Why are 401ks a lousy product ?
Let’s go over the pros and then the cons:
The PROS of a 401k
· You put money away before it is taxed. This has the benefit of encouraging you to save starting at a young age.
· Often your employer will match what you put in your 401k. So it’s often referred as “free money” .
· When you are 59.5 years old you are allowed to take money out.
The CONS of 401Ks
You are paid money by an employer. You have that money in your hands for five seconds, and then it is whisked away into this account and you can’t look at it again for another 20-35 years unless you want to pay a massive penalty.
Will you be alive in 30 years? Hopefully! Else you will never see that money again.
So you do not have total control over your money.
Let’s look at some of the other cons:
1) You can’t predict your tax rate 30 years from now.
This completely destroys the whole “tax-deferred” argument.
But let’s say you put money in your 401k at the age of 29. You are making much less money than you probably will be at the age of 59.
So your tax rate is less than your tax rate at 59, forgetting completely that taxes might be raised also (we just don’t know) between now and then. And with our national debt at over 33 trillion, the only way government can generate " income " is by raising taxes.
So we don’t really know if you are saving money on taxes or not. You are simply having your money taken from you for 30 years. But there is a very good chance that taxes will be higher. Again, ruining the entire point of putting in pre-tax income.
2) The Employer Match
Do you think companies really pay you free money?
Companies that don’t have an employer-match pay higher salaries. The Center for Retirement Research did a study based on tax data and showed that for every dollar an employer (on average) contributes to a 401k match, they pay 99 cents less in salary.
Big savings!
Also employers don’t give you all the money at once. They may spread it out over 4-6 years (six years is the regulated max ).
If you leave before the six years, you often don’t get the match. So employers actually save money in the long run by installing a 401k plan.
How many employees stay at their jobs for six years? Not that many. The average is 4.6 years according to the Bureau of Labor Statistic. Goodbye employer match.
3) Fees
People don’t manage 401k plans for free. There is a cost. Then there is a cost in the mutual funds they put their money in.
Then there is revenue-sharing between employers and 401k plan managers. Is this legal? Yes. It might not always be but it is now and it is how employers make some of the money back on matching what you put in.
Is this transparent? Of course.
Does the average person look at all the fine print detailing fees? Of course not.
Then there is the fine print on each mutual fund the 401k manager has allocated the money to. Do most people look at that fine print? No.
Many mutual funds charge extra marketing fees. Do yours? Most people have no idea. Which is how they get away with it on a trillion dollars.
Which is part of the reasons 86% of mutual fund managers underperform the market.
Now, in many cases you can say, “I want to put in a low-fee exchange traded fund” but a) will you do that? and b) they still have some fees.
4) Assumption on market returns.
The market has returned somewhere between 7-10% per year depending on what time period you look at, what index, etc.
The average investor has returned 1.8% per year over the past 40 years. The psychology of investing is very difficult. In 2009, many investors pulled out of the market, right before a 100% upward move.
And when I say, “many investors”, I’m not talking about you - I’m talking about the best mutual fund managers in the business.
5) More on taxes.
Yes, you save tiny amounts on taxes when you are young. But this is also the period when you have the biggest tax write-offs relative to your income (dependents, business expenses, etc).
So you don’t really need the extra minor savings on taxes. Trust me, you will be fully taxed at the highest rate when you pull money out 30 years from now.
So why not use that “extra” money to invest in yourself right now. Invest in skills that can benefit you or experiences that you can enjoy and make you happier.
401k plans have been around for decades. And yet the average retiree does not have enough savings for retirement. So the evidence is fully in. 401k plans did not help.
To learn more about the hidden fees in a 401k, check out these short videos.
To examine your retirement options, contact me:
Larry Carlin
larry@larrycarlin.net
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