Think about this when getting advice on how to save for retirement
By Michael Hess, Vice president at WestPac Wealth Partners
My knees are shaking as I sit in the lobby of a venture capitalist office waiting for my turn to pitch my product. If this goes well it could literally change my life and my family’s lives as well.
The assistant manager escorts me into the meeting room. I confidently stride in. I make my pitch and get two offers.
The first offer comes from Mr. Big Shot VC. He tells me:
- You and I will be partners forever.
- If I die before you die, you become partners with my heirs; if you die before me, I will become partners with your heirs for 10 years; and if we die at the same time, our heirs will be partners for 10 years after our deaths
- You’re going to do all the work
- For the first 25-35 years YOU can’t touch the equity WE build without incurring a penalty
- I’ll tell you later how much of the company I own
- I’ll protect you from lawsuits and cover the bills for a while
- WE have to take equity out when you’re 72 even if YOU don’t need/want to
Guess what? That amazing product is ME! And we’re talking about funding my 401(k) plan.
Wait…what? My parents, boss, HR person and traditional financial planner all told me the best way to start saving for retirement is through my 401(k) plan. I don’t want my kids to have to be partners with Mr. Big Shot’s kids after I die. And he’s really cool, but I do all the work? He’s not going to help me grow OUR company’s balance sheet? He’s just going to be a silent partner inasmuch as the kind of work I do? He’s not willing to commit any kind of equity/sweat equity? He won’t provide any guidance on how to build the equity in OUR partnership? And he’s not going to tell what my future ownership percentage is? Sign me up!
That’s exactly the deal I signed up for when I started my 401K. The biggest difference is that Mr. Big Shot VC didn’t make that deal with me. The United States government made that deal with me.
For the rest of my life, plus 10 years after I die, the IRS and I are partners. When I take money out of the plan, they take money out of that withdrawal in the form of taxes. The idea is that everything I put into the plan will be spent down over the course of my life plus 10 years when my heirs are forced to take out every last penny. At that point, and only at that point, is the partnership terminated.
I willingly enter the partnership knowing that under most circumstances I will not be able to withdraw any money without penalty until I’m 59 1/2 years old. So, I better cross my fingers that nothing goes wrong between now and then. Unfortunately, I’m not sure I can hold up that part of the agreement. There’s a reason there was $57,000,000,000 in early withdrawals from 401K plans in 2017 (https://www.cnbc.com/2020/02/24/americanslose-5point7-billion-annually-to-early-withdrawal-penalties.html), and there will probably be more in 2020. Life happens! I may lose my job, I may need to help my parents age gracefully, etc. To not have free access to my money could be a huge burden.
Guess what else? My partner every four years or so will get to change the agreement about how much of the company they own…without telling me first or getting my approval. From presidency to presidency tax rates change thus the government’s partnership percentage in my 401(k) changes as well. Since the U.S. is in a historically low tax rate environment right now and we are racking up trillions of dollars in debt, one may want to consider that our future possibly holds higher tax rates for everyone. Deferring a lower tax for a potentially higher one doesn’t seem prudent.
The good news is that the money in my 401(k) will have ERISA protection from creditors and will also grow tax free until I withdraw it at a later date.
But when I turn 72, I’ll be forced to take money out of my 401(k) even if I don’t want or need any income. For the rest of my life, failure to make withdrawals will result in stiff monetary penalties since “my partner” wants and needs “their share” of MY hard work.
My second offer comes from Mrs. Big Shot VC. She tells me:
- I can utilize leverage to help protect my family
- She’ll make annual monetary contributions to the company regardless of how sales are
- I can have access to the money in the company in case I need it
- I have full ownership of the company
- She won’t require me to take any money out…EVER
This offer is for the same product…ME, but this time we’re talking about paying premiums for a whole life insurance policy.
By paying premiums for a whole life policy I put protection in place in case I pass away prematurely. For families that lose a loved one, the emotional value can never be replaced. However, from an economic standpoint, being able to replace at least a portion of someone’s future earnings at a discounted rate (i.e. the premium vs the death benefit) can be invaluable.
As I pay my premiums, dividends may be paid by the insurer and can be used to buy more death benefit, build more cash value or even partially pay premiums.
As noted above, life happens. Who’s to say I won’t get fired or simply want to take a six-month
vacation? As I consistently pay my premiums for my whole life policy, my cash value can build up. My cash value will never go down in value (unless I take a withdrawal of course). So, if I decide that a six-month trip to Fiji (after COVID -19, of course) is what I want to do, I can borrow from my policy to fund the trip.
As I pay my whole life policy premiums, ALL of the cash value is mine! I have no partners who are going to keep me guessing on how much of the cash value is theirs and how much is actually mine.
Whole life policies do not require any withdrawals be made. However, whole life policies can allow me the option to spend down my other assets in a potentially more tax-efficient manner. And in the distribution phase of my life, controlling taxes is paramount to optimal financial planning.
So after thinking about it, no thanks, Mr. Big Shot VC, I’m going with Mrs. Big Shot.