Have you ever had a water leak in your sprinkler system or your pipes and it was so small you didn’t even notice – at least until you got your bill? And then you are shocked – how could the bill be so big for a leak so small you didn’t even notice it?
The same is true of leakage on your retirement plan, the truth is you probably already have leakage but have no idea that little by little you are losing money – money that over time adds up. Leaks in not one area of your retirement plan but multiple ones.
So what is leakage and what causes it? Retirement fund leakage is the premature distribution of retirement savings prior to retirement age. So there are a number of causes of this drain on your retirement accounts – many of which are likely not even on your radar. But they are slowly draining away your savings that you will need to enjoy your retirement years.
Avoid Retirement Leakage
• Emergency Fund
• Adult Children
• Penalties & Fees
• Retirement Account Drains
• Quick Fixes
Important Points:
(0:00) – Intro
(1:46) – Retirement Plan Leakage Overview
(3:24) – Low Emergency Savings
(5:33) – Adult Child Siphoning
(10:24) – Retirement Account Drains
(16:42) – RMD Mistakes
(20:20) – Stop the Leaks
(21:57) – Ask the experts
(23:30) – Pure Takeaway
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Transcript:
Joe: What does a bad camping trip and your retirement have in common? Stick around, and I’ll tell you. Welcome to the show, everyone. Joe Anderson here, CERTIFIED FINANCIAL PLANNER™, President of Pure Financial Advisors, and this show wouldn’t be a show without the big man Big Al Clopine. Aloha, Mr. Big Al.
Al: Aloha, Joe.
Joe: Wish I was there right now. He’s hanging out in Hawaii, but the question I propose to you is a bad camping trip and your retirement, what does it have in common? Have you ever had an air mattress and it’s so comfortable when you go to bed, and you wake up in the middle of the night and it’s flat because you have a small leak in it? Your retirement plan could have that same leak. We want to plug that leak today. That’s today’s financial focus. A survey was run that by the age of 60 some of you might have 31% less in your retirement plan. How could that be? Because there is leakage in the plan. You are taking loans that you’re not paying back. You might be taking small distributions out of the overall accounts. You could be paying penalties in taxes. You have to stop the leakage because this could create 31% more income potentially. Let’s break it down. Let’s bring in the big man.
Al: Retirement plan leakage. So how is it that your accounts are lower than they need to be in retirement? We’ll give you some reasons, and we’ll talk about how to fix it. First of all, many of you do not have emergency funds or have too low of emergency funds. Secondly, you’re paying for your adult kids’ education. I’m partially guilty there. We’ll get into that. Penalties and fees. You got to pay attention to that, and there’s a lot of ways on your retirement accounts that you’re actually losing money or money’s leaking out for various purposes, and then finally, we’re gonna get into how to fix it, some things that aren’t that difficult that you can implement right away. This is an important topic for virtually everybody because we are spending sometimes our retirement accounts for things we shouldn’t, or we’ve got fees and penalties we’re not aware of, or we’re paying too much for our adult children and so forth, so I’m glad we’re talking about it today.
Joe: You know, good point, Al, because if you look at it, we’re doing a lot better job of saving money, right? We are focused on saving for retirement, we’re putting money away, and it’s great. It’s our nest egg, but then all of a sudden, you got some leakage. Some things are just seeping through the cracks, and you might not even know it’s happening. Some of the things are completely obvious, but other things we’re like, “well, wait a minute. I probably should have a lot more money here. What is going on?” you know, first things first is you have to look at having enough cash on hand. A lot of you are guilty of not having that cash reserve, and you might be using your retirement account as kind of a quasi-cash reserve in case of an emergency or maybe even an opportunity. We’ve seen people take money out of accounts for starting a business, or, hey, you know what? Just something happened where you needed cash. Your retirement plan should be the last place, but, Al, some people are absolutely looking at their retirement account as that piggy bank because, as the surveys show, there’s a lot of people that don’t necessarily have this.
Al: Right, and the last survey that we’ve seen is 23% of folks out there don’t have any kind of emergency savings at all, and you’re right, Joe. People tend to use their retirement accounts for things that they shouldn’t. I myself was a little bit guilty during the great recession. I figured my emergency savings was my home equity loan, and what happened during the great recession is home equity loans, many of them, including mine, were frozen, so I had no access to the funds at that point. I realized how important it was even personally to have an emergency account because if you don’t then you’re charging credit cards, you’re pulling money out of retirement funds, and it’s not where you should be paying these expenses.
Joe: Well, you know, then people think it’s like, “well, I have an emergency fund,” you know, but surveys show that it’s across the board. Doesn’t matter what your net worth or income ore wealth is. It’s funny because even higher net worth individuals still don’t have the fundamentals down in just personal finance in regards to that cash reserve.
Al: Yeah, and I think, you know, when you look at the stats, so higher net worth households, 8% have less than 3 months, and only 1% have more than 12 months, so let’s talk about that, Joe. You know, what financial planners will often say just as a starting point is maybe you should have about 6 months of emergency funds, but that’s just a starting point. Some people can get away with less. Some people should have more. Like, for example, if you’re a worker–let’s say a construction worker. I know you’re probably very busy right now, but it’s a cyclical type business, and you have periods of time where you’re not really working. If you’re in that kind of role, you might want to have a year or more of emergency funds. On the other hand, if you’re a government employee with a steady job, maybe 3 months is fine. So you kind of have to look at your own situation and what’s gonna work best for you.
Joe: Yeah, because the last place you want to go is your retirement account for that extra cash. Here’s another big one that’s causing leakage is still taking care of your adult children. 79% of people surveyed said, “hey. You know what? The kids are still on the payroll,” and they probably shouldn’t be. Al, you don’t have any experience in this, do you?
Al: I’m part of that 79%. Ha ha! You know what? It’s hard, though. I mean, so I’ve got kids, late 20s, early 30s, and it’s not much. They’re on my cell phone plan. It’s cheaper if we do it as a family, and I don’t even feel like–i mean, they’re just getting started in their careers, so I’m not asking for reimbursement. I’m also partially paying their car insurance. I’m down to two things, Joe, but it’s–we need to be better because a lot of people in my generation and the next generation are spending too much of their dollars towards their adult children instead of saving for retirement.
Joe: Yeah. I mean, unless your retirement plan are your kids, you know? Because people are– they’re spending twice as much on their adult children than they are on their retirement accounts. It’s, like, $500 billion went to paying for kids versus $250 billion going into retirement accounts. Unless your overall retirement plan is, like, “you know what? I’m gonna be broke, and, kids, you’re gonna, you know, fund my overall retirement, and you’re gonna pay for the country club and everything else,” then that’s great, but the likelihood of that happening is pretty slim. Here’s just a few different reasons why people are doing it or how they’re doing it. You know, pulling money from the savings account is number one of course, but some people are actually coming out of retirement, al. You’re gonna have to come out of retirement and support your 50-year-old kids.
Al: Well, I hope I get it figured it out by then. You know, when you look at some of the other things, so some parents–i mean, they’re making all kinds of sacrifices for their kids and living a less comfortable life, and, you know, cool if that’s what you want to do. I mean, I think probably the biggest siphoning expense is college. Fortunately, I’m past that, but college expense is what a lot parents are–they’re diverting for several years if they have multiple kids their retirement savings into college-type funds.
Joe: We’re not saying don’t support your kids. We’re not saying, you know, if you have to take money from your retirement account in an emergency don’t take it. What we’re telling you is that you need a plan to make sure that you fund all of this, and if there’s an emergency or if you still want to fund the kids, just map it all out. You can do that with our Retirement Readiness Guide. are you ready for retirement? Go to our web site yourmoneyyourwealth.com, click on that special offer. It’s a download you can do right there in the comfort of your own home. Yourmoneyyourwealth.com. Got to take a break. We’ll be back in just a second.
Joe: Hey. Welcome back to the program. The show is called Your Money, Your Wealth®. Joe Anderson and Alan Clopine here hanging out. Alan’s in Hawaii. I’m here in the studio, and we’re talking about leakage. Not the leakage that is in your sink but in your overall retirement accounts. A lot of different reasons why we don’t have the money that we have in retirement and some of it you can’t see. Go on our web site yourmoneyyourwealth.com, click on that special offer. It’s our Retirement Readiness Guide. understand the things and steps that you need to do to make sure that you get to retirement. It’s free. You can download it right there on your computer. Yourmoneyyourwealth.com. Let’s see how you did on the true-false question.
Al: That’s true, right? Because the IRS wanted to have some kind of penalty in there so people wouldn’t just raid their retirement accounts because the retirement accounts are simply for that, for retirement. However, Joe, it’s not necessarily working because a lot of people are still raiding their retirement accounts.
Joe: Right, and there’s–this is where it gets confusing because there’s a lot of different rules in regards to taking money out of retirement accounts and different retirement accounts. For instance, if you have a 401(k) plan and you separate service at age 55, there is no 10% penalty. Everyone thinks it’s 59½ , but for 401(k) plans, it’s 55 as long as you separate from service at age 55. Let’s say you have the cousin 457 plan. Well, if you have a 457 plan, there is no 10% penalty in a 457 plan. You can take the money out at any age. Then you have the Roth IRA, right? You can take your contributions out of the Roth IRA at any time. It doesn’t matter how old you are, but the earnings need to season in the thing for 5 years or 59 1/2. I mean, now it gets really confusing. They placed these stupid rules that no one really understands, and they still– it’s not working, right? You know, they come out with simplification acts, but all they’re doing is creating more chaos in the overall system. We got to make it a little bit more easy because the stats say that 22% of net contributions in all retirement accounts are still getting pulled out early, so there’s still an issue here in regards to, like, trying to scare us not to take the money out. It doesn’t necessarily matter. People will still do it.
Al: Yeah. They do still do it, and, you know, to think about maybe an example of how this works is take 100,000 out. 8% goes to the state. Now maybe your state tax is higher or lower, or maybe you don’t have state taxes. This is just an example, but then there’s that 10% penalty that we just talked about, and then there’s the federal tax. Our example shows 20%. Some of you are 24% bracket, some 32% bracket. You know, you add these together, and you’re only getting, say, $62,000 out of $100,000, and in some cases based upon your tax bracket, what we see is people are only getting about 50%, Joe, of what they thought they would get because of taxes and penalties.
Joe: I mean, we’ve seen a couple of different instances, too. Let’s say you retire and you have a mortgage on your house, and you’re like, “you know what? I want to be mortgage free,” and you have this retirement account, so you pull out $100,000 out of the old retirement account, and you pay off your mortgage, and you’re like, “yes! All right. I’m debt-free,” but guess what happens next year at tax time. Well, you’ve got a $42,000 tax bill! Well, where are you gonna come up with the 42,000? Because you drained your retirement account, of if you still have more money in the retirement account, what are you gonna do now? You’re gonna pull another 42,000? Oh, guess what. 10% penalty, early state penalties, blah, blah, blah, blah. You’re paying tax on the tax to pay the tax to pay the tax on the tax, right? It’s craziness! So people are losing so much money just because of simple mistakes that they don’t necessarily understand the rules. In this quick example, let’s say you have $100,000. You pulled that out early. You netted 60,000 bucks, right? If you just kept that in the overall retirement account and grew it at 5% over the next 20 years, I mean, that’s a $200,000 delta. You would have 265,000 in the account. I mean, if you go out 30 years, Al, I’m sure it’s a lot more.
Al: Yeah. I ran it at 30 years and actually at 6%, which would be an expected or potential rate of return for a globally diversified portfolio, and you would end up with almost $600,000. So that 60,000– you went out, you wanted to buy a Tesla. I get it. Teslas are cool. There’s a lot of Teslas in my neighborhood, but that $60,000 today could be $600,000 for your retirement. That makes a huge difference in what your retirement will be.
Joe: Here’s the stats here, too, right? 30% to 40% of people don’t roll over their retirement account. They cash it out, and granted, the reason why this number is so high is because if you look at, you know, the median or you look at the average of retirement accounts, these are some small balances. So maybe you worked for your employer for a couple of years and you have 10,000, 15,000, 20,000 bucks in there, and you’re like, “oh, who cares? I’m just gonna cash it out and pay off some credit cards” or pay off some bills or do whatever that you want with the money. Be careful with that. That’s–these small leakages like that, that $10,000 over a 30-year time period, is significant. So if you have that time, please don’t cash it out. Tell your kids don’t cash it out, right? I made that mistake. You know, my first 401(k) plan, it had, like, I don’t know, $8,000 in it, and I was like, “oh, boom. I’m gonna cash it out, pay off some credit cards, you know, maybe go on vacation, right? Big, big, big mistakes that are being made with these accounts, and if we can just make some simple steps, that’s gonna create a lot more wealth long term. Go onto our web site. It’s yourmoneyyourwealth.com. You can click on that special offer. It’s our Retirement Readiness Guide. it’s gonna walk you through step by step of all the things that you need to be ready for if you’re looking at retirement, if you’re preparing for retirement, of if you’re just getting started for retirement. We got to take a break. We’ll be back in just a second.
Joe: hey. Welcome back to the show. The show is called Your Money, Your Wealth®. Joe Anderson, CERTIFIED FINANCIAL PLANNER™, Big Al Clopine. He’s a CPA. Hanging out. Talking about leakage in your overall retirement account. Stop the leakage. Right? Because then that helps you have a lot more money. Go to yourmoneyyourwealth.com. You can click on that special offer. This week, it’s our Retirement Readiness Guide. yourmoneyyourwealth.com, click on the special offer. It’s our Retirement Readiness Guide. Let’s see how ready you were on the true-false question.
Al: That’s a true statement, although that’s pretty much always true, Joe. They got to– if it’s like a 401(k), the employer’s required to withhold 20%.
Joe: Here’s another issue, too. Let’s say if you’re trying to do a direct rollover, right, and then if you do it wrong, they’re gonna withhold that 20%, and you have 60 days to put it into another retirement account, but they’re gonna automatically withhold that 20%, and so you have to come up with the cash to fund that–for instance. You have $100,000 that you want to do a rollover with. So they send you the check. You’re gonna get a check for 80 grand. You put that 80 grand into an IRA. You have to come up with the $20,000 to put in the IRA within 60 days. If you don’t, it’s a 10% penalty if you’re under 59 1/2 and fully taxable. So just know 401(k)s, they have that. So you want to make sure that you understand if you’re doing rollovers, direct rollovers, that you do the paperwork correctly. Make sure you talk to HR or work with a professional. Ironically, IRAs, you can take out whatever. They’re not gonna withhold anything. So 401(k)s, they have an automatic withholding. IRAs, if you take those distributions, they’re not gonna withhold anything, but you need to understand your taxes, right, because you might get into a surprise the following year when you do your tax bill because all of that comes out at ordinary income. Let’s switch gears. Let’s go to RMDs. If you look at required minimum distribution, here’s some confusion here, right, because now they’re changing the laws on us. It was at 70 1/2 for years, and now they’re pushing it to 72, and guess what. They might now look at age 75, but, Alan, if you do not take your required minimum distribution, the IRS doesn’t care for that that much.
Al: They really don’t. It’s a 50% penalty. 5-0. 50% penalty. So if you’re supposed to talk a $100,000 required minimum distribution and you don’t do it, the penalty is $50,000, and by the way, you still need to do the distribution and pay taxes on it. Now there is–a lot of people get tripped up on this because they don’t know what the rules are. The IRS in most cases will abate the first-year penalty if you write them a nice letter, but it’s not guaranteed, and you’re probably gonna get just one chance for a penalty abatement, so understand the RMD rules, how to calculate it, and make sure you do it timely because of this big penalty.
Joe: Now the purpose behind the required minimum distribution is that when you’re making retirement contributions, right, you get a tax deduction, and that money is gonna continue to grow tax-deferred until you pull it out in retirement, but some of you might not need all the money in your retirement account because you’re diligent savers or you might have a nice pension or you’re living off of social security or there’s a multiple of other reasons, but once you reach a certain age, now it’s age 72, the IRS is coming knocking on your door. They’re saying, “hey, Mr. And Mrs. Smith. It is time to take money out of the account.” why do they want you take money out of the account? Well, because they want their taxes back. They want money to get pulled out so you’re taxed on it, so again, when you’re looking at 401(k) contributions or retirement plan contributions, right, you get a tax deduction up front, but all of that money grows tax-deferred, which is great, but it’s not a true tax deduction in some degree because they want you to pull the money out at a later date, and when you pull the money out, that’s when they get their taxes back, right? They get their taxes back at a lot higher balance, and if tax rates go up, this is where we’re seeing people fall into problems. You know, and, Al, let’s walk through kind of the calculation because sometimes people don’t even know how much money that they should pull out because each year as you age, they want more and more and money to come out of that overall account.
Al: They do, Joe, and so here’s an example of gloria, who’s single, and she’s got $958,000 and change in her IRA, 401(k), whatever, and so she’s got to go to look at her life expectancy factor in the table. It’s 25.5 at age 74, so you take 958,000, which is the balance at December 31 of the year before–so you got to make sure you got the right balance–divide that by 25.5, and you get $37,585. So that’s how much she needs to take out. If she doesn’t take it out, then that’s that 50% penalty, so that’s what you got to make sure that you get done properly. You can take it out anytime. You can take it out at the beginning of the year, the end of the year. Joe, there’s a little bit different rule, though, on your first year, which is age 72, onto when you need to take that first distribution.
Joe: They’re assuming there’s trillions of dollars in these retirement accounts, and they’re not messing around, so if you’re not taking your required distribution or if you screw it up, you get, like, that first year, right, because your required beginning date is really the year after you turn 72. So that gives you a little bit of window. Oops! I turned 72 this year. I forgot to take it. Your required beginning date actually starts the following year. So you have a little bit of wiggle room there, but if you wait until the following year, just know you have to take two distributions for that year. If you only take one, the other one is gonna get assessed that 50% penalty. It gets a little bit confusing here, and also what’s confusing is what the heck you’re paying. The IRS is gonna get their money, but also, the big brokerage firms also get theirs. It’s interesting, alan. Most people have no idea what they’re paying, or they think the advice that they’re getting in their overall retirement plan is potentially free.
Al: Yeah, and I think when you look at the stats, 60% don’t think they’re paying anything, and that’s a bit of a dangerous thought because your financial advisors are getting paid. Ha! Whether you think they are or not, so find out how they get paid and make sure that you are good with that. Maybe you’re getting appropriate service and you’re getting the investments that you need, the tax planning you need, the cash flow planning that you need. Maybe it’s worth it, maybe it’s not, but understand how you’re paying your advisor. In many cases, you’re paying a lot more than you think.
Joe: Let’s get some quick fixes here. First things first is get a financial plan or get some sort of strategy in place, right? You want to make sure that, hey, you’re taking care of yourself first, right, and then you look, and all right, well– you can’t take a loan for retirement. Maybe your kids’ education you can potentially take loans, so make sure that you’re setting limits there. Understanding your fees as Alan just said. You know, some of the retirement accounts are extremely expensive. Understand what you’re paying. What are the fund fees? What are the cost of the plan fees? If you have an advisor manage it, what is their fee? So just understand that because that is a slow leak there. You know, looking at retirement fund deposits. Make sure you just automate that. Out of sight, out of mind. Fund and forget it. Let’s go to ask the experts.
Al: This is from Catherine. Well, first of all, you can give $16,000 a year to anyone that you want to, and if you’re married, you can each give $16,000 a year, so that’s $32,000, and if your recipient is married, you can each give that person $16,000, so now you’re up to $64,000 no problem. In your $100,000 example, then you’ve got $36,000 extra, so you’d have to file a gift tax return. There’s no current tax to pay. It just goes against your final unified credit when you pass away in terms of what goes to your heirs tax-free, and that–the exemption amount right now is almost $12 million a person, so I wouldn’t worry too much about it at least for most of us.
Joe: Yeah. I wouldn’t worry about taxes there, Catherine. I’d be–you know, it’s like, when it’s gone it’s gone. You’re not getting anything till I’m dead, and then all of a sudden, it’s gone, and just watch your back. Let’s go to the next one.
Al: You used to have to pay it off in 60 days, but recently, there was a tax change that allows you to pay off the loan by the due date of your return, April 15, or if you extend it, it’s October 15, but that does have to paid off. If it’s not paid off, then you’re gonna be taxed on that, and if you’re under 59½, there is a 10% penalty. Some plans require you to pay it off earlier, so check your plan.
Joe: Yeah. That’s another just example of the old leakage. So avoid the retirement account leakage, folks. Grow an emergency fund first and foremost, right? Make sure that you can tap cash readily available without going through the retirement account. Limit and cut out the kids, right? Avoid retirement account loans. When you roll over your 401(k), make sure that you understand what you’re doing. Don’t cash it out. That could cost you hundreds of thousands of dollars. And limit penalties and fees and everything else. Hopefully, you learned a couple a bit about leakage today in your overall retirement. If you need more information, you can go to our web site, yourmoneyyourwealth.com. Click on that special offer. It’s our Retirement Readiness Guide. Aloha, Big Al. Great show today.
Al: it was fun, Joe. Aloha back at you.
Joe: All right. Enjoy your time there, and we’ll see you again next week. You just watched Your Money, Your Wealth®.
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