Hiding in Plain Sight

Buried in the news at the end of August was an executive order by President Trump to the US Treasury and US Labor Departments to restudy Required Minimum Distributions (RMDs) from retirement accounts. These distributions now start at age 70 from IRAs, 401ks, and tax-sheltered savings plans (with certain limited exceptions).

The US Government’s real reason for RMDs is that the contributions to these accounts were made before taxes (i.e., tax deduction) resulting in lower taxes for the contributor – and less tax revenue for the US Government. The US Government, in theory, wants that tax revenue back during the account holder’s life time and thus requires these taxable distributions. If the account balance passes to a human beneficiary due to the passing of the account holder, then the funds, in theory, may be distributed over the beneficiary’s life time and the US Government is left waiting even longer for its taxes (aka a “stretch IRA”).

The last time the IRS life expectancy tables were updated was in April 2002, according to the Treasury Department. Since then, Americans have been living longer, with the average life expectancy rising to about 78½ years from under 77 in 2002, according to data from the Federal Reserve Bank of St. Louis.

So the age to start taking RMDs may be moved back particularly for people who are still working and/or more likely, the amount of the annual RMD may be reduced. This allows more of the account balance to continue to grow.

The executive order also asked the Treasury Department to look at allowing more multi-employer 401k arrangements. This is important for smaller businesses where the paperwork and contribution limitations calculations can be overwhelming. Retirement plans are subject to ERISA (Employee Retirement Income Security Act of 1974), which was a federal law that set minimum standards for most voluntarily established pension and health plans in private industry to provide protection for individuals in these plans. The ERISA law resulted from several Congressional investigations into the wholesale looting and rampant self-dealing of retirement plans generally by union managements. A second consideration in ERISA was Congress’ concern that support and contributions for 401k plans would only come from higher compensated people in a company and little effort would be made to get lower paid individuals enrolled into such plans.

The net result was that small to medium sized businesses have generally had to forgo the 401k plan benefit due to government regulations that may no longer be as appropriate as they once were. (403b plans are the non-profit world’s version of the 401k plan.) As the Baby Boomers retire, the whole issue of retirement savings by younger people has received much more visibility in recent years and the government’s regulatory restrictions in this area have become more obvious and counter-productive.

Allowing people to save more sooner is part of the battle. Allowing people to keep their savings longer is another part of the battle. The real battle is to make people understand that saving something sooner rather than later has huge benefits.

Each semester I show my students the Rule of 72. The Rule of 72 says that if you divide 72 by the rate of return on your investment, the result will be approximately the number of years it will take for that investment to double. If my students are about age 20 and they retire when they are about age 70, then they have a 50 year working life. If they earn 5% per year on money they start saving now, then that investment will double about every 14.4 years (=72/5). In 50 years, that is between 3 and 4 doubles.

That means $1,000 saved today will double as follows:

Start: $1,000

1st double in 14.4 years: $2,000

2nd double in another 14.4 years: $4,000

3rd double in another 14.4 years: $8,000

4th double in another 14.4 years: $16,000

$1,000 set aside today will result in somewhere around $11,467 in 50 years. This explains why “the rich get richer” – they don’t just save, they invest for the future knowing the power of compound interest.

I went downstairs to ask Riley what she thought about the Rule of 72. Riley is my Golden Retriever dog that used to share my office. (My office is on the second floor. Riley can go upstairs but her diminished eyesight is causing her real problems going down the stairs.) I found Riley resting on the floor looking out our front door window. After explaining the Rule of 72 to Riley and showing her my example, I asked what she thought. She gave a low growl at a Jack Russell Terrier walking by on a leash held by a neighbor and then Riley turned to me and put one paw on top of the other. Exactly, Riley! Doubling is a great way to go.

As the popular TV commercial goes… “What’s in your wallet?”

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