A Completely Different View of 401(k)s and Retirement Savings

Doctor Talking to a Patient

“A 401(k) plan ensures that you have money to spend during your retirement years. However, there are reasons why a 401(k) stinks.”

It’s almost always enlightening to hear from a different perspective, even in finance. This article from Born2Invest, “Retirement planning: The downsides of your 401(k),” takes a somewhat contrarian view of retirement accounts in general and the use of 401(k)s in particular. We may not agree. However, it’s worth the read.

The article notes that historically, retirement as a concept is relatively new. People just worked as long as they were able to. In 1881, Otto Van Bismarck petitioned for the creation of a government system to support the elderly and the concept of a social security system was created. Their retirement age was 70—the same as life expectancy. In 1935, the American Social Security system was created. For a few generations we worked, we saved, we got pensions from employers and when we celebrated our 65th birthday, we retired.

That world has passed. The Revenue Act of 1978 created the 401(k) and defined-benefit plans that went away as corporations passed the burden of saving and investing for retirement to employees. There is now a huge industry of employer-sponsored, employee-funded retirement plans with assets of more than $7.7 trillion. IRAs hold more than $8.6 trillion.

Why does that stink? One of the benefits marketed by 401(k) providers is that they allow owners to defer income and taxes. However, “defer” doesn’t mean they are tax-free. You’ll pay taxes when you take the money out. To be sure that you do, there are Required Minimum Distributions (RMDs). You’re taxed not just on the distributions but also on the investment gains.

The traditional thinking is that you’re going to retire, your income will decrease and so you’ll be in a lower tax bracket. But will it? If your combined income from Social Security, pensions, and RMDs send you into a higher tax bracket, you may be paying more in taxes. This is especially true if you have lost the deductions: kids growing up, no mortgage, and no pre-tax contributions.

Your retirement funds are supposed to be just for retirement. However, sometimes there are bumps along the way and, if you have no other assets, that’s where you’ll go at a high price.

401(k)s have limited investment options and you’re typically limited to mutual funds and sometimes to Exchange-Traded Funds (EFTs).

Those retirement plans are not free. A 401(k) has high administrative costs and underlying investments have fund fees, based on the companies and their management activity.

Is the 401(k) the best plan for you? The article says to consider your options, so you are not just following the herd. Workplace related retirement plans could be the best option, but you should be aware of the costs, taxes, and restrictions.

Reference: (Sep. 13, 2018) “Retirement planning: The downsides of your 401(k)”

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