Monday, August 9, 2010

401(k) Calculator Deception: Don’t Let Them Take You for an Idiot

401(k) Calculator Deception: Don’t Let Them Take You for an Idiot

Have you ever used one of those 401(k) calculators? You know the one – it lets you punch in information like your current age, your intended retirement age, your contribution amounts, and expected rate of return among others, and then once you hit the “Solve” button, it spews out a number indicating how large a nest egg you’ll have. If you have a 401(k) or other similar employer-sponsored qualified retirement plan, chances are good that you’ve probably used one of these calculators, or have seen similar estimates in a sales brochure or at a benefits seminar.

In my view, all such calculators that I have seen and examined are misleading in two major ways.

First, There Is Absolutely No Mention of Fees/Costs

You see, in those employer-sponsored plans, the fees are deducted from your returns. So say your plan costs 1.5 percent per year, and you expect to earn 7 percent. Your net return – the amount you actually end up with –ultimate income will be 5.5 percent (7 minus 1.5). Did you realize this? If not, it’s a pretty stark difference, isn’t it?

Let me illustrate with this example. To keep things simple, let’s say you invest $20,000 in a lump sum, and have not added anything to it. At a yearly interest rate of 7 percent, your account would have grown to $152,245 in 30 years. Notice, this is true ONLY if the 7 percent is the AFTER-COST return. But in reality, there’s an annual fee attached (let’s assume it’s 1.5 percent), meaning that your account will actually be growing at a rate of 5.5 percent. Are you ready for this? At the end of 30 years, the balance will be $99,679 – that’s 35 percent less! All I am saying is, let the actual numbers tell the true story.

Second, They Only Show You How Much You’ll Accumulate

But they NEVER show you how much of that “huge” amount really belongs to you – and by that, I mean the portion that you and/or your heirs actually get to spend.

To their credit though, most of the calculator programs give you a long, winding, legalistic, small-font disclaimer in gibberish, at the end of the page, like this one from the Profit Sharing/401K Council of America:
All estimates and dollar values are pre-tax. No deduction has been made for the income tax payable on these amounts when they are distributed. It is up to you and your tax advisor to calculate your income tax liability for distributions.
Don’t you find it quite odd that these bright individuals and organizations could design such complex calculators, but somehow neglect to include just one more space for you to type in your estimated tax rate so you can have an idea of how taxes will impact your “sugar-coated” gross distributions?

I wonder if it has anything to do with the fact that most investors, armed with a more complete picture of how things might turn out AFTER-TAXES, would think twice and perhaps turn to other better options? Like non-qualified alternatives that allow for income-tax free access and transfer to heirs and which also do not impose any “required minimum distribution” rules once you hit age 70½.

A Few More Questions to Ponder

Did you realize that you and/or your heirs will have to pay taxes on every dollar that comes out of your qualified employer-sponsored plan? And the tax rate will be whatever it is at the time (in the future) that those funds are withdrawn? And there is absolutely no chance whatsoever that your tax rate will be zero?

How proper, prudent, and respectful is it to you, as an investor, for companies to bury this CRITICAL piece of information in a disclaimer that you are almost sure not to read? More than a little sneaky, if you ask me.
Call Laser Financial Group at 301.949.4449 or visit us on the Web to schedule a complimentary consultation where we can do a REAL projection of what you can expect to earn with your qualified or non-qualified retirement plan.

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