As you think about that picture a little bit more, do you see yourself working as a greeter at Wal-Mart? Living with your kids because you ran out of money? Lying in a hospital bed and depending on government programs to decide the quality of your healthcare? I doubt it. If you’re like most Americans, you see retirement not as a time of hardship and stress but one of reward and new experiences.
Make no mistake. Which scene you end up living is a choice. It doesn’t happen by accident at all. It takes tremendous discipline to end up in either scene and you have more control than you can imagine on how it all turns out. So which scene are you preparing for? How are your daily decisions affecting the last chapters of your life story?
A mentor of mine once told me that solving big problems often requires outside-the-box thinking. Getting advice from people who are in the box with you doesn’t work because the instructions are outside the box. So on that note, let me start with a statement to get your attention focused: most of the things that you’ve been told about building financial security by your parents, your CPA, and your investment advisor are absolutely wrong, and I can prove it. Let me give you two examples that might sound familiar:
- Put away as much money as you can in programs like IRAs and 401(k)s to lower your taxes and save for retirement.
- Pay off your mortgage as quickly as you can for a secure retirement.
Both of those statements are common knowledge and accepted as truth by many investors and their advisors. The problem is that they both are absolutely incorrect. In fact, they are actually two of the reasons we are currently in the greatest financial crisis in American history with more than half of baby boomers not being able to ever retire according to AARP.
Let’s look at IRAs and 401(k)s and tax deferred programs of any kind; all of these programs are touted as saving you taxes but in reality they save you absolutely no taxes at all and in fact put you at risk of paying much more in taxes than other methods of retirement wealth accumulation. Let me prove it for you; when you fund an IRA or 401(k), you are simply postponing the taxes that are due on those earnings and any and all future growth of those earnings until a later date. The bet that you are making when you do that is that your tax rate will be lower in retirement. Here are a few problems with that in-the-box thinking:
- Currently we are in one of the lowest tax brackets in over 100 years of tax history. Given the financial condition of America post-great recession, the government will need to come up with some way to pay for all of the money they spent that they had to borrow. Higher taxes could certainly be a reality going forward.
- When you retire you lose most of your best deductions like mortgage interest, being able to use your kids as a deduction, and all of your business deductions. Although you might have less income, you may end up giving a larger percentage of what you make to the government than you did while working as a result. This problem is a reality even if tax rates never rise again for the rest of our lives (don’t bet on that one).
- All earnings in tax postponement strategies like IRAs and 401(k)s are taxed as ordinary income upon withdrawal and will not get any preferential treatment like long term capital gains. So even though almost all of your retirement money will likely be invested for longer than 12 months, you will pay the maximum rates (ordinary income) on all of the money.
Second, let’s look at paying off your mortgage as quickly as you can and look at the problems that creates:
- You lose your greatest tax deduction ever (your mortgage interest) by firing your best business partner ever, Uncle Sam. Thinks about that for a second! For all of those years that you had a mortgage, the government was subsidizing your housing costs by giving you money towards your mortgage payment in the form of a tax deduction on your mortgage (hopefully, some light bulbs are popping for you right about now).
- If you choose to pay down your mortgage quicker by making extra payments or taking a 15-year loan, and you need access to the money in an emergency like unemployment, disability or bankruptcy, your bank–the one you had a perfect payment record with and made extra principle payments to–will deny you a line of credit 100% of the time under those circumstances.
- If you are forced to sell your home, a house with a large mortgage will sell quicker and for more money than one with little or no mortgage. Here’s why: the buyer realizes that after the seller pays off their debt they will not be making a “killing” or might even be upside down and taking a loss. Compare that to buying a house where there is little or no mortgage. Buyers are much more likely to low-ball this home because they know the seller will pocket most of the cash and “can afford” to take a bit less money.
- If you are ever forced into foreclosure, a house with a smaller mortgage will foreclose much faster than one with a big mortgage and especially one with negative equity. The truth is that banks will work with people who have little or no equity way more than someone who they can quickly foreclose and get back their money. When you have large mortgage with little or no equity, the bank would rather help you get back to being a paying customer than attempt to sell your house and chase you for the short fall or have to eat it themselves.
Now that I’ve blown your mind (hopefully), check in with me next week for the action steps you can take today to get out of the box and build your dream of financial security and independence for life regardless of what happens to taxes, the stock market or any other investments you can think of.
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Information presented in this blog post is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. Discussions and answers to questions do not involve the rendering of personalized investment advice, but are limited to the dissemination of general information and may not be suitable for all readers. A professional adviser should be consulted before implementing any of the strategies presented.
photo credit: Eliezer Borges via photopin cc