Retirement Rescinded – Part Two

In Part One of what is now starting to look more and more like a diatribe against tax-sheltered retirement plans, I discussed some of the problems that I believe are common to employer-sponsored, defined-benefit pensions plans as well as IRA and 401k plans.

Part of my issue with IRAs and 401k plans has to do with what I believe is a long-term bias that can turn into a disaster.

Of course these vehicles are a terrific way to reduce taxes during your earning years while allowing those funds to grow unmolested by taxes.  On the other hand there is no guarantee what the tax rate will be at the time of retirement when withdrawals begin.  So while there should be a net tax savings, that amount cannot be determined for certain prior to retirement.  Tax laws and rates change.

For young people these financial instruments are great.  And a market crash correction is a blessing for those in their 20s and 30s as they get to load up their funds with stocks when they are cheap. And the longer stocks stay depressed, the better.

(It is highly improper any more to speak of a market “crash.”  These declines are now just “corrections.”)

The situation folks approaching age 60 and beyond face is a very different one from those just beginning their careers.  A market that drops 40% the year you retire followed by ten years of moribund growth can be a disaster as your time horizon is very different from the 30 year-old.

And here’s my gripe.  Due to the regulations governing IRA and 401k accounts, there is a limited set of strategies individuals can employ to hedge against a major correction.  And a hedge is something that could be wise as people near or enter retirement.  Should that crash correction happen — and they do, you know — things could get unpleasant really fast.

I keep saying it — people forget how risky common stocks can be.  If you’re a retiree or hope to be one in the next 10 years, look yourself in the mirror and answer these questions:

  • Do I have a plan in place to reconfigure my portfolio, whether tax-sheltered or otherwise, to preserve my wealth in the event of a 40% to 50% market crash correction from which the overall markets will not recover for 10 years?
  • Will I be able to time the implementation of this strategy so I miss most of the draw-down from the crash correction?
  • Or will I do what many do — sit there and hope things turn around?
  • Or will I wind up selling at the bottom in desperation to preserve what’s left?  This is too often what happens.

Maybe you have so much money that a 50% haircut doesn’t matter to you.

Remember that bonds are not immune to market moves.  And the interest US treasuries earn doesn’t even keep up with inflation – if you use honest inflation figures.

I’m very worried.  But maybe that’s just my nature.

My point is simple — the long-term bias that served the IRA and 401k investors so well for decades might turn around and bite them just when they need those funds.

Being in a tax-sheltered fund limits the options to “tail-hedge,” or otherwise take specific actions to keep from being road-kill when the next crash correction arrives.  There are tail-hedging strategies that involve derivative plays and other vehicles that simply cannot be employed in a tax-sheltered fund.

So in an effort to supposedly reduce the amount of risk permitted in your IRA, those making the rules might have instead actually prohibited you from reducing that risk.

I’ll get more specific on this in the next post in this series.

As always, thanks for reading.

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