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Alan Haft
Alan Haft
 

Are Your Clients Worried?

How CPAs can better advise clients on managing retirement plans.

November 23, 2009
by Alan Haft

In my last column, I revealed the trouble with qualified IRS retirement plans such as 401ks, IRAs, 403bs, SEPs and more. In this column, I divulge conventional solutions that claim will improve the results of these plans for your clients.

Before addressing these solutions, I’d like to first begin with a brief recap of several important points:

  • Most qualified plans were never meant to replace pensions, they were only meant to supplement them and that’s it.
  • As a result, we are now being asked to retire on plans that even if funded and invested to perfection, will leave many of us with completely inadequate retirement income.
  • The contribution limits of these plans are low and restrictive.
  • If one cannot make contributions, they are not permitted to make up for missed contributions in later years.
  • Fees are typically quite high.
  • Fund choices are limited and often below average.
  • The value of the tax deductions one receives when making a contribution is often over estimated. In reality, the tax deduction one receives is actually a loan against future income whereas a true tax deduction is something that does not have to be paid back. Furthermore, it should be noted that the tax deduction is almost always spent rather than reinvested.

Conventional solutions that strive to improve upon these shortcomings typically revolve around discussions about the quality of the investments, fees and/or the amount being saved. However, I would like to begin by first focusing on the issue I consider of paramount importance and one that is often neglected: the issue of one’s behavioral mindset.

In the past, most people retired with a pension, and as basic as it may sound, it’s important to ask, “what exactly is a 'pension'?” It has nothing to do with the value of the account one has when they retire, rather, the pension is all about the income they receive.

Back in the seemingly ancient days of pensions, the retired individual didn’t know nor did they likely think much about the value of theaccount that was busy generating a lifetime of monthly retirement checks. Similarly, does anyone receiving Social Security really know or care about the value of the account generating their benefits? Not at all. Most people receiving Social Security are only concerned about the income they receive.

When it comes to retirement plans, however, today’s mindset is completely different: the primary focus is inverted. Given today’s age in which pensions are basically extinct and the retirement plan is often the only account an individual has to carry them through their retirement, the individual’s priority is most often focused not on the income the account will produce but rather on preserving its value as much as possible while taking out whatever amount of income it can support.

On the contrary, pension managers of the past had a distinct advantage over us. In the past, over a 30-year working career, the pension manager needed to set aside roughly 15 percent of an individual’s wages in order to provide them with 70 percent of their current income at retirement (60%, if married). If the pension manager was faced with the additional burden of needing to preserve the account value and generate the 70 percent target income, they would need to set aside not 15 percent of the wages but rather an astonishing 30 percent, which would have been a feat just short of impossible. As opposed to the behavioral mindset of today, the pension manager wasn’t required to preserve the account, rather, they would usethe principal and its earnings to generate a reasonable income for the retired individual — whose statistics show will rarely do this for themselves given the preservation mindset of today.

For most people, this may be a lot to comprehend but evidenced by the recent market disaster that prolonged many retirements, it’s critical for us to address these important points with our clients without delay.  After all, with rare exception, today’s individual is completely responsible for their own income at retirement and the need to take responsibility for this is a harsh reality most clients now need to face.

This leads me to the conventional solutions we often hear about that are said could increase a client’s chances for heightened retirement income success. Let’s take a closer look:

Save More

Some say one solution to generate more income at retirement is to simply save more money. Doing so would obviously increase the balance of a client’s account at retirement and therefore the amount of income it can produce, but how many people can really put away the 30 percent to 50 percent of their earnings that would be necessary to produce a comparable amount of income that a pension would have provided?  The answer is, “not many.” Most people could never stash away 30 percent to 50 percent of their income so that they can preserve their account value while generating a comparable pension, so to me, this “solution” is really just a moot point.

Work Longer

Sure, working into your 70s or part-time during retirement can obviously improve the amount of income you can expect to generate at retirement but unless voluntary, many people would simply not choose this path. While for many this may end up being a reality, it certainly wouldn’t be the optimal choice.

Increase the Return

Betting on a higher rate of return would certainly increase the account value at retirement and thereby the amount of income it can be expected to produce, but not only do our clients have no control over the rate of return they receive, most would agree the chances of sustaining a high return over a lengthy period of time is highly improbable. As such, when projecting how much an account will be worth at retirement and the amount of income it can produce, many would be far better off assuming a moderate rate of return and treating higher results as a welcomed plus rather than betting on higher rates and regretting lower returns.

Lower the Fees

I often hear that to better the end results of retirement plans, Wall Street and third-party administrators should lower their fees. Given our clients have no direct control over this issue — while it certainly sounds like a solution that could help the results — the politics of Wall Street and Washington make the chances of this happening distant and remote. Besides, even if fees were reduced, the effect on the amount of income a client can expect to receive at retirement would be  minimal at best.

Conclusion

So, is all hope lost?

Not quite.

Congress and many economic support groups are well aware of these issues and have recently proposed some interesting solutions such as:

  1. Giving tax incentives to people who convert their plan into pension type of income at retirement.
  2. Limiting access to accounts before retirement.
  3. Developing a system that can protect against the loss of principal.

While these are ideas being proposed for the future, some are actually available today but are not widely known or promoted because they do not support the traditional system currently in place. Ironically, as a result of the repeal of the Glass-Steagall Act, the competition is now coming from the insurance industry, which is the very organization that handles the payouts from lotteries, pensions, structured settlements and other forms of distribution that require at least some level of income guarantees.

By planning ahead, your clients can use the distribution capabilities of the insurance industry to:

  1. Eliminate or minimize tax.
  2. Protect the account from market loss.
  3. Eliminate or reduce fees.

In an upcoming column, I will cover the proper techniques for doing this and how your clients can increase the efficiency of retirement income dollars by two to four times the amount generated when compared with the traditional plans.

Stay tuned, and until then, feel free to e-mail me with any questions you have.

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Alan Haft is an investment advisor, author of three books including the national bestseller, You Can Never Be Too Rich, and makes frequent appearances in national print, television and radio media such as The Wall Street Journal, Money Magazine, CNBC, BusinessWeek and many others.