What's Wrong With Retirement Plans?

Up to this point, I have merely indicated the nature of retirement planning using the product approach. The product approach is an approach to retirement planning which focuses on selling products as solutions. Retirement accounts are special tax favors which provide tax benefits to you in exchange for adherence to certain guidelines. These guidelines are arbitrary and disconnected with financial goals and your purpose for creating a financial plan. Instead, a purpose is implied: retirement. More specifically, retirement at age 59 1/2. Although there are loopholes to get around this retirement age requirement, the rules are designed to have you retire no earlier than this age by default.

The problem lies in the fact that financial goals are what determine whether you retire, when you retire, what you do with the money and on what timetable. The government, in its infinite wisdom, circumvents this process through retirement accounts by setting the rules and dictating goals that are disconnected from your values. Instead of your retirement solution (the account and the investments in the account) conforming to your financial plan, your financial plan is forced to conform to the retirement account.

In other words, you are implementing a solution to a problem before you understand the problem you are facing and before you have a comprehensive financial plan. 

Most of the people I do consulting with haven't had the opportunity to sit with a financial adviser who helps them build an outline for a financial plan, define the purpose for a financial plan, and then define the goals necessary to achieve that purpose.

Instead, the entire process is substituted with faux goals of future retirement income, a "necessary" savings amount that must be achieved each month and investment return goals that must be met to achieve the preset goal dictated by the retirement account and its rules. The cart is truly put ahead of the horse here.

This makes the retirement account a completely arbitrary construct. The plan serves to mask the fact that an actual financial plan hasn't been devised that moves the client towards achieving financial success. What does this mean for you?

It means that the "traditional approach" of socking away money into a 401(k) really only does one thing: it creates the illusion that you are doing something beneficial for yourself before you've actually identified, in concrete terms, what that beneficial thing is. I don't mean to be harsh, but that is the reality of the situation. When was the last time your adviser discussed your central purpose in life, had you write out your values, goals, and then discussed budgeting with you? All of these activities are what determine not only why you're saving money but how much you'll actually need (at least in terms of today's dollars).

From there, and only from there, can you try to put together a plan and then find ways to implement the plan in the most efficient way possible.

A Solution

I'm going to go ahead and kill a sacred cow: The solution to this mess is to make a comprehensive financial plan, and ditch retirement plans as defined by the government, and determine what you really need. What about all of those tax benefits? Don't you need the ability to contribute to a retirement account on a pretax basis? What about tax benefits from the often touted Roth IRA or Roth 401(k)?

These benefits seem nice on the surface, but they cut into something that might be more valuable to you in the short and long-term: control. They also aren't as important as you have been told. First, control. Retirement accounts, as defined by the government, put you into a little box and effectively tell you that you will retire. You will quit working. You will live off of your savings. You will not use the money during your lifetime except for certain arbitrary instances which the government deems as "emergencies" or "special cases." What about emergencies?

Emergencies in life are rarities, by definition. If they constituted the commonplace, then you would simply be unable to survive. But, by using a government-created retirement plan, you are forced to plan for the uncommon. You are forced to maintain a separate savings--thus dividing your attention away from your financial goals so that you can plan for a scenario in which your plans are temporarily derailed or you "miss the mark" somehow due to circumstances beyond your control. Very inefficient.

Now for the tax issue. The tax benefits have a "wow" factor, but I don't think they are worth the price of admission. Yes, government-created retirement accounts provide certain tax benefits. The money inside of the account is not taxed. For traditional accounts, the money is taxed at ordinary income tax rates. For Roth accounts, the money is not taxed at all when you reach your normal retirement age. But, think about ordinary investment accounts. When you buy a stock, you aren't taxed on the investment gain until you sell, and even when you do, you pay capital gains tax rates which are, many times, lower than ordinary income tax rates anyway. So, the government retirement account doesn't give you much of an advantage there. During your lifetime, you maintain control over your investment account and the profits should you need them in the event of an emergency.

Want more control, plus compound interest earnings? Use a high cash value life insurance policy. The cash value reserve in these specialized policies builds quickly, there are no taxes due on the savings portion as long as the policy remains in force, and no restrictions on how the money may be used.

This is not meant to be taken as an endorsement for stocks or life insurance, as such.  I just want to indicate that retirement accounts are not needed, and they often get in the way of making a financial plan efficient.

When you don't use a government-created retirement account, you do miss out on some tax favors. But, you build a savings under the assumption that you will achieve your goals. You don't go into this with the premise that you will need to have a retirement savings and two other emergency savings accounts (one for emergencies and one designated for 6 months or a year's worth of living expenses if you lose your job or whatever). If you run into an emergency situation, well then you have the funds you need right there in your non-government controlled savings. That's what it's there for.

Any financial plan that focuses on retirement planning as separate from other aspects of financial planning is guilty of something called compartmentalization. Compartmentalization is when you divide up an idea (in this case, your financial plan) into "compartments." Each compartment is treated as a separate problem. That's why financial advisers tell you that you need a retirement savings, then a 529 college savings fund designated solely for educational purposes, an emergency savings in case your water heater blows up. An emergency savings in case you lose your job, An insurance plan in case you die prior to saving enough money for retirement (and/or enough money to pay off your financial obligations).

The reality is that retirement planning is part of a larger financial planning picture, and even then it's a much, much smaller component of financial planning than the entire industry thinks it is. You get to retire when you have enough savings to live on (if you ever get to that point) and only if you decide that you'd rather not work anymore.

But, if you've done a good job defining your central purpose in life (the productive purpose which defines you as a person and which motivates you and brings you happiness) then you'll likely find that retiring from productive work is unappealing at best. Sure you might want to slow down a bit in your old age. You might want to volunteer your time more than you did when you were younger. But, a central purpose would be so important to you that you'd never give it up entirely or even put it on the back burner.

I guess you can see by now that I adopt an integrated view of financial planning. I don't see "retirement planning" as an end goal which is separate from "life insurance planning", "savings and investment planning", "estate planning", "budget planning", or "college and career planning". Yet, this is exactly what government-created retirement plans attempt to accomplish--a compartmentalization of financial goals.

I think, if you are pursuing your rational best interest, you will want to reconsider using retirement accounts and consider an integrated approach to financial planning.

This post is part of a series on retirement plans. Want to read more? Here's the rest in the series:

Arbitrary Retirement Plan Rules, Part 1: 401k Plans

Arbitrary Retirement Plan Rules, Part 2: IRAs

Arbitrary Retirement Plan Rules, Part 3: Annuities

Arbitrary Retirement Plan Rules, Part 4: Employer Pension Plans

Arbitrary Retirement Plan Rules, Part 5: A Solution