The Importance of Being Earnest:
A review of the affluent case
The retirement equation
TOTAL
CONTROL
Portfolio risk
Consumption
vs. savings
Market
returns
OUT OF
YOUR CONTROL
Retirement
Policy
regarding
taxation,
savings &
entitlements
Employment:
earnings and
duration
Longevity
SOME
CONTROL
1
The Browns: Let’s look at some factors under their control
The Browns
Have one working spouse that since 1972 consistently earns 6x the median income (in 2012, 6x MI = $340,000)
Buy a home once they save enough for a down payment, and which they own free and clear by retirement
Make annual pre-tax 401(k) contributions equal to 6% of wages, which an employer matches up to a 3% rate
(subject to prevailing caps)
Put aside another 4.5% of after-tax income in a savings account, for a total lifetime savings rate of 22% (2%–3%
over averages for their income demographic)
Invest in a balanced portfolio of 65% equities at age 25, declining to 45% by age 65 (remainder in fixed income)
Are subject to an effective Federal tax rate (incl. payroll taxes) of 20%, and a 3% state tax
Intend to spend 80% of their pre-retirement after-tax, after-savings cash flow in retirement
The above example is hypothetical and is shown for illustrative purposes only.
2
How do affluent families cut 20% from their pre-retirement spending?
Sources of spending conservation often seen in affluent families:

Mortgage, paid off

Opportunity to downsize real estate needs

Gifts/tuition for children no longer needed, now in workforce

Work-related apparel, transportation, entertainment and food expenses

Gas, insurance and maintenance expenses on a second car

Home improvements

Charitable contributions

Costs of supporting aging parents eventually fade
3
Baseline case
Source: TPC, BEA, NAR, BLS, J.P. Morgan Asset Management, Census, Bloomberg.
Shown for illustrative purposes only.
4
Where they get their cash flow from
Source: TPC, BEA, NAR, BLS, J.P. Morgan Asset Management, Census, Bloomberg.
Shown for illustrative purposes only.
5
That all looks fine, but what about…

People that want to or have to retire early, or live much longer than expected?

People that save a lot, but not in the most efficient vehicles, either by choice or due to lack of access?

People that invest too conservatively?

People that spend too much money?

People that want to spend more than 80% of pre-retirement income after they retire?

Future policy risks regarding entitlements and taxation?

What are the benefits and disadvantages of Roth 401(k) plans, annuities, non-qualified deferred compensation
plans, Sep IRAs and non-deductible IRAs?
6
Early retirement can be costly, even for diligent savers
Source: TPC, BEA, NAR, BLS, J.P. Morgan Asset Management, Census, Bloomberg.
Shown for illustrative purposes only.
7
Comparing different means of saving
Source: TPC, BEA, NAR, BLS, J.P. Morgan Asset Management, Census, Bloomberg.
Shown for illustrative purposes only.
8
If you manage your own future, you cannot under-invest…
Source: TPC, BEA, NAR, BLS, J.P. Morgan Asset Management, Census, Bloomberg.
Shown for illustrative purposes only.
9
…or over-spend
Source: TPC, BEA, NAR, BLS, J.P. Morgan Asset Management, Census, Bloomberg.
Shown for illustrative purposes only.
10
For the big spender, it’s hard to invest out of an under-saving hole
Source: TPC, BEA, NAR, BLS, J.P. Morgan Asset Management, Census, Bloomberg.
Shown for illustrative purposes only.
11
A comment on savings consistency – The impact of periodic
savings lapses
For purposes of highlighting the impact of savings lapses, the baseline case in this chart does not include an initial home purchase. This has
the impact of increasing pre-retirement financial assets, from which the impact of savings lapses can be more readily examined. Shown for
illustrative purposes only.
12
So far, we have examined factors under the Browns’ control.
Now let’s consider the ones that aren’t
TOTAL
CONTROL
Portfolio risk
Consumption
vs. savings
Market
returns
OUT OF
YOUR CONTROL
Retirement
Policy
regarding
taxation,
savings &
entitlements
Employment:
earnings and
duration
Longevity
SOME
CONTROL
13
Example: Equity market returns
Source: Robert J. Shiller data set, J.P. Morgan Asset Management.
Shown for illustrative purposes only.
14
And another: The national debate about the debt and the deficit
Source: CBO, OMB, J.P. Morgan Asset Management.
Shown for illustrative purposes only.
15
Potentially adverse changes that could affect the Browns of the future
Potential outcome in the future:
Social Security: Changing indexation results in payments lagging behind overall inflation by 0.4% per year.
Benefits are means-tested, and the eligibility age for full benefits is raised from 66 to 69
Medicare: An affluent family must purchase supplemental Medicare insurance at a cost of 2% of
pre-retirement income
Taxation: Tax rates on all brackets revert to higher pre-2001 levels. In addition, Pease limitations on itemized
deductions are increased (3% exclusion raised to 4%, $300k threshold lowered to $250k)
Restrictions on the use of pretax savings plans: Limits are applied to 401(k) contributions as per the
Bowles-Simpson proposals (the “20/20” rule), over-riding existing caps
16
The Browns of the future: Baseline case, subject to policy and
market risks
Source: TPC, BEA, NAR, BLS, J.P. Morgan Asset Management, Census, Bloomberg.
Shown for illustrative purposes only.
17
Assessing the relative impact of policy, market and behavioral
changes to retirement assets
Impact of:
Social Security means-testing and eligibility delayed by
one year
Cost of supplemental Medicare insurance premium equal to
2% of pre-retirement income
Bowles-Simpson limits applied to pre-tax 401(k) contributions
Tax rates revert back to higher pre-2001 levels
Source: TPC, BEA, NAR, BLS, J.P. Morgan Asset Management, Census, Bloomberg.
Shown for illustrative purposes only.
18
Annualized equity market returns are 1% lower
Shift of 5% from equities to fixed income
Savings rate lowered by 3%
Some conclusions for affluent families
The importance of being earnest
Know what your savings rate is, including pre-tax contributions to savings plans. It should be > 15%
Monitor investment risk in assets put aside for your retirement. Under-investing and over-spending is a potentially
toxic combination
Accelerating retirement by even 2–3 years can substantially change the trajectory of your retirement assets, and
requires adjustments in advance to your savings, or after the fact to your spending
401(k) plans can be more effective than IRAs due to higher limits and employer matching on the former
The prior four decades of equity returns benefitted from the Volcker disinflation, a phenomenon that is unlikely to
repeat itself. As a result, real returns over inflation may be modestly lower than in the past
Congress has focused much of the deficit reduction burden on affluent families earning more than $250,000 in
adjusted gross income. In the future, they may continue to do so, through policies which increase effective tax
rates, and limit pre-tax contributions to savings. They may also means-test the largest component of retiree
spending (medical)
Lifespans are gradually increasing, increasing the amount of assets families need in retirement
19
Some rules of thumb: Many people underestimate the importance of
their investment and saving decisions
Breakeven calculations on working, spending, investing and saving
Our overly conservative investor would need to spend 15–20% less in retirement than in the baseline case, or
increase the lifetime savings by 5–7% to maintain the same wealth cushion
Accelerating retirement by 2 years requires either a lifetime savings rate that’s 2% higher, or a 15% further
reduction in spending in retirement
For every 1% decline in lifetime savings rates, real equity returns need to rise by roughly 0.5%
Every additional year you work adds financial assets sufficient to support an additional 5 years in retirement
Moving from a high-tax to a low-tax state allows for post-retirement spending to rise by 4%–5%
Families would have to work for 2 more years to offset the impact of all our adverse policy changes
By the time the Browns retire, 70% of their financial assets will come from their investment decisions, rather than
from their initial contributions to savings
Ratio of retirement spending to lifetime savings contributions, in 2012 dollars: 3.0x
20
Saving is a constant battle against the temptation to over-spend
Perhaps more than any other country, the United States effectively encourages its citizens
to spend, which may be why consumption is so high relative to GDP (71%). Examples of
pro-spending policies include:
Lower sales, VAT, excise and import duties on a wide range of goods and services, including fuel, food, wine,
electronics, accountants and lawyers
Favorable tax treatment of housing (mortgage interest deduction, capital gains exemption on sale of residence),
which results in lower population densities, greater suburban sprawl and increased household spending on home
improvements, transportation, etc.
Lack of single-payer health care which leads to greater healthcare consumption (U.S. private sector healthcare
expenditures are more than twice every other OECD country)
The private sector finances most post-graduate education expenditures, unlike other OECD countries
21
Appendix
22
Additional options to invest with pre-tax and after-tax dollars
Option
Comment
Roth 401(k)
Roth 401(k) plans are like traditional 401(k) plans, but involve contribution of after-tax dollars to
an account that compounds tax free, and which is not subject to taxation upon withdrawal.
Largest benefits generally accrue to families that anticipate higher tax rates in retirement, and
families whose intended contributions are higher than prevailing 401(k) caps. Since traditional
and Roth 401(k) contribution limits are the same, the latter allows greater value to compound
since it is funded after-tax.
Non-qualified
deferred
compensation
plans
Contribute pre-tax dollars into a tax-deferred account without being subject to IRS contribution
limits; withdrawals are taxed at ordinary rates. The pre-tax compounding is beneficial to wealth
dynamics, but families should be conscious of unsecured credit risks and monitor concentrations
accordingly.
Non-deductible
IRAs
Benefits vs. after-tax savings: the IRA compounds on a pre-tax basis. However, some income
that would have been taxed as capital gains is taxed as ordinary income upon withdrawal. The
net benefit depends on the time horizon (the longer the better), and the nature of the investment
in the IRA (the less tax-efficient, the better).
Annuities
Same as non-deductible IRAs, but typically with higher fees
Sep IRA,
Solo 401(k)
For self-employed individuals, who can effectively save more in these plans than non-selfemployed individuals subject to IRS limits on employee contributions, and who benefit from
traditionally smaller employer contributions. However, the potential tax savings need to be
weighed against a plan’s administrative complexity, and the cost of contribution requirements
that might have to be extended to other employees.
23
What it takes to spend 100% of pre-retirement income in retirement
Source: TPC, BEA, NAR, BLS, J.P. Morgan Asset Management, Census, Bloomberg.
Shown for illustrative purposes only.
24
Viable retirement cash flow targets under baseline case:
Before and after potential policy and market shifts
Using historical data
Using the policy and equity market assumptions
for the future discussed on pages 14 and 16
Shown for illustrative purposes only.
25
Taxes
Source: IRS, J.P. Morgan Asset Management.
Shown for illustrative purposes only.
26
Equities
Source: J.P. Morgan Asset Management.
Shown for illustrative purposes only.
27
Important information
Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and
are subject to change without notice. We believe the information provided here is reliable. These views and strategies described may not be suitable
for all investors. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be,
and should not be interpreted as, recommendations. Past performance is no guarantee of future results.
This material is distributed with the understanding that J.P. Morgan is not rendering accounting, legal or tax advice. You should consult with your
independent advisors concerning such matters.
J.P. Morgan Asset Management is the marketing name for the asset management businesses of JPMorgan Chase & Co. Those businesses include,
but are not limited to, J.P. Morgan Investment Management Inc., Security Capital Research & Management Incorporated and J.P. Morgan
Alternative Asset Management, Inc.
IRS Circular 230 Disclosure: JPMorgan Chase & Co. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax
matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the
promotion, marketing or recommendation by anyone unaffiliated with JPMorgan Chase & Co. of any of the matters addressed herein or
for the purpose of avoiding U.S. tax-related penalties. Note that J.P. Morgan is not a licensed insurance provider.
JPMorgan Distribution Services, Inc., member FINRA/SIPC.
© 2013 JPMorgan Chase & Co.
28