Intro: Hi guys, it’s Giang from Moolahwise.com and in today’s video I will be debunking the two most common myths in a 401k that we were all led to believe. After that I will also explain some benefits of saving in a 401k. Then we will be discussing where to save your money if you want to avoid these traps.

Ok lets get into it!

But first story time….

A analogous story to the 401k: So if someone comes to you and tells you that they wanted to get into business with you where you and him will be business partners. In this partnership this partner will collect a third of the profits in 20 or 30 years after you have built up this business. Additionally, this partner will not help you build this business or help you with any of the overhead that you are required to pay to get this business off the ground and this partner will not pay for any risks when the business takes a hit. This partner will not help you with any of the business growth and expects you to do all the work. On the other hand, this partner can raise his share of what he collects from you at any time and you can’t do anything about it. Additionally, if you try to sale the business early , he will get to collect another 10% of the profit. Another thing I want to point out is that if you try to just “keep the business in the family” and not cash out, he will force you take out money at an age of his choosing or else there will be a 50% penalty for missing previous years cash out amounts. Would you get into a business with this partner? I know I have alluded to it but this partner is uncle Sam and this is exactly what you are doing when you save your money in a 401k. So let me ask do you want to be building your retirement plan or uncle Sam’s retirement plan?

Myth #1: I get to deduct the contribution on my taxes and I will be in a lower tax bracket when I retire? Is this really true? Lets explore if this will be true or not. First let me ask you do you believe that the taxes in your retirement will be the lower, the same, or higher? While you ponder that question, lets go over to google and google the words Federal tax rates for 2022. So in this example, lets just assume that the taxes will be the same as today and in retirement. 

As google shows that, you are in the 12% tax bracket if you make up to $41,775 filing single and up to $83,550 if filing jointly. So lets just assume that there will be no changes to the current tax code when you retire. Why do I bring this up? So lets say that you and your wife make $100,000 / year right now and you are filing jointly at 22% tax bracket. So if this myth was true then instead of living on $100,000 per year you will have to live on $83,550 / year just to get into the lower tax bracket at 12%. So below is the breakdown on one side is how much you will be taking home after paying 22% when you are making $100,000 / year and I have broken it down to per month amounts after taxes. You can see that when you apply the 22% tax to $100,000 you will have $78,000 / year after taxes. And when you divide that by 12 then you are left with $6,500 / month. On the right side is how much you get to keep after getting into the lower tax bracket in retirement. So for this example, lets just say that you and your wife pulls out $83,550 / year so you be in the 12% tax bracket. You will see that after paying 12% of $83,550/ year you will end up with $6,127 per month after taxes. You went from living on $6,500 per month before retirement to living on $6,127 per month. One last thing to point out is that the money in a 401k isn’t taxed yet, so for you to end up with $83,550 in your hand you will have to take out more money to end up with the $83,550 in hand after taxes which will deplete your 401k balance even faster.

Now keep in mind this example doesn’t include inflation so the cost of your life could be much higher then it is right now. What if your life cost 2x, or 3x then what it cost now? So think about it , you have to learn to live on less while your money’s buying power is still going down just so you can get into the lower tax bracket. All on top of that, not earning a income anymore. In this example, this is just to show why that myth is not going to be true. I don’t know about you but I didn’t save all this money in my retirement account so I can learn to live on less just so I can be in a lower tax bracket.

But wait there’s more…

Losing the biggest deduction you have in retirement: So Another thing I want to point out is that during retirement, you will lose the two biggest deductions in your working years. Which are the mortgage and the kids. Hopefully, you should have the house and the kids paid off by retirement already so then you would lose those as deduction which could of help you with the tax bill. For a further explanation of this concept, refer to my x-curve video explaining the relationship to money vs responsibilities for different parts of our lives as we age. Guys, keep in mind in this example, I am assuming that the taxes are going to be the same today as in retirement. What are you going to do if uncle Sam raises the taxes? I don’t know about you but I don’t want to see my money inside my 401k to be taxed to oblivion!

Pulling out 4% of my balance per year so I don’t outlive my money: The second myth I want to discuss is what everyone in the financial industry calls a 4% rule. What is the 4% rule? It’s a rule that says if you take out 4% of your total nest egg per year then you won’t run out of money in retirement. Let see if this is true or not… Let’s go to google and google the 4% rule excel template. So you will get to this screen. Then just fill in the excel sheet. A couple of things to point out is that I am assuming that the inflation is at 3% and I have a nest egg of $1,000,000 and I am assuming that I will start distribution when the RMD (required minimum distribution) is required at age 72.5. If you don’t know what RMD is, it just a the minimum you are required to take out after age 72.5 from your retirement accounts. If you don’t withdrawal the minimum required then you will owe 50% in taxes for the previous year you aren’t taking a RMD. Another thing I want to point out is if I saved a $1,000,000 nest egg and all I get is $40,000 / year to spend, that is pathetic! Remember guys this is a pre-tax amount so if you want to end up with $40,000 per year you would actually have to pull out more then $40,000 per year to neutralize the taxes before you can end up with $40,000 in your hand.

But lets see when I will run out of money in retirement? As you can see from this excel template, I will run out of money when I am 82.5. Even just living on a pathetic $40,000/ year I will still run out of money by the time I am 83. A couple of things to point out is that I haven’t factored in taxes on this distribution.  Hopefully, I can still drive an uber or I can hand out samples at Costco in my eighties,  so I can supplement my income! 

However, if you assume 0% inflation then my nest egg of $1,000,000 will last forever but we all know that the inflation can’t be zero! The moral of the story is don’t run out of money in retirement. To avoid this you can either save more, spend less , or save your money in a vehicle where you pay the taxes up front. If you don’t know what other vehicles are tax-efficient then watch my other video on the (3)buckets of taxes explained to get a better understanding of a tax- advantage place you can save your money. Let me ask you are you saving for your retirement or uncle Sam’s retirement?

But there’s got to be some good to the 401k right?

What are some of the good of a 401k: Some of the upside of a 401k is the company match. The company match is where the company will match you a certain percentage of what you contribute to your 401k. The advice that I was given was to contribute to the 401k up to the employer’s match because it is essentially free money. And this extra matching from the employer will go to neutralizing any future taxes and fees. Then anything beyond the match to put into other more tax efficient accounts.

So what are my options?

What options do I have?: Some of the options a person may have from a traditional 401k is maybe they have a roth 401k at work where they can get the taxes over with. Or maybe they can do a strategic roll out where you can roll out a certain amount of money from your 401k per year over several years and pay the taxes then fund a more tax efficient account. But before you do this strategy please consult with your financial advisor and tax consultant because this strategy may not be right for you. Another option you can have from a traditional 401k is saving your money in a IUL where you get the taxes over with up front. When I say IUL, I just mean indexed universal life insurance. 

So what is the moral of the story?

So what is the moral of the story?: In conclusion I hope you learned some of the 401k myths that we are lead to believe are not true. Additionally, just save your money in a tax efficient account so you can get the taxes over with. Its like paying the taxes on the seed when you save your money in a tax advantage account. While paying taxes on the harvest in accounts like a 401k. You get to decide whose retirement plan you are building. Are you building Uncle Sam or your retirement account? 

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