Welcome to this tutorial on the Qualified Plan Calculator inside the Truth Concepts Software.  What Todd will be going over below is how to use the calculator to show the whole truth around this arena.  Could be a 401k plan, an IRA, a SEP IRA, simple, the 403b, Profit Sharing Pension Plan, anything that falls under the government’s domain in the Qualified Plans.  This calculator will tell the whole truth about the money inside this plan.  You can view the visual tutorial by clicking on the Tutorials tab on title menu of the home page. 

We’ll look at the 401k and let’s say we have an individual who is 35 as our current age, and we’re going to look out to age 64 which is 30 years.  We’ll have a present value, this is going to be the money currently in the plan and let’s put $100,000 and let’s put an earnings rate of 8%.  So what we see is right off the bat we have account value that is going to grow to $1006,266 and the rate of return is the 8% that we put in there.  Let’s also put in an annual payment.  So I’m going to click on the payment block and I’m going to put in here $10,000 I could increase this if I want to but I’m just going to put in a level $10,000 per year from 35 to 64 and it didn’t change our rate of return but it did move our account value up to $2,229,724. 

Now, I would do this in the order I’m doing this right now and what I want to do is show the benefit of the Qualified Plan, the reason that this individual put it in there which typically is well I get some tax help from the federal government most people look at it as free additional dollars that go into the qualified plan in reality it is a tax deferral.  They also put money in there for the employer match that’s available and we’ll assume that this individual has both of those.  So I’ll click on the tax cost and deferral button and I would like to use the federal income tax so right down here in the I need to put in all of his other income.  The number that should go in here is his net taxable income after all of his deductions except for the deduction for the qualified plan.  So let’s assume that number for this person is $65,000 and what we see is nothing has occurred because I haven’t brought in the tax deferral so now I have to click on tax deferral and when I do it’s going to apply the deferral.  When we do we see the rate of return went to 8.5%.   We see that the value of that tax deferral was $489,290 and what that number represents is the tax deferral plus the growth off that tax deferral off this timeframe so total value of having the government “free” money. 

Now let’s also add the employer match I do that by clicking on employer match.  We could either put a level amount in here or put in a %.  I’m going to put in 50%.  The client typically only hears the 50% number even though most plans don’t match all of the contribution.  In this case, we’re going to assume that the plan documents say the person gets a 50% match but only up to the first $2,500 of their contribution.  So I’m going to put in under maximum match $2,500.  What we see is the ROR went from 8.5% up to 8.78% now we have an additional benefit which is $235,734 worth of net employer match which is the match compounded out over the timeframe.  At this point in this scenario this individual has $2,382,657 dollars in the account.

So now we need to start looking at the costs.  Where I would start is the management fee.  When we look at a management fee, we’re going to put a conservative one in here of 2.5% along the way $439,000 was taken out of the account by management fees bringing our account value down to $1,299,640.  This typically is the number that most people see that the value of account this would be the statement that they would have.  In reality the only way they get to that $1,299,640 is if they pay the tax on that.  So I’m going to add the tax cost in there just by clicking on tax cost. When I do you see if they liquidate the account at age 64 he would have to pay $439,000 in tax which would leave him with $860,000 this is really the number the client needs to have in his head as the value of this account even though the account statement is going to show the gross $1,299,000 he only really has $860,000.  We see that his ROR is 4.94%. 

Something I want to add to this if he makes the decision to contribute to his qualified plan and he doesn’t have money for permanent life insurance then that means in order to protect his family he’s going to have to purchase term insurance.  So I want to add that as a cost in order to make this decision.  Here I’ll click on term insurance which will open up the input box on far right I’ll put in $850 term premium I’ll put in for this 30 year plan.  I could go in and put in a different amount for each year or copy them from an illustration.  Also in this input box we can adjust our payment in any year into the qualified plan, we could have a withdrawal stream we could change in any year what that withdrawal was, we could also change the earnings rate in any year.  We could paste the market history in here, there’s all kinds of things we could do with this input box.  In order to open up or close this box term insurance box or at the top we have a picture of a spreadsheet button which will also open that up. 

What’s happened is since we added a term premium as a cost it dropped our ROR to 4.63%.  We couldn’t take our term premiums out of our qualified plan so term premiums are going to come from income or other assets.  In order to find out what the real impact is to our other assets what we’ll do is add a cost of money.   So I’m going to put in 5% COM.  And all that does is show the cost of carrying this term insurance really is $59,297.  It didn’t change our ROR.  The argument we hear is they would never take this money out in one lump sum they’re going to stretch it out over time and that’s probably true so let’s see how that affects our ROR in this arena.  What I’m going to do is change my projected age to 85.  I want to make sure I stop my payment though at age 64.  We’re going to stop contributions at age 64, we’re just going to look at the scenario out to age 85.  If he didn’t take any withdrawals, which we know he cannot really do, this account would continue to grow and would have $3.8 million dollars in at that point.  By law he would have to start taking money out at age 70 and a half currently and that may change but if we look at this and assume he is going to pull money out at age 65 starting, click on withdrawal button I can put in a flat amount to pull out or I could have the computer calculate how much to pull out.  I click on Auto and it’s going to calculate that $98,283 to come out each year and totally liquidate the account at the end of this timeframe which is 85.  The ROR is 5.15%.  Before it was 4.65%.  There’s not a big difference if he takes it out all at once or if he stretches it out.  The impact from taxes and all other costs are still the same. 

This block on far right column of numbers it keeps track of our money that we’ve actually earned in the account and what percentage.  This breakdown is that 20% of money that we spent was our own money.  That was our contribution and it was only our contribution, we put in $10,000 a year but part of that was a tax deferral so we didn’t really put in the whole $10,000.  It only puts our portion of the contribution into the plan. 55% was the net earnings on our contribution.  16% is both the tax deferral and growth on the tax deferral by the end of the timeframe.  9% is the free and clear match and the growth on that employer match.  So this is the breakdown of dollars we either spent or ended up with in the account.  We see a 5.15 ROR. 

That is really helpful, what we’ve got is a picture of the qualified plan, the whole truth whatever the client has in there already, the ROR, the variables that can be put in place with the market and the term insurance and it graphically presents it and makes it really clear the whole truth about qualified plans.  Thanks Todd!

Bold italics are the client’s answers

 

I’m glad we get some time together today.  We are going to be using software to numerically prove the truth about how money works as it grows and to discover the most efficient way to get your money to work as hard as it can.  Before we begin I have a few questions.

 

If we were meeting here 3 years from today, what has to have happened for you to feel pleased with your progress?

 

I’d like to have my money working harder for me, feel like I have financial options

 

Ok, what is the biggest danger for you now?

 

The loss of my 401k value, don’t know where to invest

 

I understand, what is your best opportunity right now?

 

My business is decent, and  I enjoy my work,

 

That is great and something to be grateful about for sure!  Are you conceptual or analytical?

 

Both actually…I know that’s an  unusual combo but its helpful

 

So, what do you think builds more wealth, increasing the rate of return

or decreasing the costs to build that wealth?

 

increasing the rate of return …that’s what I’ve always been told by the media and my other financial advisors

 

Response: well let’s take a look, I’ll pull up a Maximum Potential Calculator and we’ll figure it out.  This is from a suite of calculators known as Truth Concepts.  It enables us to be very transparent in our work with you by showing the gains as well as the costs.  You can actually buy the software yourself if you so choose at www.truthconcepts.com .

We use it to analyze all sorts of things about your finances as you can see here on this list of calculators, but for now lets look at the issue of returns versus costs.  

MAXIMUM POTENTIAL CALCULATOR:

We’ll look at a Period of 35 years and you said your Income as $100,000.  It should Increase at least 4% a year if not more and for starters we’ll set an after tax Earnings rate of 5%.  You can see on the right hand side that if you didn’t have to eat or pay taxes or spend money in any way, your Maximum Potential would be 16 million. 

 

Now, watch what happens as we add Truth to the situation.  Right here in the middle we have Total Taxes at 40%, that’s everything, fed/state/sale tax/property tax you name it.  Notice how 2.9 million of taxes dropped the savings down to 9.8 million.  That is opportunity cost in action which we’ll talk about in a few minutes.  For now lets stay focused on this issue of increasing returns or decreasing costs being the better way to build wealth. 

 

So, we’ll set Debt Service at 34% as statistics show the average American family spends about 34% of their income in debt service.  Now were down to 4.2 million.  And we’ll set Life Style at 23%.  Ouch, now we’re down to 494,000.  Lets change Other to Gifts at just 1% and here in the middle we have what most people are doing, which is saving 2% of their income.  Now I see you are saving more like 10 or 15% and I commend you for that! But if this picture were true, there would be 329,000 and you can see that is not even one years worth of income  (which is 379,000)  So, on the right we’ll stay focused on that 329,000 figure. 

 

 Again, lets stay focused on our question here:  Can we build wealth more effectively by changing the 5% net annual earnings rate on the left or by decreasing costs in the middle?

Again, right now I’m not including inflation to keep this simple.  On the left hand side, lets try changing our 5% to say 10%.  I know it might mean increasing risk, but lets try it.  Before I do, you watch the 329,000 on the far right.  Going from 5 to 10% did what?   Brought it up to only 885,000. That’s horrible! At least it’s two years of income, but that won’t cut it.

 

You are right, so lets go back to 5%.  What if we reduced costs.  Now when I say that, are you thinking I’m going to ask you to eat out less?

YES!   

Well, lets see if we can find ways to reduce costs that don’t reduce lifestyle.  What if we shifted our assets around a bit and were able to reduce taxes to 35%?  What did that do? 

It changed 329 to 1.1!

And what if we reduced debt down to 24%? 

IT MORE THAN DOUBLED! 

Yes and look how much we are saving? 17%.  So reducing costs which allowed us to save more, enabled us to build wealth much more effectively than increasing returns.

This is a good example of that first Prosperity Principle we spoke of last meeting.  We called it THINK and reminded you that prosperity thinking is often opposite of what most people do in the economic world.  Here most people think chasing high returns is the way to wealth.  Now you know that reducing costs is the way.  And you are clear that  its not lifestyle costs we are wanting to reduce, but taxes and debt costs.  Reducing taxes and debt costs which enables us to increase savings will build wealth more effectively.

Next question for you:  Do you remember the third Prosperity Principle of MEASURE as it is related to opportunity costs? 

Ahh, NO

 That’s not surprising, again, its because most people (including the media and most financial advisors) never take opportunity costs into consideration when making economic decisions.  Lets take a look at how people buy cars.  We’ll pull up this Automobile Calculator that shows the true cost of paying cash.  What do you think of the statement that you finance everything you buy?

 

I’m not sure I understand it.

 

I didn’t used to either.  So let’s figure out if it’s true.  If you finance everything you buy, then you either pay someone else interest or you give up interest you could have earned.

A good friend of mine says you pay up or you pass up.   Let’s take a look

 

AUTOMOBILE PURCHASES…THE TRUE COST OF PAYING CASH.

 I’m going to say you had an account with $200,000 in it that you designated your “car buying account” and it was earning a net 5%.  We’ll look at a 20 year time frame and say you bought a car every 4 years for $30,000.  No increases or sales tax yet, we’ll keep it simple.  Over on the right, your account of 250,000 would have grown to $530,000 if you hadn’t bought any cars.  And we know that 5 cars at 30,000 each would be $150,000.  Yet you can see on the right the account is not 530,000, its 250,000.  That is a $279,000 difference.  Why did $150,000 worth of cars cost you $279,000? 

  I’m not sure

Ok, lets work through it.  Going back to the statement “you pay up or you pass up interest”  in this case, didn’t you pass up interest, the 5% that the account was earning, on the $150,000 you took out of it to buy the cars.  Over that 20 year period of time, that $150,000 could have turned into $279,000.  That is opportunity cost.  We must measure it so we know what we are dealing with and then we can do something about it.

 ? So now, tell me what is your least favorite money spot right now? Your 401k,  your mortgage, your life insurance, your stock account, anything?  Lets take a look at what is really going on there.   What is working about that investment? What is not working about that investment?

 

 OR ? So now, tell me, is there an economic decision you are getting ready to make?  Let’s take it through a calculator so you have the whole truth about the matter.

The Truth Concepts Qualified Plan calculator gives a graphic overview of the whole truth about qualified plans.  It shows clients why not maxing out their qualified plan may be the best strategy.

In this calculator the Rate of Return box on top right toggles On and Off.

Definition of “Additional Income” is “net after taxes but before qualified plan deduction”.  For example, if someone is earning $150,000 they have $30,000 of mortgage interest deductions and $10,000 of charitable deductions, then Additional Income is $110,000 for the Qualified Plan Calculator and if they are putting $15,000 into their QP, then Additional Income is $95,000 for Accumulation and Distribution Calculator.