn’t have to be that way. Here’s the secret most financial experts know, but aren’t telling you: today’s most popular ways of saving for the future are creat- ing some of the biggest risks in modern financial history. Yes, that includes 401(k)s and Individual Retirement Accounts, or IRAs. What does that mean? This book will show you. This book will teach you the New Rules of Retirement Saving and how you can use these rules to transform your savings strat- egy, eliminate risk, and increase your ability to enjoy the relaxing retirement you envision for yourself many years from now. As you read this book, you may get a sinking feeling as you re- alize you’re saving for retirement in the wrong way. I’m here to tell you, it’s not your fault. Our nation’s savings infrastructure is

THE NEW RULES OF RETIREMENT SAVING • 3

slow to react when new risks develop, and most Americans are still saving under the old rules. But you are responsible for what you do next. So don’t save with the strategies of yesterday, strategies that can’t overcome the risks of today. Use these new rules of saving. When you finish this book, I promise you’ll feel more confi- dent, more hopeful, and more prepared about your future and how to save for it. I promise that if you follow the New Rules of Retirement Sav- ing, you’ll never have to start a book by writing, “I did it wrong.” Crisis in America There’s a crisis going on in America today, and you’ve inadvert- ently become part of it. As a country, we have a problem using old financial strategies that no longer work to manage today’s financial realities. We are using old rules to address new problems. In most areas of life, we’ve kept up with the times. Certainly no one today takes a photo at the beach with a Kodak camera, drives to the store, drops off the film, waits five days to pick up the prints. Today, you just snap a picture of that sunset on your phone and share it with the world via Instagram. Likewise, if you want to watch a movie on Friday night, you’re far more likely to watch it on Netflix than to drive to a video store, pick out a DVD (or VHS!) and bring it home. In fact, we’re using new rules for most things we do. Do you bank online? Avoid eating too much red meat? Drive a car with an airbag? Research TVs online before buying one? In all these cases and more, we’ve recognized that today’s reality requires new rules. We’ve found better, more efficient, more rewarding ways to do many of the things we depend on for a happy life. But not when we save for retirement. There, the vast majority of us still play by very old rules.

4 • MARTIN H. RUBY

Your retirement savings represent your ability to enjoy a re- warding, happy future. And yet, most of us are using rules that are outdated and, worse, no longer valuable. Imagine if every time you wanted to take a trip, you had to call the airline and have them mail you a ticket. That’s the way it used to work. It’s silly to accept that kind of inefficiency today, when you can get tickets electronically in a matter of minutes. Or imagine if you broke your arm, but didn’t use an X-ray to see what’s broken. For years, doctors had to guess what kind of fracture you had. Today, no one with access to good medical care would rely on guesses rather than X-rays. When it comes to saving for retirement, most of us are making do with approaches that are as inefficient as mailing airline tickets and as risky as setting broken bones without X-rays. It’s time to update our rules. They’re All Talking About You Do you know what they’re saying about you? No, not your best friends or work buddies. I’m talking about the media. Fox News. Forbes. The New York Times. USA Today. It's hard to find a news outlet these days that hasn't weighed in on the "savings crisis" in America. Most workers aren't saving enough for retirement, and you may even be among them. And that means you may be underprepared when your future arrives. Simply put, your retirement could be at risk. And the media is right . . . to a point. What the media is missing is that it’s not your fault. You and your friends undoubtedly care about your future. You’re saving. You’re just saving under an old set of rules ! And because you’re saving under an old set of rules, saving has become so problematic, so unrewarding, that many of your peers have given up all together. The rest of you do it out of obligation, but not with any measurable satisfaction. This book is a guide to breaking that cycle.

THE NEW RULES OF RETIREMENT SAVING • 5

Yes, I’m Talking to YOU Are you saving in a 401(k) or IRA? Great job! You’re doing more than many Americans. I know it’s tempting to say, “This book isn’t for me. I already know what I’m doing.” But this book is for you. It’s for every saver who has been mis- led by what’s popular in today’s savings market, with little regard for whether what’s popular is also what’s successful. My client Andrew is a perfect example. 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 talk- ing about other people. I figured I was smart enough to know how to save. 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. I promise. If you’re like the vast majority of savers today, no matter how smart you are, you’re saving under the old rules. The Old Rules of Retirement Saving Save through your employer. Invest in the market. Defer your taxes. Lots of today’s common savings rules were created for a far dif- ferent kind of saver. They were created for savers like my Uncle Irwin. Irwin would be eighty-eight this year, and he did something that is pretty for- eign to most people reading this book: he worked for the same company his entire career . Irwin worked his way up the ranks, from salesman to management and finally to the senior leadership team. As a reward for his decades of loyalty, when Irwin retired, his

6 • MARTIN H. RUBY

company gave him a pension. During his later working years, he also saved in a 401(k), which his company matched handsomely. The current rules of saving were created for people like Irwin. They were created for a time when employers shouldered most of the financial commitment for an employee’s retirement fund, ei- ther through pensions or high 401(k) matches. My uncle didn’t contribute much to his retirement accounts: his pension was en- tirely funded by his company, and his 401(k) was heavily subsi- dized by his employer. Most of his annual salary went to daily use, not long-term savings. If you’re reading this book and you have a pension like Irwin, good for you! Keep on saving under the old rules. If you’re reading this book and your employer matches 10 per- cent or more of your 401(k) contributions like my uncle’s did, that’s great! Keep saving under the old rules, too. If you’re like most Americans and you’re saving for retirement without generous support from your employer, these rules aren’t going to work for you. That’s why I’ve created a new set of rules. Three Rules for a Better Future This book is about the New Rules of Retirement Saving. It’s about taking the same kind of insights and advancements that have taken place throughout our world, and applying them to re- tirement saving. These three rules are based on a blunt assessment of the risks you face today as a saver. Follow them, and you’ll be on a better path to saving. Why three rules? I could have created twenty or thirty new rules, from broad statements on savings philosophy to minutiae about daily savings activities, but I know you’re not going to re- member twenty rules. Besides, I’ve found it really boils down to three big actions. And if you take these three actions, you’ll be

THE NEW RULES OF RETIREMENT SAVING • 7

better prepared for retirement . . . not based on the past but based on the present and the future. So what are the three New Rules of Retirement Saving? Rule #1 : Know Your Risks Rule #2 : Choose a Strategy That Addresses Your Risks Rule #3 : Take Action Now Sounds simple? It’s actually a fundamental shift from the way you’re saving today. Over the rest of this book, I’ll help you learn about each rule and put it to work in your own savings strategy. By the end, you’ll see how these three simple rules can transform your approach to the future. Picture You at Seventy-Five Take a moment to imagine: What will your life be like when you’re seventy-five? No, I’m not talking about the iPhone 84, or getting robots to fold your laundry (which I’m all for, by the way). I’m talking about how you envision yourself living as time goes by. Look through the telescope of the future and allow your mind to focus on what your life will be like then. This type of future-gazing is something too few of us do, but it’s essential to retirement planning. Here’s how I see my life at age seventy-five: My wife and I have sold our current house and moved to something smaller within walking distance of restaurants and shops. When a new restaurant opens, we will be among the first to try it out. I’ll continue going to the Broadway theatrical series as a favor to my wife, and she’ll continue humoring me by going to University of Louisville men’s basketball games with me. Each summer, we’ll spend a week on Hilton Head Island with our daughters and grandchildren. We’ll travel to visit friends across the country, and maybe even get a condo on the beach in Florida. I’ll have more time to volunteer and support organizations that are important to me. And you can bet

8 • MARTIN H. RUBY

I’ll make as many of my grandkids’ soccer games and ballet recitals as I can. When I think about my life at seventy-five, very little of it has to do with money. And yet, the picture I see can only be supported if I have the income to make it a reality. Will I have the money to go to Hilton Head? Will I be able to give generously to United Way? Will I be able to eat out when I want without worrying too much about what’s on the right side of the menu? Or, will I be anx- ious about fitting an occasional expensive meal into a tight monthly budget? When people tell me they don’t have time to think about their future (let alone save for it), I ask them to go through the same exercise mentioned above. Picture life at seventy-five. Take a moment and do it yourself. Write down five or six things you want to be sure you’ll have. It’s okay if these things change over time. The important thing is to picture them now: At seventy-five, I want to: ____________________________________________________ ____________________________________________________ ____________________________________________________ ____________________________________________________ ____________________________________________________ What did you write down? Even if you chose not to put any- thing on those lines, I want you to at least think about it. After all, these are the things that will make up your retirement. The new rules of saving will make sure the goals on the above list become reality. They can save you from sacrificing pleasures down the road because you didn’t plan well today.

THE NEW RULES OF RETIREMENT SAVING • 9

“Outside the Box” Thinking I’m here to give you a new lens through which to view your finances. It’s going to feel different than what you’ve done before. I’m reminded of a story from the early 1900s when the auto- mobile was just being introduced. A spokesman for Daimler Benz was asked about the future of cars, and he remarked, “There will never be a mass market for motorcars because there is a limit on the number of chauffeurs available.” His assumption was, of course, that every car needed a chauffeur. That blinded him to the potential of the personal automobile. The same is true with savings today. Too many of us are saying, “There’s a limit to how successful I can be because there’s a limit to the strategies I’m using to save.” As you’ve probably guessed by now, we’re about to blow that assumption out of the water. Let’s start with the first New Rule of Retirement Saving: Know Your Risks.

CHAPTER TWO

Rule #1: Know Your Risks

“Risk comes from not knowing what you’re doing.” ~ Warren Buffett

et’s talk risks. You take risks into account more often than you proba- bly give yourself credit for. Do you wear a seat belt? If you do, you are helping mitigate the risk of a fatal car crash. Do you eat fresh fruits and vegetables? With those wise dietary choices you are helping address the risk of heart disease and other ill- nesses. Do you check the weather report before you leave the house? That is also a good idea. You’re trying to eliminate the risk of getting drenched on your way to lunch. Those risks are relatively easy to address because it doesn’t take much to avoid them (I can buckle up in less than four seconds). Savings risk is different. It takes time to understand, and it takes commitment to change the way you’re saving. Your Three Biggest Risks A book is sometimes an impersonal medium. When I meet with a client, I get to look at them across the table, get to know their family, or understand their financial situation. So you might be thinking, “How can he know MY biggest risks?”

12 • MARTIN H. RUBY

Here’s a secret: almost everyone is struggling with the same three risks. Read the following descriptions and think about whether they apply to you: No. 1: Structural Risk — This risk is about the mechanics of saving. How are you saving? What savings vehicles are available to you? Who is helping you save? Is your employer contributing to your savings program? If so, how? Are government resources available to you? If so, what are they? Do you know which ones you should take advantage of and how to do so? How is your sav- ings program structured? These questions can make the difference between whether you are successful or not, especially if your goal is to provide a comfortable retirement for yourself. No. 2: Market Risk — Anyone who has followed the stock market over the last two decades is well aware of this risk. When you are saving money for your future, you want it to grow. Placing money in the stock market for that purpose comes with a risk that can best be illustrated by a pair of scales. Losses on one side. Gains on the other. The market giveth, and the market taketh away. This risk pertains to more than just Wall Street. Any time your savings are invested where loss is possible, whether it be stocks, bonds, real estate, or a host of other assets, you face real risk that your savings will not experience sufficient growth to offset losses. No. 3: Tax Risk — This risk is quite simple: How much of your retirement account will you get to use, and how much will you give to the IRS in paying taxes? Tax risk is perhaps one of the most underappreciated risks today’s savers face, and many Americans are doing nothing to address it. Many seemed resigned to pay any and all taxes presented to them as if there were absolutely nothing they could do about it. They believe Benjamin Franklin, who noted, “In this world nothing can be said to be certain but death and taxes.” Or perhaps Will Rogers, who said, “The only difference between death and taxes is that death doesn’t get worse every time Congress meets.” “The uninformed taxpayer will pay much more in taxes than the informed taxpayer.” I said that last one.

THE NEW RULES OF RETIREMENT SAVING • 13

More than any other factors, these risks will impact how you save, how your money grows, and, eventually, how you spend your money. Encountering these risks one at a time is challenging enough, but you have to face all three, right now. In the next chapters, we’ll look at these risks one by one and help you assess how each risk may be impacting your retirement plans.

CHAPTER THREE

Structural Risk

“Money amassed either serves us or rules us.” ~ Horace

et’s go back to my Uncle Irwin. In retirement, my uncle loved playing golf. And why not? Irwin had a great life. When he graduated from college, he got a job with a manu- facturer, and over the next forty years he slowly climbed the cor- porate ranks from assistant to manager to division manager to vice president. At age sixty, he retired with a pension that sent him a check for $80,000 every year . . . for the rest of his life. So he didn’t have to worry if the stock market was up or down or how much money was left in his retirement account. His company guaranteed him that pension check for life. No wonder he played so much golf! You probably know people like Irwin, unless you’re under the age of fifty. Then there’s a good chance you don’t. You see, people like Irwin just don’t exist among today’s younger generation. Today’s retirement landscape is unlike any in history. And a lot of it has to do with structural risk. “Structural risk” sounds like an actuarial term, but actually it’s a simple concept: This is the risk that comes with the mechanics of saving. What are the vehicles available to you? What are the rules of the saving game? Who is going to help you save?

16 • MARTIN H. RUBY

Let’s look at the structural risk that existed for Irwin. He could be your grandparent, parent, or uncle… anyone working and sav- ing in the 1950s, 60s, and 70s. Here’s what Irwin had: • He had an employer who was saving money for him every month — money that would be paid to him in re- tirement. • He had a pension that guaranteed him a hefty portion of his final salary for the rest of his life . . . no matter how long he lived. • He had the promise of Social Security to supplement his income in retirement. All in all, I would call that a pretty sweet deal, wouldn’t you? Today, these kinds of guarantees are only available to a small por- tion of workers: firefighters, teachers, and government employ- ees. If you don’t fall into one of those categories, I’ll show you what you face instead.

The Three-Legged Stool

Irwin’s savings approach — and the approach Americans have been relying on for much of the last cen- tury — is a three-legged stool. That means the money he relied on in re- tirement was supported by three “legs” of assets. Irwin’s saving was supported by his employer’s contributions, his own savings, and the government through Social Security. Take away any of those three legs, and the stool would wobble and fall over. Irwin

THE NEW RULES OF RETIREMENT SAVING • 17

didn’t have to worry about that, because each of his legs were strong. Now, think about your own personal savings stool. Probably, the personal savings leg is doing okay. You know you should be saving and are putting something away each month (right?). How about the other two legs? Employer and government? Maybe not as strong. Let’s look at why. Leg No. 1: Employer Savings Pensions are on the endangered species list. There was a time in America that you could land a good job with a big corporation, spend thirty or forty years there, work hard, earn raises and pro- motions, and then retire with a gold watch and a guaranteed life- time paycheck. That leg of the stool started to wobble in the 1960s when corporations found it difficult to keep their pension prom- ises. Defined benefit pension programs were part of the perks and benefits of nearly every employer of any size. It was one way they sought to attract loyal, long-staying employees. As the 1970s moved into the 80s, long-staying employees began to stop matter- ing so much to corporate America. Fringe benefits became too ex- pensive and administratively burdensome to maintain, so they just began dropping them. How did things change? Maybe you’ve heard about the Studebaker automobile. The Studebaker was ahead of its time. It was the first to come out with innovations like curved windshields, disc brakes, seat belts, and mechanical power steering. For some reason, the fickle American car-buying public just didn’t go for them like they did Fords and General Motors cars. So the last Studebaker rolled off the line in 1966. The United Auto Workers (UAW) had worked hard at the ne- gotiating table. Studebaker workers had excellent pension plans

18 • MARTIN H. RUBY

and lush benefits. But when laid-off employees began to collect their pensions, they learned that Studebaker didn’t have enough money to pay the benefits. Howls of protest reached Capitol Hill. Congress was moved to pass the 1974 Employee Retirement Income Security Act (ERISA), which regulated pension plans. The objective of the new legisla- tion was to protect American workers and ensure their pensions were sustainable. However, as so often happens when our govern- ment makes laws, the new demands forced corporations to back away from pensions altogether. Birth of IRAs and 401(k)s One interesting byproduct of ERISA was a new law that al- lowed taxpayers to contribute into something called an “Individ- ual Retirement Account,” or IRA. Companies liked them, because IRAs took the pressure off the company to plan for an employee’s retirement. These new IRAs could grow tax-deferred. The IRS al- lowed workers to reduce their immediate taxes by funding their retirement accounts and they would owe no taxes on the money until they withdrew it! IRAs began popping up like daisies in spring, especially when tax time rolled around. In 1978, the IRS inadvertently created 401(k) plans when it es- tablished a new section of the IRS code that allowed for tax-de- ferred accumulation. The little paragraph went virtually unnoticed until Ted Benna, a young Pennsylvania benefits con- sultant, devised a clever way to apply the new law to corporate benefits. Benna realized this piece of the tax code could potentially provide tax benefits for both employees and employers. From one man’s discovery, an entire industry was born. With 401(k)s, employees didn’t have to pay any taxes on their savings today. It sounds like the IRS wouldn’t like that, but in re- ality, the IRS saw 401(k)s as an opportunity. After all, these savings accounts were not tax- free — they were tax- deferred . At some point, after the accounts grew to fruition, the IRS would get its

THE NEW RULES OF RETIREMENT SAVING • 19

taxes. And it hoped at that time, since the accounts had grown in value, there would be more taxable income than when the money was contributed. This was a big shift in the dynamics of retirement. The 401(k) put employees in charge of saving for their own retirement. The employer, instead of guaranteeing a pension payout, would now administer a self-funding retirement plan. This is the great shift from defined benefit to defined contribu- tion. Think about that change in wording for a moment. It is not merely a matter of semantics. What is the difference? Defined benefit: the old pension plans have a defined benefit you would receive every month. The outcome is guaranteed. You get a check for $80,000, for example, every year for the rest of your life. Defined contribution: 401(k)s and 403(b)s have a defined par- ticipation amount. There’s a guarantee on the amount of money that will go into the account each month, but there are no guaran- tees on how much it will grow or — more importantly — how much money you will have at your retirement. We went from being assured income in retirement to only be- ing assured of a structure in which we could save. The problem with defined contribution plans is that many of the contributions aren’t so well defined. Originally, employer contributions to 401(k) plans were pretty high. That’s why they were considered “defined contribution” plans: the employer was putting in a defined amount. In the begin- ning, most employers contributed a “match” to their employee’s 401(k) accounts. That is, if you put in $10, your company might put in $10 and help you save for retirement. This kept 401(k)s more closely aligned with pension plans. Sure, you didn’t get a guarantee under a 401(k), but the employer was still contributing a large portion of a worker’s retirement funds. That’s often not the case today.

20 • MARTIN H. RUBY

Over the past decades, e mployer contributions have fallen, with many employers contributing less or not at all. And just because your current job offers a plan or a match today, doesn't mean that will always be the case. ¹ This is why the employer leg of your retirement savings stool is probably less stable for you than it was for the generations be- fore you. How You Save Today The two most common ways to save for retirement today are 401(k)s and IRAs, and their Roth counterparts. This is what most American workers rely on to build the employer leg of their stool. As we’re about to see, both have some significant shortcomings when it comes to creating a strong base for your retirement. Let’s look at the non-Roth version first. Your account may be called an SEP (simplified employee pension), an IRA or a 401(k). Whatever it’s called, it’s likely struc- tured the same way. Here are the basics: • 401(k)s are tax-deferred savings vehicles. Tax-deferred means you deduct your contributions from your taxable income in the year you make your contributions. If you make $100 a year and contribute $10 to a 401(k), the IRS bases your taxes on $90 of income rather than the full $100.

¹ Investopedia. May 13, 2023. "What Is a Good 401(k) Match? How It Works and What's the Average" https://www.investopedia.com/articles/personal-finance/120315/what- good-401k-match.asp

THE NEW RULES OF RETIREMENT SAVING • 21

• Your contributions and all the earnings in your 401(k) are then taxed when you withdraw the funds in retirement. So if you take $100 out of your 401(k) in retirement, you may only get a check for $60 once taxes are paid. Remember: you pay not only federal taxes, but state and local taxes as well. • Most 401(k) assets are invested in mutual funds and other funds tied to the stock market. This means 401(k)s tend to do well when the market does well and suffer when the market collapses. Other savers invest their 401(k)s in bonds, or some mixture of the two. Bonds can come with their own sets of risks when interest rates are low like today. • There are also many regulations around 401(k)s. If you access any of the money in your account before age fifty-nine-and- one-half, you’ll have to pay a 10 percent penalty on top of the taxes you owe. • And the government requires you to start withdrawing money at the designated age . Why, you may ask? Because it wants to begin taxing those assets. • There are limits to how much money you can contribute each year. In 20 2 3 , that amount is $ 22 , 5 00 a year for savers under the age of fifty . ² • And finally, like all financial products, there are fees built in to 401(k)s, both from the plan administrator and from the indi- vidual mutual funds within the account. These fees run around 1 or 2 percent, which may not seem like a lot until you do the math. If your account earns 6 percent this year, you could only net 4 percent after fees. Let’s say you’re sixty and have amassed $1 million in your account. Those two percent fees now cost you $20,000 a year.

² IRS. October 21, 2023. 401(k) limit increases to $22,500 for 2023, IRA limit rises to $6,500" https://www.irs.gov/newsroom/401k-limit-increases-to-22500-for-2023-ira-limit- rises-to-6500

22 • MARTIN H. RUBY

IRAs and 401(k)s are the most common retirement savings ve- hicles today, but their Roth counterparts are gaining on them. Every so often, Congress gets something right, and that was the case when they created the Roth 401(k) and Roth IRA. These ac- counts work a little differently when it comes to taxation: • Funds are contributed with post-tax dollars, meaning this ac- count is not tax-deferred. So if you make $100, and contribute $10 to a Roth, the IRS still taxes you on all $100 of income. • Because savers have already paid taxes on their contributions, their funds grow tax-free. That means you do not owe any more taxes on the funds in your account. This includes all the earnings you’ve accumulated as your account has grown over the years. If you take $100 out of your account during retire- ment, you’ll get a check for all $100. • Taxation is the main difference

between a Roth and a traditional account. However, many other features are the same as tradi- tional 401(k)s. There is still a 10 percent tax penalty on any earn- ings withdrawn before age fifty- nine-and-one-half, though con- tributions can be taken out at any time. • These accounts are still often

linked to the market through mutual funds, meaning when the market crashes, so can ac- count values. • There are still limits on how much money you can contribute each year, and even limits on who can have a Roth. Does your three-legged stool look like this?

THE NEW RULES OF RETIREMENT SAVING • 23

• The fees are similar to their traditional counterparts: 1 to 2 percent a year.

If you’re thinking, “Gee, neither of these options sounds all that great,” you’re not alone. Many savers are frustrated with the op- tions available to them. That’s because in both Roths and traditional accounts, the bur- den of savings has shifted from the employer and a pension to you and however you decide to save. Regardless of the account type you choose, the responsibility is on you, not your company. So we know the employer leg of your stool is weak. Now you have you and the government left holding up your stool. How strong is the government’s leg? Social (In)Security Social Security is the way our government participates in your retirement income. Each paycheck you receive has a portion with- held for Social Security, in return for the benefit you’re promised in the future. Should you count on Social Security to help fund your retire- ment? Maybe not. I’ll explain why. Below is a paragraph the Social Security Administration is in- serting into the text on page one of every Social Security statement they send: “Social Security is a compact between generations. Since 1935, America has kept the promise of security for its workers and their families. Now, how- ever, the Social Security system is facing serious financial problems, and action is needed soon to make sure the system will be sound when today's younger workers are ready for retirement. Without changes, in 2033 the Social Security Trust Fund will be able to pay only about 77 cents for each dollar of scheduled benefits.”

24 • MARTIN H. RUBY

Seventy-seven cents on the dollar? That’s a pretty dire outlook. So why the warnings? Demographics, demographics, de- mographics. Here’s the thing: when most people think of Social Security, they think of some pot of money in Washington that the govern- ment gives out to retirees each month. If you were to actually fly to Washington and look in the Social Security Trust Fund, you’d mostly find a bunch of IOUs. Social Security is paid from the current Social Security taxes collected. This is why demographics matter. In 1960, there were five tax-paying workers supporting each Social Security beneficiary. That means five people were paying the taxes to deliver one Social Security check to one senior citizen. Not too bad. By 2009, that demographic had shifted dramatically. That year, there were three-and-one-half workers supporting each Social Security beneficiary. Imagine a pyramid with five people holding up a single person. Not too hard. Now try to hold up that same person with only three helpers, and it gets a little harder. This decade, it's expected there will be only two workers for every Social Security beneficiary, meaning you and your spouse are ba-sically paying taxes to support one retiree all by yourselves. Your pyramid is looking pretty weak, right? That’s why many experts have questioned whether today’s So- cial Security system is sustainable for the future. What’s causing these dramatic demographic shifts? Our U.S. population is aging . . . fast. Seniors are living longer than ever be-fore, and couples are having fewer babies as well. That means we’re creating more retirees, but fewer future workers to pay So-cial Security taxes.

THE NEW RULES OF RETIREMENT SAVING • 25

An average of 10,000 baby boomers retired every day. In retire- ment, they’ll start receiving their Social Security checks. ³ A report by the Social Security Administration summed it up like this: “[After] 2015, almost 33 percent of our workforce, in- cluding 48 percent of our supervisors, are eligible to retire.” ⁴ Nearly a third of our workforce is eligible to retire! Younger generations are going to have to work VERY hard to support them all. When I ask clients who are in their forties and fifties about So- cial Security, most answer, “It will be great if I get it, but I’m sure not counting on it.” It’s a good stance to take if you’re under sixty. Because when you have two workers supporting one retiree, you can’t deliver the same benefits as when nine workers were supporting that same retiree. Balancing Your Stool With the employer leg and government leg of your stool sawed off (or at least sawed much shorter!), people like you are trying to balance on the one remaining leg: what you alone are able to save.

³ Smart Asset. September 8, 2023. "What Retiring Baby Boomers Mean for the Economy." https://smartasset.com/retirement/baby-boomers-retiring ⁴ Social Security Administration. 2012. “Annual Performance Plan for Fiscal Year 2013.” http://www.ssa.gov/performance/2013/FY%202013%20APP%20and%20Re-vised% 20Final%20Performance%20Plan%20for%20FY%202012.pdf.

26 • MARTIN H. RUBY

Your three-legged stool is now, in es- sence, a one-legged stool. I like to call it a barstool (and not just because this discussion may lead you to drink!). Help! I Need Somebody! A final structural risk many Amer- icans face is financial advice and assis- tance. I’m always amazed by this conver- sation, which I have with almost every new client who comes into our office. Me: So how is your 401(k) cur- rently invested? Client: Um, I’m not really sure.

Me: Is it in mutual funds? Client: Yes, mutual funds. Me: Which ones? Client: Um, I’m not sure. Me: Large cap, growth stocks, bonds, emerging markets? Tar- get-date funds? Client: I’m not really sure. Whatever they told me I should be in. Me: Well, how’s your account doing? How’s it done these past few years? Client: I’m not really sure. I try not to look at it. Did that hit a little too close to home? If it did, don’t be ashamed. The majority of savers respond in a similar way. Here’s the big problem with today’s savings culture. You are re- ally on your own. Today’s savers have been put in charge of grow- ing their own retirement funds. In the past, someone managed a company’s pension fund. Those people — financial experts —

THE NEW RULES OF RETIREMENT SAVING • 27

were in charge of making sure there were enough assets to cover a retiree’s pension check. Today, you have to be that expert. And most of us don’t have the financial background, training or time to make those deci- sions; 401(k)s — and investing in general — can be very compli- cated. It doesn’t help that your employer probably doesn’t offer any advice because they’re concerned with the legal ramifications of a human resources department offering employees financial ad- vice. In short, American businesses have bought in to a savings structure that has transferred much of the risk in saving for retire- ment from institutions to you as the individual. It’s no wonder so many savers are looking for something better. Advice From Time Magazine So what should you take away from all this? Time magazine put it best in an article by Dan Kadlec: “It’s time to recognize that your retirement security is in your hands alone.” Today’s generations must depend on themselves to save for the future. In the article, entitled, “Why Your 401(k) Match Will Get Cut,” Kadlec made the following observation about the future of retire- ment in America: “We have a retirement savings crisis in America and the safety net keeps being eaten away. Social Security is a mess. Public and private pension plans are underfunded. We’ve moved squarely away from secure defined- benefits plans towards riskier defined-contribution plans, and now de- fined-contribution plans are under assault.” 5

⁵ Dan Kadlec. Time. Dec. 13, 2012. “Why Your 401(k) Match Will Get Cut.” http: // business.time.com / 2012 / 12 / 13 / why-your-401k-match-will-get-cut / .

28 • MARTIN H. RUBY

So what is the takeaway from all of this? Don't expect your em- ployer to take care of you. Don't expect the government to take care of you. You have to do it on your own. That’s at the heart of structural risk.

CHAPTER FOUR

Market Risk

“The difference between playing the stock market and playing the horses is that one of the horses must win.” ~ Joey Adams

here are a lot of things I don’t miss from the 1990s. Flip phones that could barely text. Beanie Babies that somehow convinced millions of adults to buy stuffed animals. Win- dows 95. But one thing from the 90s I miss every day is the stock market. The 1990s were real go-go years in the market. You could pick almost any stock and it would go up. You could actually invest in something called “Dart Funds,” where a stockbroker threw a dart at a sheet of stocks and invested in whichever ones the dart hit. And you know what? Dart Funds were making good money! We all know where the go-go years of the 1990s ended: the dot- com bubble burst. And boy, did that bubble burst hard in 2000. According to Investopedia, from March 11, 2000, to October 9, 2002, the technology-heavy NASDAQ lost 78 percent of its value, falling from 5046.86 at its peak and bottoming at 1114.11, when the implosion ended. The troubles of the stock market were not limited to just technologies. The S&P 500®, the barometer by T

30 • MARTIN H. RUBY

which the health of the overall stock market is often measured, fell by nearly 40 percent. ⁶ My friends who were thinking of retiring around the year 2000 truly understand the concept of “market risk.” In January they thought they had $1 million to retire on, and by December their accounts were depleted. A few bad years in the market had wiped out what it had taken them years to save. The hit was so bad, a common joke was that 401(k)s had become 201(k)s. But there’s more to market risk than how much is in your ac- count when you go to retire. A bad market crash can hurt, but so can years of underperformance in the market. The truth is, almost all of our retirement security is in some way tied to market performance. 401(k)s and IRAs are extremely susceptible to market swings, particularly for younger savers, who are encouraged to put more of their money into funds exposed to the stock market. That introduces a huge level of uncertainty into our best-laid savings plans. The Worst Decade in Market History 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 had to live through the Great Depression. But here’s a surprise: their genera- tion isn’t the only one that grew up during one of the worst mar- kets in history. Yours did, too. Years 2000 through 2009 are estimated to be the single worst decade for the S&P 500®. You might have heard it called the “lost decade of investing,” because the market ended the decade pretty much at the same point it started.

⁶ Andrew Beattie. Investopedia. January 2, 2022.“Market Crashes: The Dotcom Crash.” http://www.investopedia.com/features/crashes/crashes8.asp.

Page 1 Page 2 Page 3 Page 4 Page 5 Page 6 Page 7 Page 8 Page 9 Page 10 Page 11 Page 12 Page 13 Page 14 Page 15 Page 16 Page 17 Page 18 Page 19 Page 20 Page 21 Page 22 Page 23 Page 24 Page 25 Page 26 Page 27 Page 28 Page 29 Page 30 Page 31 Page 32 Page 33 Page 34 Page 35 Page 36 Page 37 Page 38 Page 39 Page 40 Page 41 Page 42 Page 43 Page 44 Page 45 Page 46 Page 47 Page 48 Page 49 Page 50 Page 51 Page 52 Page 53 Page 54 Page 55 Page 56 Page 57 Page 58 Page 59 Page 60 Page 61 Page 62 Page 63 Page 64 Page 65 Page 66 Page 67 Page 68 Page 69 Page 70 Page 71 Page 72 Page 73 Page 74 Page 75 Page 76 Page 77 Page 78 Page 79 Page 80 Page 81 Page 82 Page 83 Page 84 Page 85 Page 86 Page 87 Page 88 Page 89 Page 90 Page 91 Page 92 Page 93 Page 94 Page 95 Page 96 Page 97 Page 98 Page 99 Page 100 Page 101 Page 102 Page 103 Page 104 Page 105 Page 106 Page 107 Page 108 Page 109 Page 110 Page 111 Page 112 Page 113 Page 114 Page 115 Page 116 Page 117 Page 118 Page 119 Page 120 Page 121 Page 122 Page 123 Page 124 Page 125 Page 126 Page 127 Page 128 Page 129 Page 130 Page 131 Page 132 Page 133 Page 134 Page 135 Page 136

app.stonewoodfinancial.com

Made with FlippingBook - Online Brochure Maker

The New Rules of Retirement Saving | Stonewood Select