The rules of money changed in 2022.
To illustrate this from a different angle, let’s assess how the “traditional” retirement planning model came to be…
Modern retirement planning has its roots in the Employee Retirement Income Security Act (ERISA) of 1974. That legislation created the Individual Retirement Account (IRA). Then supplemental legislation created the 401(k) and the SEP IRA for self-employed individuals in 1978.
ERISA marked a monumental change in the US.
Prior to this legislation, it was common for employers to provide employees with a lifetime pension plan. Companies would invest in this plan on behalf of their employees. Then they would make lifetime payments to each employee after they retired.
As such, the burden of retirement planning fell to corporations.
This gave rise to the “three-legged stool” principle. It said that a sound retirement consisted of three things:
- Social Security benefits
- Corporate pension payments
- Personal savings
ERISA changed everything. It shifted the responsibility for retirement planning from employers to employees.
This gave companies the green light to phase out their pension plans. It had become clear that lifetime pensions weren’t sustainable anyway.
That eliminated one of those three legs on the retirement planning stool. It also set in motion what was almost certainly an unforeseen chain of events.
Suddenly millions of people became responsible for their own retirement planning. And they were sold on using the 401(k) and the IRA as their primary savings vehicles. This created millions of new customers for Wall Street – almost overnight.
When they realized this, financial institutions created scores of investment funds designed to go into retirement accounts. First it was mutual funds. Then index funds. And then exchange-traded funds (ETFs).
Fast forward to today and there are over 15,000 different investment funds out there for people to choose from. And every single one of these funds comes with its own fee structure. These fees ensure that the fund managers get paid no matter how their investments perform.
Thus, retirement planning became a massive industry… and Retirement Inc. was born.
Then clever marketers crafted slogans like “What’s your retirement number?” and “Stocks only go up over time”.
The industry pushed the idea that we should all plan for retirement the same way – by funneling a small portion of our savings into diversified funds held within qualified retirement accounts.
We do this for 30 or 40 years to work up to as big of a “retirement number” as we can. Then when we retire, we start selling off our funds to create income for ourselves. And we hope that we don’t outlive our money.
Wall Street and guys like Dave Ramsey made an absolute fortune pitching this method of retirement planning. And I suppose it worked okay during the Age of Paper Wealth from 1982 to 2022.
But this approach is riddled with holes. In fact, there are three fundamental weaknesses that Retirement Inc. completely ignores.
For starters, planning for retirement this way pits us against the tax code.
Any withdrawals we make from a 401(k), IRA, or SEP IRA are subjected to ordinary income taxes. That means the “retirement number” we worked up to isn’t our actual number. Because a portion of it will be taxed away from us.
Today, the average income tax bracket for American retirees is 12%. At that tax rate we only receive $88,000 for every $100,000 we withdraw from a qualified retirement plan. The other $12,000 gets taxed away.
And here’s the kicker – tax rates today are lower than they’ve ever been. Yet the national debt is over $34 trillion and Congress is running trillion-dollar deficits each year.
This begs the question – what happens if tax rates go up?
It certainly seems likely that they will at some point. And then retirees will have an even greater portion of their nest egg taxed away from them when they go to access their money.
The second weakness to this approach is that it leaves us vulnerable to inflation.
We saw yesterday how the US dollar has lost nearly 88% of its purchasing power since 1970. That means an investment portfolio worth $100,000 in 1970 would need to be worth $833,333 today just to have the same purchasing power.
In other words, inflation is constantly eating away at our investments – so we need to generate a rate of return that outpaces inflation to get ahead. Our nominal rate of return doesn’t tell the full story.
To be fair, a properly constructed equity portfolio does stand a good chance of beating inflation over time. But most of the smorgasbord of funds out there are far too diluted with poor investments. I wouldn’t trust them to beat inflation going forward.
The third major weakness of Retirement Inc’s approach to financial planning is that it puts us on a see-saw.
When we’re working, we use our income to build up financial assets inside of retirement plans. Then when we retire, we sell off those assets we spent our life working for.
So during our working years, our assets are going up… but we’re not getting any income from our investments. Then in retirement we do get some income – but we deplete our asset base in the process.
That’s the see-saw. It’s a constant choice between assets and income.
This strikes me as silly.
Why would we make such a choice? And why would we work so hard for 30 or 40 years only to sell off everything we worked for later in life?
Wouldn’t it be nicer to instead build a legacy that will live on long after we’re gone?
I bet most people agree with this sentiment. It’s just that Retirement Inc. convinced us that their way is the only way… And they control the financial media and massive advertising budgets.
Tomorrow we’ll flip the script and envision a better approach.
-Joe Withrow
P.S. I mentioned that a properly constructed equity portfolio should outpace inflation over time. We demonstrate exactly what that looks like in a special report available on our new author site: https://joewithrow.com/
Just scroll down to the bottom of that page to get the report.