That’s how much you need if you plan to retire and draw a measly $80,000. Where did I get that figure?
Most financial advisers recommend withdrawing no more than 4% of your savings. The idea is that if you’re account grows at a decent amount, then that should still leave the principal balance in place. But what if you have a negative year? You either need another source of money, or you will have to cut into your principal.
So, assuming you have a 401K holding $2,000,000, when it comes time to retire, you call ’em up, and ask them to cut you a check for $80,000. Then when it comes time to file your taxes, are you ready to pay your dues to Uncle Sam? Assuming you have an effective tax rate of 25%, you are left with $60,000. Oh, remember all those tax deductions you used to get for your kids, and for the mortgage interest you paid when you had one? Gone. What about tax deductions for money stashed in a 401K? Gone. Yup, you’re, as BawldGuy says, “tax naked.” Ouch!
And don’t expect a thank you from Uncle Sam. He teamed up with Captain Corporate America and put this plan together in the first place. They knew you were going to be stuffing tons of money into your plan, because everyone else is too, so they rigged it so they could get a slice of your pie in retirement.
Cross checking with reality
What’s that? Your 401K isn’t close to $2,000,000? What do you have? Is it greater than $80,000? If so, you have beaten the average. The average amount of retirement savings for people ages 55-64 is around $80,000. Maybe you have something like $100,000, and are 20 years away from retirement. How much growth do you think you’ll need? Over 16% each and every year.
Ouch 2! But wait. Doesn’t the power of money grow exponentially? What if you are a bit younger and actually have 30 years until retirement? Pay it no mind that 30-year-olds average even less in retirement funds. To get from $100,000 to $2,000,000, you need 10.5% growth every year with no losses. Now that’s better, but better NEVER means good enough. Considering the average performance of investors using mutual funds over the past 20 years has been less than 4%, what are you odds you can do 2.5 times better than everyone else?
Losses will mess up your growth
Don’t forget that the math of losses and gains says that for any negative loss, you need an even bigger gain to get back to where you started. Let’s say you were shooting for 10.5% this year, but instead got hit by an 8% loss. What would need next year to get back to where you started? 8.7%. But that’s just to get back to where you started. Get back on your original plan of averaging 10.5%, you would need over 32%. Spread your recovery time over two years, and you only need 21%. In investor-speak, we say not going to happen.
Simply put, mutual funds inside 401K plans don’t work. They never have. Otherwise, you would be hearing about all these people retiring on their fabulous mutual funds. And double check those celebraties who keep telling you to dump all extra capital into paying off your home mortgage. Are those people retiring on mutual funds? Or are they retiring on money made off their TV and books, and possibly their own cash flowing rental property?
What does work
The key to retirement is acquiring cash flowing assets. That way, your retirement isn’t based on liquidating your portfolio. This more than anything can protect you from big time market downturns. Don’t worry about paying your personal home off early. It doesn’t yield any money. Instead, you should be seeking rental property, stocks, and permanent life insurance. These items really form the basis of a wealth building plan. If you want to discuss your options, drop me a line and we can chat.