There are a lot of ways to save for retirement, but the 401(k) plan is the most popular type of employer-sponsored retirement in America when you consider just how many people are signed up for it. And it’s all a scam.
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Good. Now I’ve got your attention.
401(k) plans are growing in popularity. In 2004, 401(k) plans were $2.2 trillion in assets. As of 2014, 401(k) plans held $4.4 trillion in assets, almost 20% of the retirement funds in the U.S.
A 401(k) retirement plan is an arrangement that allows an employee to set aside a certain percentage of their income to be deposited into the account each month. The amount deferred is not taxed until it is withdrawn or distributed from the plan. Typically the contributions are then invested in a portfolio of mutual funds.
So every piece of personal finance literature will tell you why you should invest in your 401(k). We’re here to tell you why you shouldn’t.
You Can’t Touch That 401(k) Money for Decades
A 401(k) plan is a forced savings vehicle. It’s just another product – like anything else people want to sell you – and should be assessed on its merits. The fact of the matter is that the assets in your 401(k) are extremely illiquid. They cannot be withdrawn unless you reach a certain age (59.5), retire, leave your employer or die.
If you ever decide you need access to your own money at any point you are charged a hefty penalty. If you are like some Americans and your 401(k) is your only source of savings, then there might come a day when you need to dip into those savings.
You Don’t Make Anything on 401(k) Money
You don’t really make money on 401(k) plans. Firstly, you are likely invested in a bad plan, because there are tons of bad plans out there and most people don’t really know what they’re doing.
You get paid once, or twice a month. A certain portion of your income is removed and goes straight into your 401(k) and that money goes through a financial system that is very, very good at charging fees. Banks charge fees. Mutual funds charge fees. Everyone in between is most definitely charging a fee as well.
So that money goes through the system and then is deposited into some mutual fund.
Are you invested in mutual funds? Then you’re being hit with tons of fees. Fees that, due to the magic of compound interest, eat away huge chunks of money from your future self over 30 years. Expensive management fees are the biggest rip-off in retirement savings. The best 401(k) plans charge clients on average 0.29%. The worst: much more than that.
Smaller companies are hit the hardest. Large plans with thousands of participants can afford to cut fees due to sheer volume. A small plan with a few million in assets might charge 1.45% or more. That means for every $1000 invested, participants must pay $14.50. Those extra fees don’t come with a better manager or any other perks either. Fees are inevitable, and it’s because of fees that most retirement plans return less than the stock market.
One major selling point of investing in a 401(k) is that you are able to contribute your income untaxed. That is, your money is taxed at the end, rather than the beginning.
Is that desirable?
A good 401(k) salesman will inform you: yes, of course. Once you retire, you will automatically be in a lower tax bracket and therefore you will automatically benefit. So the idea is: you invested tax-free when you were being taxed in a 25% tax bracket and then when you retire you drop into a lower tax bracket and are taxed on some lower, say, 15% tax bracket.
Who says that’s going to happen?
Who says you are going to stop working?
Independent of need, many people continue to work because they find it personally rewarding. The traditional retirement age of 62 or 65 is no longer considered old. If you are in any sort of career, then you DEFINITELY expect to be earning more once you are 20-30 years into your career versus when you first started and had just opened up your 401(k).
So now your 401(k) withdrawals are being taxed at a higher tax bracket. Why isn’t this outcome just as likely as one where you’ve retired and are in a lower tax bracket? In fact…isn’t it more likely?
Just one more thought. Do you think you can predict with any certainty what the tax rates are going to be in 30 years? Before the Reagan era tax cuts, and as recently as 1981 the highest tax bracket garnished your income by a whopping 70%.
You’re told that the stock market returns 8% a year, and that if you invest in your 401(k) and let it grow you will be safe and happy in retirement.
It’s all just good salesmanship.
No one can predict what will happen in the future. You can put your money blindly into a 401(k), invest in a few mutual funds and hope for the best or you can take control of your money and investments.
In truth, the average investor in a 401(k) plan is getting almost no return on investment and are actually falling behind the inflation rate. The majority of people aren’t even saving enough in total dollars to retire.
The problem isn’t necessarily the 401(k). The problem is the way that the 401(k) plan is presented and marketed by the media and financial “experts” as a sure thing. And there’s no such thing as a sure thing when it comes to investments.