For years I dutifully followed the rules. Without question. Without thought. I wanted to retire and live the dream. So I followed the path I was told would get me there – Contibute as much as you can to your IRA or 401(k). I saw the charts of how my money could grow over time to build me that nice nest egg. If I could just keep keep following the path, I would have a safe and secure retirement.
Somewhere along the line, cracks started to appear in the plan. My job was becoming unsustainable. I did the only thing I knew…….stepped on the gas. Maxing out every retirement savings plan I could. It wasn’t that this was a bad plan. It’s just that I could have done it differently if I had the tools I have now.
If you are doing work you love, saving dutifully, and investing wisely the traditional advice might be the right track for you. If so……..Steady on!
But what if this isn’t your story??????
I used to think that it was blasphemy to even whisper in the dark that maybe investing in your IRA or 401(k) wasn’t a slam dunk, no brainer thing to do. Turns out, I was wrong.
The IRA and 401(k) can be great tools. But they are just that, tools. They may or may not be the right one for the job.
This time of year, your bank, mutual fund companies, financial planners, and almost everyone in the financial industry is telling you to make that IRA contribution before your tax filing deadline. They will give you all the reasons they think it’s a good idea.
Financial decisions are never that straight forward.
It isn’t that one decision is right or wrong. They are different choices. Different choices with different trade offs.
It’s always about trade offs. No option is perfect. What you want is the best option for you and your situation.
So what are the trade offs? What are the reasons why you might not want to invest your money in an IRA or 401(k)?
It Isn’t An Investment
IRA’s and 401(k)s aren’t investments but rather they are based on rules of the Internal Revenue Code that allow special tax treatment in exchange for complying with the limitations set out in the code.
This may seem like splitting hairs but it does matter. With a few limited exceptions, the investment options you have within these vehicles would be available to you outside of the vehicles. The reverse is not true. Which leads me to reason number 2.
There Are Investment Limitations
The 401(k) or IRA is the wrapper around your investment choice. How you can invest the money within those plans is limited by law and/or your provider. The provider may be your employer, mutual fund company or other financial institution. They set the parameters for the investment options. Some plans allow you to self-direct your investments but the law either specifically or logistically limits your investments. Paper assets (stocks, bonds, mutual funds) are often your only choice.
You Might Get Better Returns Elsewhere
Paper assets are often touted as if they are the only asset class. Business and real estate historically have provided better returns. If you look at the wealthiest people in the world, they didn’t get that way with passive investments in paper assets. Unfortunately real estate is difficult to hold inside retirement plans. Tax treatment of real estate is less desireable inside the plan and you add a significant compliance burden. Holding a business within a retirement plan is even more complex. Get it wrong and you will end up with a tax bill you didn’t expect.
You Might Get Better Diversification Outside The Plan
Don’t put all of your eggs in one basket. How often have you heard that one? Yet, how diversified are you if you have only paper assets? In theory stocks and bonds aren’t 100% correlated. Meaning if one goes down the other one may not. But that isn’t always true. Often in the worst markets they can move in the same downward direction. Diversifying in real estate or a business interest can provide you with an investment that isn’t correlated with paper assets.
You Have More Control Outside The Plan
I will admit that this concept can work both ways. When your money is tied up in a retirement plan it can be “out of sight out of mind”. It can keep you from blowing through money you will need later. But this attitude sets you up to be a passive bystander to your wealth. Learning active, disciplined investment skills puts the power (and responsibility) in your hands. If you are willing to take the reigns, you don’t have to play by their rules.
Someone has to make sure all the IRS rules are followed and the right reports are filed. All that costs money. That cost is likely passed on to you.
You Focus On Accumulation Rather Than Cash Flow
Traditional plans focus on accumulating a sum large enough for you to meet your financial needs for the rest of your life. The problem is that you have no way of knowing what that amount will be. This leads to a common problem once you retire. The fear of running out of money.
If you had to plan to provide yourself with all the water that you needed for the rest of your life, which would you want?
A) a huge water tank or B) a spring fed stream.
Your money is the same way. It is impossible to know how much you will need. Any amount you accumulate could be depleted with the wrong set of circumstances. Cash flow streams can provide you with income that out lives you.
It Assumes You Will Be In A Lower Tax Bracket When You Withdraw Money At Retirement
Under the traditional model of retirement this is likely true. The retiree lives off their dwindling savings and therefore dwindling tax bill. If you focus on cash flow producing assets, it’s entirely possible that your income will continue to grow throughout your life.
Converts What Could Be Capital Gains To Ordinary Income
Capital gains tax rates have historically been lower than the rates for ordinary income. If your investment produces significant capital gains, have effectively converted your income to a higher rate. Roth IRAs have different rules but they also have other limitations that are beyond the scope of this article.
What The Government Giveth The Government Can Taketh
The benefit of having been around the block a few times is that I have seen how the tax policy winds can shift. I’ve seen people make decisions based on the law at the time, only to have the rug pulled out from under them with a law change. I’ve heard discussion of the government taking over 401(k) and IRA plans. Even if that sounds crazy to you, try to imagine if the stock market fell by 70%. Would it be so unimaginable for politicians to see an opportunity to take things over to “save” the system? That very idea was floated in the past. So it doesn’t really take too much imagination.
Both Sides Of The Equation
Now you have heard the other side of the story. I’m sure I haven’t covered every possible scenerio, but that isn’t the point. It was to illustrate that it isn’t as black and white, no-brainer, slam-dunk of a decision as you have been lead to believe. The 401(k) and IRA have their benefits. But there are trade off. The key is to make the best desision you can that gives you the best opportunity to meet your goals.
If you liked this radical idea, you might like to read my Radical Retirement Manifesto. You can get it here.
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