That Traditional 401(k) is bad for your health when it comes to retirement

  • That Traditional 401(k) is bad for your health when it comes to retirement

    Americans who are planning and saving for retirement can often expect to hear financial experts dole out the following advice: Invest in your company’s Traditional 401(k), but the problem, though, is that a Traditional 401(k) is bad for your health.

    The advice resonates well. Where else can one have the advantage of taking pre-tax dollars and investing them into the stock market, and with the possibility of receiving a “company match”? A company match is where the employer also invests “free money” into your account under some agreed-upon formula (e.g., dollar for dollar up to 6% of your contributions). This does have a lot of appeal.

    Americans, for the most part, have seized upon this retirement savings vehicle in bold fashion. According to the Investment Council Institute (ICI), as of June 2014 there was roughly $4.4 trillion in these accounts alone. This is a growth of 50% in just 9.5 short years!

    Amazingly, 401(k)’s make up just under 20% of all assets earmarked for retirement. The total retirement allocation is just over $24 trillion. One has to start to believe that all of the doom and gloom about Americans not saving enough may just be a tad bit overblown. It would almost appear that a good chunk of the majority has actually done the responsible thing and saved for their futures.

    Now this isn’t an exact science, but according to the American Benefits Council, there were 638,390 defined contribution retirement plans in the U.S. in 2014. Out of the total of these plans, 513,000 were 401(k) plans that covered more than 88 million total participants, with 73 million participants being considered “active.”

    With close to 147.5 million people in the labor force, it would appear that at least half of those working had a piece of that total $4.4 trillion in savings. Yes, it could be argued that just a handful of people did all the savings. But the reality of the numbers could lead to the realization that, again, there is a large number of people who have already saved and are continuing to save for their retirement. It should also be noted that out of the total labor force, according to the Bureau of Labor, 22% of workers did have some form of pension available to them too.

    It begs the question: is all this saving a good thing? On the surface, the argument could be that this is a great thing, not only for workers but also for the overall US economy. The greater number of people who plan for their own retirement will hopefully reduce the number of people who will not have to rely on a tax base that is, due to demographics, getting smaller.

    The harsh reality though, is that due to legislative changes from Congress over the last three decades, this strategy of investing into employer retirement plans using the current traditional investment approach of taking pre-tax dollars to fund for retirement is very bad in the long run.

    Back in 2010, our federal government passed a law, the Affordable Care Act, that stated each person had to have health coverage or else they would be penalized. In retirement, this means that every person who is considered to be retired, who is of the age of 65 or older and who is no longer covered by an employer or spouse’s employer health plan, must enroll into Medicare. By the way, this rule just also happened to be on the books since 1993.

    So what’s the big deal? Medicare is cheap when considering what health insurance costs on the individual market, and it also provides very good coverage for those who use it correctly. Many who argued for the Affordable Care Act would cite how awesome Medicare was. It was Utopia! You paid into it while you were working, and you reap the rewards when you retire. It’s a fair system. The little guy gets the same insurance as the big guy.

    The deal is the fact, which is often left out of many financial plans, that Medicare has been means-tested since 2007. Meaning that when a person retires, the bulk of their health coverage will depend on how much income they have. Or in simpler terms, if you have a lot of money then you will pay more for the exact same health coverage as others who do not have a lot of money.

    Does this really matter? After all, we have been lectured to for years by some in the media and in some political circles that rich need to pay more of their fair share. Well, let’s look at the math: a person who is 65 years old and retires today and wants to be fully insured through Medicare, can expect to incur about $3,900 in total costs in premiums for his/her health insurance or $7,800 per couple.

    As of 2014, Part B of Medicare costs $1,258 per year. Part D, for just the premiums (and depending on the where you live), is about $650 a year. A quality supplemental Medicare plan, such as a Medigap Plan F policy which covers all gaps in Original Medicare, costs roughly $2,000 (this also varies based on residency, age, and gender).

    The other nugget that’s often neglected to be mentioned, is that Medicare has been inflating at over 7.5% for the last 48 years. Will that continue in the future? Probably. According to the Medicare Board of Trustees, Medicare premiums are expected to continue to inflate at roughly 6.2% through at least the year 2022.

    This means that a couple retiring today who plan on living in retirement through age 85 can expect to incur close to $319,208 in just their premiums alone! This number does not factor in any co-pays, excess charges, or deductibles for any medications a person may have to take. Nor is it considering any coverage for procedures that relate to dental, vision, hearing, or podiatry, unless of course the retiree uses their Medicare coverage correctly. So much for being free and fair… Toothless deaf-mutes of the world, rejoice! You guys will be fine.

    To calculate your future health costs please click here

    If they hit only the first Medicare Income bracket throughout retirement, they will pay just under $373,000 for the exact same coverage. If they reach the highest Medicare Income Bracket they will pay about $615,000 just for premiums for the exact same coverage!

    The problem gets worse for those who are 55 years old today. With everything staying the same, the cost if a couple retires at age 67 and lives until age 85 could be $550,000.

    If they earn just $1 too much and wind up in the next bracket, they may incur $646,000 in costs. If they earn the maximum, the cost for their premiums alone could be slightly over $1 million!

    But where do employer retirement plans fit in? As stated previously, Medicare is means-tested. The income used to determine what the bulk of your costs will is, according to Social Security, “your adjusted gross income PLUS any tax exempt interest you may have or everything on lines 37 and 8b of the IRS form 1040.”

    For those of you who are not accountants, some examples are: Wages, Social Security, any Capital Gain, Dividends (even from Muni Bonds) and distributions from Traditional IRA’s, 401(k)’s, 403(b)’s, 457’s, the fillings in your teeth, Keogh Accounts, SEP IRA’s and Cash Balance plans.

    Now if that same couple followed the typical advice and just happened to save a lot of money in their employer retirement plans using the traditional pre-tax method, they may be considered high income earners when they distribute their savings from these accounts.

    That additional higher income may force them to pay extra for their Medicare premiums which will all be deducted automatically from any Social Security benefit they may receive too.

    This is one of the main reasons why Social Security is not going to go broke. Ultimately, retirees are going to see the amount of their Social Security benefit reduced by the bulk of their Medicare premiums and those who happened to have too much income, especially those that “saved” a lot in their Traditional 401(k) plan, they will receive even less.

    For more information on how your Social Security may be impacted by your health coverage please see our article titled, “Is Social Security really going broke…probably not and you can thank a Baby Boomer”.

    Again, what’s the big deal?

    Let’s take that same couple who retires today and we’ll use the Medicare Trustees Report that states inflation will stay level at 6.2%.

    If they hit only that first bracket throughout retirement, they will pay just under $373,000 for the exact same coverage. If they earn the maximum amount Medicare penalizes, they will pay about $615,000 just for premiums for the exact same coverage!

    The problem gets worse for those who are 55 years old today. With everything staying the same, the cost if a couple retires at age 67 and lives until age 85 could be $550,000.

    If they earn just $1 too much and wind up in the next bracket, they may incur $646,000 in costs. If they earn the maximum, the cost for their premiums alone could be slightly over $1 million!

    In a nutshell, that employer sponsored retirement plan may be costly to your tax bracket, your Social Security, and your health, but there is a ridiculously easy solution to this that most, if not all, employers have not told you about:

    Instead of saving for your retirement using traditional methods, invest into an employer plan that is a Roth account. The beauty of a Roth is the simplicity of paying the tax now, so no matter how much the account grows, when you withdraw the assets, if needed, after 5 years of investing and at the age of 59.5 or later, it’s not considered to be income by the IRS or Medicare.

    Yes, you may pay slightly more in taxes today, but when you are retired the Roth option will provide you the ability to control not only your tax obligation, but it will also help manage your own health costs as well as possibly saving your Social Security benefit.

    The only problem: when was the last time your employer told you any of this?

    The Jester

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