Filbrandt Reports

Retiring in the Next 10 Years? Beware the "Six Traps"

Volume 17, Issue 7

Executive Summary:

Filbrandt & Company has identified 6 critical mistakes university professionals make with their retirement planning. We call them the “Six Traps:”

  • Trap #1: Loss of benefits
  • Trap #2: Lack of tax balance
  • Trap #3: Lack of cash
  • Trap #4: Loss of control
  • Trap #5: Unintended risk
  • Trap #6: The rollover

We've Identified Six Big Retirement-Related Mistakes Professors Often Make

Through our decades of providing financial advisory services to university professionals, we’ve identified six big retirement-related mistakes that professors often make. If you make the mistakes while you're employed, you have a safety net of a salary and the university behind you. If you make the mistakes after you are retired, they can be very costly.

This report reveals what we call the “Six Traps.” Reviewing these traps will help you avoid negative impacts on your retirement plan.

To achieve financial success in your retirement years that may be quickly approaching, view the transition in a totally different way than you have ever imagined before. Start now to understand that you will be transferring from the employee ranks of a major institution to the land of the self-employed.

For many years, your employer has provided you with an array of exceptional employee benefits that are matched only by the largest of private companies. They include a competitive, guaranteed salary, employer-sponsored retirement plan, health insurance, disability insurance, life insurance and sick days.

You worked hard through decades of teaching, researching, mentoring and writing. But these employee benefits will end when you finally leave the university, never to return as a paid staff member.

If you are 65 to 70 years old, you will be spending the next 20 to 30 years in the land of the self-employed — a land that is not at all forgiving to the uninformed.

When you leave the university, you will have whatever assets you have been able to accumulate, plus your brain that has served you well in academia.

Unfortunately, when you leave the ranks of employees receiving a salary, the financial world looks at you much differently than when you were a valued employee.

The financial traps outlined in this report can be sidestepped if you act now.

First of all, be prepared that when you become self-employed, the banker may not look at you the same way as when you were employed with the university.

When you are receiving your university salary, the banker is very likely to loan you money, because you represent little to no risk. But after you retire, when you go to the banker for any kind of loan, the first question will be whether you are employed. How will you answer? “Retired.” The next question will be, what is your salary? Your answer will be “None.”

You’re the same person, but you become a different level of risk after you are retired, and getting a loan will likely be far more difficult.

  • Now is the time to accumulate as much cash as you can in your bank account. Do not be concerned about the low interest rates.
  • Now is the time to negotiate a line of credit
  • Now is the time to consider refinancing your home if it makes sense

Lack of cash is the single biggest reason most small businesses fail. Do not think of your retirement account or IRAs as a cash source. They are way too expensive. For every dollar you need, you will need to withdraw around $1.40 in order to pay Uncle Sam his taxes. Remember, the bank cannot accept your retirement plan as collateral for a loan, no matter what the amount.

Much more important information that you need to know about your impending “self-employed” status follows:

Retiring in the Next 10 Years? Beware the "Six Traps"

Trap #1: Lack of Cash

The vast majority of professors who have reached what we refer to as the “transition” point of their careers have tenure, which is a great benefit. They really can't be fired. They have group disability insurance, so if they become disabled, the insurance policy will kick in and pay a significant portion of their salary. They might have some sick pay that they've accumulated, so they have a lot of stability if they can't work because of a sickness or some other negative occurrence.

Interest rates have been low for years, and many university professionals ask us, “Why do I need a lot of money in the bank? It's not earning any interest.” They will usually have a few thousand dollars in the bank. It’s another source of cash in an emergency.

It's hard to argue for a big cash balance. But for a self-employed (retired) person, not having money in the bank for walking-around money or other short-term obligations is not wise. If a retired professor goes to the bank because she doesn’t want to take out more money out of her retirement account because of taxes, and needs some money, the banker is going to ask how much she has in the bank. If she has nothing in the bank, the banker is not going to look very favorably at extending credit. Remember, retirement accounts cannot be used as collateral for a loan.

The benefits of cash shouldn't be measured just in terms of what the bank interest rate might be, but in terms of opportunity cost. One of the goals of a professor we spoke with recently was to sell his house in Chicago and to move out east. His mortgage has 10 years of payments remaining. He plans to retire in three years or less, and he's paying about a total of maybe $3,000 to $4,000 per month on the mortgage. I asked him why he was paying $4,000 on his mortgage and he said, "That's what the mortgage payment is."

“But you're going to sell the house,” I replied. “You and your wife agree that you're going to sell the house right after you retire and you're going to move out east where you're from and, and that's where you're going to live.”

His house’s value will grow independently of how much money he puts in it. But his bank account, which had $5,000 or $6,000, wouldn’t grow unless he deposited more cash.

There's no guarantee that house values are going to go up, so I suggested he refinance the loan at as low of a monthly payment as possible.  Then he could take most of that $4,000 a month and put it in the bank. That would create a fairly substantial sum. Maybe he could take that money and spend it on the improvements he told me he needs to make on the house out east. Or maybe he could take that $48,000 each year and get the tax man on his side of the table and by putting it in his supplemental retirement account, which was zero at the time.

He paid about $28,000 in federal income taxes the previous year. He could reduce that by a third simply by putting $20,000 a year into his retirement account. It's another way of building up cash. As a small business person, we’ve learned over the years that the banker can be difficult to deal with after you are retired and have no salary.

Retiring in the Next 10 Years? Beware the "Six Traps"

Trap #2: Loss of Benefits

Replacing the benefits and income provided by the university becomes a primary objective for many professors when they reach retirement. Most university professionals have three major assets:

  • Their retirement account, which could consist of $1 million or more
  • Their home
  • Their group life insurance program

Many have other assets like a second house, a cottage, a side business or a farm. Ninety-nine percent of university professionals have the three assets listed above. Incredibly, most of them ignore the group life insurance. They think about health insurance, disability insurance, Medicare or even Social Security when they're approaching retirement. But rarely do they think about life insurance.

One big mistake is to have $1 million of group life insurance on your retirement day, and then have that $1 million go to zero the next day. Even before state and federal income taxes, you just lost $1 million of your total assets that you may have committed to your spouse and-or children. Just be aware that that's going to happen and take precautions -- either within the benefit program so it can be extended, or do something on your own if you want to retain that $1 million of life insurance.

A benefit of life insurance generally is that the insurance death benefit is generally income-tax free, which is the opposite of a retirement account. Let's say a professor has a $2 million retirement account that has taken 40 years to accumulate, along with a $1 million life insurance policy that took her about a half hour to accumulate. (All she had to do is sign up and pay the first quarterly premium, and she had $1 million of life insurance.)

The retirement account is not $2 million in real money. If the university professional dies the next day or even if she lives for the next 30 years, in order to get $1 out, she has to pay up to $1.40. She has to pay 30 or 40 cents per dollar to the government in the form of deferred income tax. To make the math easy, a $2 million retirement account really is not much more than $1 million after you take out state and federal income tax. When she dies, there will be taxes on that account for whoever withdraws the funds.

Professors who are on the verge of retirement can take some very specific steps to avoid the risks associated with the loss of benefits. First, they should have a good idea of what they want to accomplish in retirement for themselves, their spouse and their family. Then they should assess how much of their goals are going to be met by the employee benefits that they have in place. Since they're going to leave those behind the day after retirement, they should consider replacing some of them before becoming an unemployed (retired) individual.

Retiring in the Next 10 Years? Beware the "Six Traps"

Trap #3: Loss of Tax Balance

Tax planning is an important part of financial success. Most university professionals with whom Filbrandt & Company has met over the years think one way to get a bigger bucket of money is to get a higher return on investment. Or, some prefer to put more money in the bucket and let it earn a higher rate of return. Taxes have to be considered, but they should not be the first consideration. An investment’s merits beyond taxes should be the first consideration, but the tax planning can be a very large determinant of how much there will be for retirement or to transfer to family.

We find that our typical client has much more of his retirement savings in what we call the pre-tax bucket. On day one of employment, the university puts money in a retirement plan, and it is mandatory that the professor put a certain match into this retirement account. None of that money hits the person's tax return in that year. It compounds tax-deferred. But when that money comes out of the account, it will be subject to state and federal income taxes. Generally what we see if someone has accumulated $1 million, 90 percent of that is going to be in a retirement account and around 10 percent is going to be in a bank account or maybe some personal mutual funds outside of the university retirement plan.

Therefore, at retirement, there's not much flexibility. If the family needs $50,000 a year, most of that $50,000 is going to come out of the retirement plan, and income taxes will be assessed. If the former university employee needs more money because of health issues, because of a change in residence, or some other emergency or opportunity, withdrawing another $10,000 or $15,000 will put them in the next higher marginal income tax bracket. That means it becomes more expensive to take that money out.

If they took out that extra $10,000 or $15,000 out of a bank account, there would not be any income tax. If they had it in a tax-free bucket like a Roth IRA, they could take the money out and there would be no income tax. Most of our clients, when we first meet them, have a disproportionate amount of their assets in income-tax-deferred accounts.

When a professor lets his group life insurance policy expire, then he’s down to his house and retirement account as his two major retirement assets. Ninety percent of that retirement account is going to be in income-tax-deferred assets. Professors don't have any flexibility. They've been told over the years to defer, defer, defer. No one told them that the government could change the tax brackets so their income might be less, but the brackets might be higher. That's the trap.

If you're in the position today of having $1 million saved, with $900,000 in a retirement account, and you plan on working another five years, perhaps you should bypass the deduction for additional contributions into the retirement plan other than the mandatory. Or, perhaps take some excess savings and use your university's Roth plan or some other after-tax account.

Retiring in the Next 10 Years? Beware the "Six Traps"

Trap #4: Loss of Control

There's been much consternation about the disappearance of guaranteed pensions at universities. Many large corporations still have pensions in which the retired executive gets a certain amount a month when he or she retires, and the liability for that payment is on the corporation. That no longer exists in most universities.

In the TIAA-CREF system, there was a time that ended about 20 years ago when a participant had to annuitize his or her retirement account balance. If the professor worked for 45 years and had $2 million in his retirement account, he could not take the $2 million out in one chunk like he can today. He had to annuitize his $2 million with TIAA-CREF. That was the rule of the university. What that meant is he turned the contract over to TIAA-CREF with the $2 million of assets. In return, TIAA-CREF insured that he and his wife would receive a monthly payment for as long as they lived, which they liked.

What people didn't like is that once they were deceased, there would be no balance remaining for their children or grandchildren. Remember when interest rates were so much higher 20 years ago? If you managed to accumulate $2 million, you didn't have to be an investment genius: You could take it to the local bank and maybe get 8 percent on a simple money market account, if you were allowed -- but you weren't by the universities.

Eight percent on $2 million is $160,000. You'd still have the $2 million for your family when you died. University professionals started to understand that and they protested. The rules were changed, and now they don't have to annuitize. The loss of control refers to professors checking the box on an annuitization form without knowing exactly what they were doing. Even if they knew what they were doing, they were losing control of that $2-million asset.

Most professors for the past 20 years have not done that, because they wanted to retain control of their assets. But with interest rates being so low and the stock market being volatile, the idea of annuitization or having a guaranteed lifetime income is becoming more in vogue. Professors are asking, “Where am I going to take my $2 million and get a safe return? Treasuries are paying 2 percent. The stock market is at an all-time high. What should I do?”

As we talk with retirees or professors nearing retirement, we introduce this idea of a guaranteed income that's produced by an annuity. But rather than doing the entire $2 million, we often suggest annuitizing just a portion of it. Once you annuitize, you can't unannuitize. The advice we give most of the time is, if you're going to do it, think about it one more day and then do it tomorrow. If you do it tomorrow, do it for a part of your $2 million, not the entire amount.

Retiring in the Next 10 Years? Beware the "Six Traps"

Trap #5: Unintended Risk

There are many unintended risks in the transition from being a university employee to being self-employed without the safety net of the university. At Filbrandt & Company, the soul of our work is managing people through transitions. There are many transactions that take place during the transition, but the key is managing the transition.

One example is a woman I met years ago at a major university. She had a retirement account close to $1.5 million. Her husband had already retired and she was going to retire. After looking over her statements, I asked her if she had any other stock.

“I don't have any stock,” she said. “All I've got is what I've shown you here.”

“Is this your name on the top of the statement? Is this really your account?" I asked. She said it was.

“This statement says the TIAA-CREF stock fund,” I said. “This is really stock.”

“But it's CREF,” she said. “That's different than stock. I don't consider that stock.”

“I hear you, but you have no other TIAA-CREF investments,” I told her. “This is it.” She had about $1.2 million, and it was all in the TIAA-CREF stock fund. It’s stock and it has some volatility.

“You look concerned,” she said.

I recommended to her that she sell half of it that day.

“If I sound urgent, I am being urgent, because you're going to retire soon,” I told her. “You need serious money out of this portfolio. The market has been going up nicely. I don't know how long it's going to go up, and neither do you. You don't really understand the rules of the game you’re playing, or what you have in the game.”

She took my advice, and then within two years, the market plummeted. She's been a client now for more than 20 years because of that. She didn't know what she had.

Retiring in the Next 10 Years? Beware the "Six Traps"

Trap #6: The Rollover

Rollover is a general term for taking money out of a retirement account. It could be a university retirement account, or it could be any employer’s retirement account. Rolling over your retirement account means putting that money into an IRA. The major benefit -- if it's done properly -- is that the money is transferred from the retirement account to the IRA and there's no current income tax. The secondary benefit is that IRA can be self-directed. In other words, the professor who owns the IRA can use a bank savings account if he's very, very conservative, or could buy shares of Apple stock. Neither of those options are available in a university retirement account.

What's the trap? Many times, faculty members roll money out of their retirement accounts for other people's reasons or purposes, not the one that I just described. When a broker, a banker or an insurance agent finds out that someone is going to retire, he or she will normally knock on that person’s door and suggest a rollover. Why? Because that person wants to move the money from the retirement account (where they can't earn commissions) to an IRA at the bank or at the brokerage firm. They put it into products in which they can earn a commission.

That's not necessarily bad, but it's unnecessary. There's no university we're aware of that forces one to take money out of a retirement account when they retire. The university retirement plan will hold those assets. There are some asset protection rules to be aware of. The IRS considers a retirement plan as a safe haven from creditors. IRAs, in a lot of cases, are not. If a retiree gets in a terrible car accident and is sued and loses the lawsuit, there is a good chance that an IRA asset could be seized or used to pay the claim. That won't happen if the money is in a retirement account.

When you retire, there are going to be many people knocking on your door to get you to move the money somewhere else. Their motivation is so they can get paid for whatever advice they give. The good news is that in the university environment, you can take your time and actually leave the money at the university.

The university has negotiated low fees with the vendors that they have: TIAA, Fidelity, and others. You want to keep taking advantage of that.

Plan for Your Future

While reading this report, you may have had an “a-ha” moment — realizing one or more of these traps could adversely impact the plans you have made for yourself and your family upon retirement. To ensure you are avoiding these six traps, and to identify and review your unique situation as it relates to retirement planning, investment planning, and estate planning, please contact us. Call us at 800-431-9740, or visit our website at and click the contact tab to schedule a no-obligation appointment to speak with one of Filbrandt & Company’s retirement planning specialists.


By Michael J. Filbrandt, CLU®, ChFC®                              

Chairman of the Board, Filbrandt & Company

Volume 17, Issue 7

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