are traditional IRAs and 401k/403k plans the future financial disasters?

[friendly_jacek]

I guess everyone on this board agrees that inflation will be very painful and U$D will lose its value in the next decade or so.

Even if the funds in IRA and other tax-deferred accounts just keep up with inflation, this will generate a tremendous nominal return. This nominal gain will be taxed at unknown (but likely high) future income tax rate even if there is no real return on the investment.

To me, it sounds like the present nominal tax saving is not worth the risk of future income taxation on the fake gains. On the other hand, the present low, 15% tax rate on stock revenue will not last forever either, so that will erode non-tax deferred accounts to some extend as well.

Roth conversion is a consideration but only for some with AGI lower than 100,000 if I understand correctly. Hell, maybe the 10% penalty on early IRA withdrawal is a good deal while it lasts?

[c1ue]

Re: are traditional IRAs and 401k/403k plans the future financial disasters?

FJ,

The primary benefit of tax free retirement accounts is the ability to avoid taxation before withdrawal - or more specifically that gains are not taxed at all until withdrawal.

Even with inflation - this benefit does not go away.

There are only 2 ways these retirement accounts are worse than any other 'bin' holding securities:

1) If the accounts limit you from exercising your desired inflation protection strategy due to inability to hold funds in foreign currencies, trade options, or other equity exercises due to the accounts themselves

2) Limits on how much you can deploy (or more specifically, losses are much more difficult to make up via asset rebalancing)

Ultimately you should look at the accounts you have, along with your strategy, to see if limitation 1) is a factor.

Limitation 2) is just something you have to live with.

That's the great thing about inflation and/or currency depreciation: no matter where your money/dollars are, the purchasing power per unit will decline equally.

[friendly_jacek]

Re: are traditional IRAs and 401k/403k plans the future financial disasters?

That's the great thing about inflation and/or currency depreciation: no matter where your money/dollars are, the purchasing power per unit will decline equally.

I'm not sure I agree.

Example:
Scenario#1. i invest $100,000 now in US equity (with little dividends) in tax-deferred account and lets say my investment just tracks inflation but balloons to $1,000,000 due to rampant inflation in the next 10-20 years. I collect my retirement and pay income tax on $900,000 fake return, basically giving away a big share of my inflation protected $100,000 stash in state and federal income taxes of unknown level but likely higher than the present (50% or more I'm afraid).

Scenario#2. i invest $100,000 now in US equity (with little dividends) in taxable account and lets say my investment just tracks inflation but balloons to $1,000,000 due to rampant inflation in the next 10-20 years. I sell the stock and pay only the capital gain tax (hopefully close to the todays 15%) on the $900,000 fake return, basically preserving most of my stash.

Scenario#3. I invest in gold and I pay the 28% gold tax. Probably better off compared to #1.

Scenario#4. There is no capital gains tax in Switzerland. You get the picture.

[friendly_jacek]

Re: are traditional IRAs and 401k/403k plans the future financial disasters?

Finally, I found someone who agrees, at least in part:

"The fund business spends millions of dollars lobbying for tax-deferred investment programs, which give them inflated assets on which to charge management fees. Tax-deferral is not for the benefit of the shareholder; they will pay taxes on withdrawals at higher rates than if they paid them now, at least on the profits which might qualify for preferred long-term capital gains treatment."

From http://www.marketwatch.com/news/stor...D&siteid=yhoof

[c1ue]

Re: are traditional IRAs and 401k/403k plans the future financial disasters?

I'm not sure I agree.

FJ,

Rather than suck up a big capital loss right away with taxes, you're better off trying to find a way to invest in your desired security within your existing tax-free retirement account.

Some ways:

1) part time job with some institution that has self-directed brokerage accounts as an option in their retirement packages

2) lobbying for appropriate funds to be available for your existing plan (although I personally HATE mutual funds)

3) lobbying for your existing plan to add a self-directed option

There might be other ways out there - in general I would suggest exhausting all possible options before sucking up the early withdrawal hit.

If you've worked in a number of places before and still have money there - I'd even check to see if any of these plans have changed and added the option since then. You never know!

Note the loss would not just be the 10% penalty, you also get hit with income taxes.

The other thing that I like about the tax-free accounts is that you are much more flexible in being able to get in/out of investments - in the sense that you don't have to worry about cap gains or short term cap gains taxes. This way you can switch out if your investment conditions change earlier than anticipated.

This was very nice when I bought GLD and sold GLD within a 30 day span - I would not have done that with a straight account since my projected return after factoring taxes would not have been worth the risk.

[dbarberic]

Re: are traditional IRAs and 401k/403k plans the future financial disasters?

This leads me to a side question.

My 401K investment options limit me to primarly US focused funds (by cap size) and one international: American Funds Euro Pacific.

I've reallocated current investment and future investments to about 75-80% foreign and the rest US, however I keep reading that one should be in foreign stocks, bought in foreign currency, and paid dividends in foreign currency. However the 401K demoninates everything in USD$. Is that really a big deal since the foreign fund own foreign stocks and and dividends recevied will be used to repurchase shares of foreign stocks? Am I at risk here when compared to actually buying the stocks directly myself on the foreign exchange using an account denominated in foreign currency?

[dbarberic]

Re: are traditional IRAs and 401k/403k plans the future financial disasters?

Re 401K/401B/403Ks:

Jim Puplava as mentioned several times on his weekly show that he seems to think that when things get really bad that the US government will pass legislation requiring the different retirement accounts to purchase zero coupon Federal government bonds as a way for the Federal government to get its hands on the retirement assets to bail itself out.

[Guest]

Re: are traditional IRAs and 401k/403k plans the future financial disasters?

Yaaaawwwwwnnnnn !

[ Postscript: OK Sorry guys. Did not mean to be discourteous. 401K discussions about the intricacies of one's retirement plans just put me to sleep like a lead pipe over the head, and I'm probably closer to retirement than all of you!

If I was stuck on a desert island with someone that wanted to discuss 401K's I think I'd swim out to sea! Must be something wrong with me! ]

[c1ue]

Re: are traditional IRAs and 401k/403k plans the future financial disasters?

I've reallocated current investment and future investments to about 75-80% foreign and the rest US, however I keep reading that one should be in foreign stocks, bought in foreign currency, and paid dividends in foreign currency. However the 401K demoninates everything in USD$. Is that really a big deal since the foreign fund own foreign stocks and and dividends recevied will be used to repurchase shares of foreign stocks? Am I at risk here when compared to actually buying the stocks directly myself on the foreign exchange using an account denominated in foreign currency?

Theoretically any foreign investment mutual fund should give you the full benefit of a foreign currency strengthening vs. the dollar.

However, you first have to get through the mutual fund management: what stocks/bonds/whatever are actually owned by the fund? What's the expense ratio? What's the turnover ratio? What are the top 10 holdings?

I hate mutual funds because the 'direction' of the fund is actually only a guideline. Even looking at the top 10 doesn't help because most funds' top tens only constitute 10% of total NAV.

So it boils down to whether you trust the manager and whether the historical performance is reliable.

Ugh.

[dbarberic]

Re: are traditional IRAs and 401k/403k plans the future financial disasters?

Theoretically any foreign investment mutual fund should give you the full benefit of a foreign currency strengthening vs. the dollar.

However, you first have to get through the mutual fund management: what stocks/bonds/whatever are actually owned by the fund? What's the expense ratio? What's the turnover ratio? What are the top 10 holdings?

I hate mutual funds because the 'direction' of the fund is actually only a guideline. Even looking at the top 10 doesn't help because most funds' top tens only constitute 10% of total NAV.

So it boils down to whether you trust the manager and whether the historical performance is reliable.

Ugh.

Well given the limited 401K selections, it is "the best of the worst options".

[quigleydoor]

Re: are traditional IRAs and 401k/403k plans the future financial disasters?

Theoretically any foreign investment mutual fund should give you the full benefit of a foreign currency strengthening vs. the dollar.

However, you first have to get through the mutual fund management: what stocks/bonds/whatever are actually owned by the fund? What's the expense ratio? What's the turnover ratio? What are the top 10 holdings?

You also have to read the prospectus carefully and figure out if the fund employs currency hedging. Most international equity funds are quite vague about how they manage FX exposure.

[Andreuccio]

Re: are traditional IRAs and 401k/403k plans the future financial disasters?

I'm not sure I agree.

Example:
Scenario#1. i invest $100,000 now in US equity (with little dividends) in tax-deferred account and lets say my investment just tracks inflation but balloons to $1,000,000 due to rampant inflation in the next 10-20 years. I collect my retirement and pay income tax on $900,000 fake return, basically giving away a big share of my inflation protected $100,000 stash in state and federal income taxes of unknown level but likely higher than the present (50% or more I'm afraid).

Scenario#2. i invest $100,000 now in US equity (with little dividends) in taxable account and lets say my investment just tracks inflation but balloons to $1,000,000 due to rampant inflation in the next 10-20 years. I sell the stock and pay only the capital gain tax (hopefully close to the todays 15%) on the $900,000 fake return, basically preserving most of my stash.

Scenario#3. I invest in gold and I pay the 28% gold tax. Probably better off compared to #1.

Scenario#4. There is no capital gains tax in Switzerland. You get the picture.

Jacek, you're not crediting the tax deferred accounts properly in your example, which skews your results in favor of the taxable accounts.

There are two types of tax deferred accounts that I'm familiar with. The first are those like 403b's, and, I assume, 401k's, where the money invested is not taxed. Investments accrue tax free, and upon withdrawal everything is taxed.

Let's say we use this type of tax deferred account in your first scenario. If we credit $100,000 to this type of account, then the accounts in the three other scenarios should only be credited with the equivalent amount after taxes. If you're in the combined 35% state and fed, that would be $65,000.

I ran one scenario to get you're result of $1,000,000 in about 20 years: 12% returns for 21 years. The $100,000 yields about $1,080,000, while $65,000 yields $702,000. If the $1,080,000 is now taxed at 35%, you'll get $702,000, with your taxes paid.

The $702,000 in your taxable account, however, hasn't yet been taxed. $637,000 of it (702 minus your original 65) will be taxed, using your example, at 15%, which costs you $95,550, leaving you with $605,450 total.

The other type of tax deferred account I'm familiar with is the Roth IRA. Here, your initial investment is post-tax, so we would only have $65,000 to invest. This would, again, grow to $702,000. The benefit of the Roth, however, is that all money can be withdrawn tax free. Thus, with the Roth, it doesn't matter if inflation pushes you into a higher bracket, or if they raise the tax rate on ordinary income to 95% to pay for Bush's Folly in Afghanistan/Iraq/Iran, or whatever, that $702,000 is your's to keep.

I think your best bet is to invest in Gold within a Roth, and vacation in Switzerland. Or better yet, Northern Italy. :cool:

(Actually, my preference is to have all three types of accounts going: 403b, Roth, and taxable. There are advantages to each.)

[friendly_jacek]

Re: are traditional IRAs and 401k/403k plans the future financial disasters?

Andreuccio,
I also have all three types of accounts going, but I'm afraid that the tax deffered ones are going to be a gold mine for government with the accelerated inflation on the horizon.

Thanks for running the numbers. You used the current (relatively low) rates of income taxes. I'm afraid the rates will increase and likely double (at least) in the future. With the 70% rate, the IRA/401K/403b accounts will only yield 300,000 or so.

I'm too young to remember but here is the history (from Wiki):

• In 1913 the tax rate was 1% on taxable net income above $3,000 ($4,000 for married couples), less deductions and exemptions. It rose to a rate of 7% on incomes above $500,000.
• During World War I the top rate rose to 77%; after the war, the top rate was scaled down to a low of 25%.
• During the Great Depression and World War II, the top income tax rate rose again. In the Internal Revenue Code of 1939, the top rate was 75%. The top rate reached 94% during the war and remained at 91% until 1964.
• In 1964 the top rate was decreased to 70% (1964 Revenue Act), then to 50% in 1981 (Economic Recovery Tax Act or ERTA).
• The Tax Reform Act of 1986 reduced the top rate to 28%, at the same time raising the bottom rate from 11% to 15% (in fact 15% and 28% became the only two tax brackets).
• During the 1990s the top rate rose again, standing at 39.6% by the end of the decade.
• The top rate was cut to 35% and the bottom rate was cut to 10% by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA).

[Andreuccio]

Re: are traditional IRAs and 401k/403k plans the future financial disasters?

Andreuccio,
I also have all three types of accounts going, but I'm afraid that the tax deffered ones are going to be a gold mine for government with the accelerated inflation on the horizon.

Agreed. But that's what makes the Roth IRA so attractive. Unless they change the rules mid-stream, which I guess we can't rule out, the money in a Roth is post-tax, and thus won't be taxed again upon withdrawal.

There's no way to know what taxes will be in the future. But, as an example, in the scenario I ran above, with capital gains at 15%, combined state and fed taxes would have to exceed 56% for the taxable account to beat the 403/401k. (605,450/1,080,000=.56) As your brief history shows, that's happened before, but it's not always the case.

[brucec039]

Re: are traditional IRAs and 401k/403k plans the future financial disasters?

Finally, I found someone who agrees, at least in part:

"The fund business spends millions of dollars lobbying for tax-deferred investment programs, which give them inflated assets on which to charge management fees. Tax-deferral is not for the benefit of the shareholder; they will pay taxes on withdrawals at higher rates than if they paid them now, at least on the profits which might qualify for preferred long-term capital gains treatment."

From http://www.marketwatch.com/news/stor...D&siteid=yhoof

Is it generally considered for some reason I'm unaware of that at retirement time when withdrawn the funds will always be taxed at a higher rate than today? I'm sure at least some people retire on less than they make now, not more.

In our example, we are in the 25% marginal bracket, so the money that goes into 401k and IRAs saves us that much off our tax bill.

But we intend on retiring somewhat early, having our home paid for, brand new cars purchased right before retirement, and our lifestyle now (two homes in two states for business needs) requires so much more than we can certainly live on a much lower income than today. (Going from one large and one small home to one small one in a rural area) We would need to withdraw so little to live on each year that our marginal income tax rate then would be (if not raised) just 15%. Wouldn't that be better for us than a Roth or no tax-deferred account at all? (I am able to buy gold ETF's and non-dollar denominated bond funds through the IRA)

All this math....makes Mongo's head hurt!