Question:

Re: Qualified Plan Tax Deduction,I had a woman that made deductions to her 401K plan, without a match from her company.  As you suggested, I recommended that instead of putting all of the money into the 401K she could use some or all the funds for the private reserve strategy to eliminate her credit card debt and for major purchases. She said that she was going to lose her tax deduction if she followed the insurance concept.  (If I remember correctly, the deduction amounted to approximately $1,750/yr.)  She claimed she needed the deduction to balance her budget. Later I found out that she took a loan from her 401K to pay off the credit card debt. What else could I have done and what steps I could I have taken to offset the loan from the 401K plan and what COW tools could I use?

Coaches response:

Yea that's a tough one.  There isn't necessarily anything in COW that would have addressed the circumstance in a better or different way than Qualified Plans, Qualified Plans 101.  That being said...if a prospect says they HAVE to fund pre-tax 401k to balance their budget then they're making our case for us.  Meaning that they likely are cutting it so close that they have zero cash cushion.  America has it backward...we've been brainwashed to fill up the RISK Tank for our future lifestyle before we put any money into a SAFE/Accessible tank.  And then when the need arises for money we are stuck with unattractive options.  As for needing the tax deduction to balance the budget...here's something that I see many prospects/advisers make:

Assume a client has been putting $10k per year into a pre-tax 401k.  A COW Adviser comes along and shares how the pre-tax 401k works and the client has an "ah-ha" moment and decides to divert those dollars into a Roth 401k, Roth IRA, or permanent life insurance.  As the agent is preparing the numbers/proposals he/she shows $10k per year going into a life policy.  But THAT really would mess up a budget...because the $10k has to pass through the tax filter.  Assuming a marginal tax rate of 22% plus 5% for the state, an accurate annual life premium would have been $7,300 per year and $2,700 to taxes.  This may sound very basic but I've seen this oversight made many, many, many times.

 As I'm writing this I'm also thinking that an appropriate question you could have asked the prospect would have been..."I totally understand that you need the tax deduction today to balance your budget.  But what deductions will you have to offset the income tax due in retirement when you withdraw this money from your 401k/IRA??"  Sadly the answer is "NONE".  Even sadder is that the client has now grown accustomed to a pre-retirement lifestyle that is dependent on the deduction.  When people retire there is no way they are going to reduce their lifestyle by choice...so they end up having to take even more income from the pre-tax account to make up for the lost deduction, which compounds the tax problem!!

In short, as the adviser, our role is to explain/show how qualified plans work and ideally lead our prospects/clients down the path of enlightenment so they ultimately say/ask "I'm not sure I really like having ALL of my retirement money in there.  What are the other options?"  

The Allocation Mix presentation addresses this issue and clearly helps your clients communicate what they WANT and helps you move them in that direction.  Remember, people, move in the direction of their wants...not necessarily their needs.  As an adviser, we simply have to ask what our prospects/clients want and then build a plan that delivers it.