Don't Drain Your 401K For A Pension Payment

Pension to 401K

The traditional concept of pension, where companies provide a monthly cash flow for employees post-working until they die, is pretty much a dead proposition in American society today as the 401K has become that vehicle for companies to assist their employees to save for retirement or life after work.  If, as employees, we shun the opportunity to use this vehicle without an adequate alternative, it is to our own detriment.  So the possibility of a person getting money until they die, which a pension offered, is no longer on the table.  It is now the 401K, but should we treat our 401K like the distribution feature of a pension which provides that monthly cash flow?   

Silence on 401K Distributions

One of the primary objective of the 401K vehicle is to allow for tax deferred accumulation of a nest egg of securities (stocks and bonds), with or without company match, and though we face unmitigated risks with little or no protection to the downside in building that nest egg, whatever success we have is majority ours and partly Uncle Sam's.  I guess we that invest in 401K, especially when there is a dollar for dollar match is hard to turn down, understand those risks and even if we don't those are the risks assumed.  However, through Google search results, I have my doubts about education concerning how exactly should recipients take 401K distributions, other than 4% rule, it is not largely discussed.

I will broach the topic here and give suggestions towards the end.  Although you have many years to go before you retire, I'm 40 years old now, so for me, I'm 19-1/2 years away from when I can potentially take distributions from my 401K, so I want you to at least hear the question raised and it be on your mind so that it can be planned for.   

The Ideal

Though Fidelity reports that the average American's 401K balance is $92,500, let's live in fantasy for a moment and say you have been the person who has faithfully stocked away 6% - 18% of your income into your 401K so that one day you can retire and your portfolio has grown to $1.2 million over the years.  You should be able to retire off that and live into old age, right?   I'm about 90% sure I could.  If you aren't yet 59-1/2, you cannot start taking that money without penalty. Although you have done a fabulous job accumulating that nest egg, now comes the distribution phase, which I don't see being discussed, how should we manage the distribution we need to take from our 401K.  Maybe I'm just not in the know, but neither is Google for that matter then, and I don't personally have a financial advisor, but I consider this be a tragic moment if the philosophy is now to merely spend it all down in order to live and continue to pay for the expenses of life and hope we don't outlive our money.  The traditional pension used to provide a monthly cash flow, now we must do that for ourselves, and in order to free up cash, what I understand a distribution to be is a need to liquidate a portion of the portfolio of stocks and bonds that you have built up over a period of time, some through the terms of RMD (Required Minimum Distribution) at 70, and some forced by need to still pay for living expenses.

Let's Value Our Wealth Like Buffet

Is that what Warren Buffet does?  His philosophy when buying a stock is to have a holding period forever!  I think we can learn a thing or two from one of the greatest investors in history.  Though we must take distributions at some point, why should we relinquish our wealth gained through sacrifice and risk in the stock market in order to merely pay for cost of living expenses because we are not working anymore.  I hope you are already thinking this and have a plan not to do this.  If not, get a plan, or this will be the biggest tragedy, next to, losing a great deal of wealth when selling your portfolio at a downturn and locking in loss.  

If you have a financial advisor and this has not been discussed, then plan to have this discussion and  if his/her philosophy is spend it all down by taking no more than 4% at a time, you need to find a different financial advisor that has a great grasp on this problem and solutions and will not give you the aforementioned answer, because in my opinion that is the wrong answer.  The distribution part of the plan is just as crucial as the accumulation and if this isn't clear, you might not continue to live how you are accustomed nor leave the type of wealth and legacy commensurate of your hard work to your family. 

At age 70, if you have a non-Roth 401K, you are required to take RMD, or face 50% penalty by the government.  So again, Uncle Sam, your partner, will not let that money go tax deferred into infinity, he wants his cut.  At 70 is the age, if you have not taken any distributions that you will be required to.  If you have waited until 70 before taking, that is indication to me that you were a little wiser than the rest, if from 59 - 70, your wealth is potentially still growing in the stock market and you have other cash flow to pay for your living expenses.  But for those of us that were planning to take distributions right at 59-1/2, if you plan doesn't involve liquidation and purchase of income streams or repurchase of securities that can provide income stream, you are ruining the wealth you have worked so hard to achieve.  

Wealth Disparity

If you happen to follow this liquidation and spend path and die just before you are broke, then you would have left your loved ones nothing and they would have to start from zero.  This mentality may potentially explain some of the disparity in wealth between whites and blacks/latinos.  I am African American, and though this blog is written for all working class Americans, I especially hope it resonates with Black/Latino Americans because if you view two of the articles below, you can see this disparity, despite even education, is staggering.  So if we are among those who have done great by the 401K, don't just give back the wealth that was once accumulated.

• Blacks still far behind whites in wealth and income
• The Racial Wealth Gap: Why A Typical White Household Has 16 Times The Wealth Of A Black One

401K Distribution Solutions

Here are some proposed solutions I have to use distributions from our 401K that you and possibly your advisor should be thinking about.  Using 4% on $1,000,000 example is $40,000 annually of which this calculator will show how much is net after taxes by state.  In Texas, the net is $32,946 ($2745 per month (32946/12)).  The example of cash flow, in each bullet point, is that which could be generated if a single distribution is made for $40,000 of which $32,946 is the net.  You could take larger distributions at one time in order to achieve the overall net income you need to achieve 4% on $1,000,000.

• Using a distribution(s) to develop positions in options trades using particularly covered call and secured puts for income generation - $600 - $1200 per month
• Using a distribution(s) to purchase positive cash flowing real estate - distribution serves as down-payment on a $160,000 property with net cash flow of $400
• Using a distribution(s) to become a private lender earning an interest by lending on that money for monthly cash flow - $329 per month if lent at 12%
• Using  a distribution(s) to repurchase securities that have a considerable and reliable dividend or interest payment - depends on the stock/bond, $400 - $800 per quarter
• Using  a distribution(s) to purchase an immediate annuity (this option should be used sparely as it does not leave asset like before mentioned items) - approximately $326 - $602 per month.  See Annuity calculator

I hope you have been reading my blog as I will stress it is imperative that you get a financial education early in these areas I mentioned above, even if you need to put up a little money to do so because you can possibly preserve all that wealth by doing so.

Conclusion

Now that the pension is a dying proposition,  we will be responsible for our own cash flow post-working, but the pension seemed to be black box that just gives money and we don't have to think about how that is generated.  Now, we know what's in the box and it's securities that we accumulated over time that is our wealth.  I suggested above that we don't just take that wealth and spend it down, but instead, use techniques that generate the cash flow necessary for paying for living expenses, but preserve our wealth.  This is what should be in the conversation as well and maybe this can serve as first in starting the discussion.

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