- Kevin McCollester
What's wrong with my 401(k)?
Since 1980 when the first 401(k) plan was created, over 50 Million Americans have invested in this retirement savings and investment program. Income in retirement used to come from employer sponsored pension plans, but those type of employee benefits are no longer commonplace. The 401(k) is now the most common vehicle employers offer as a retirement plan. Here are some of the "features" of 401(k) plans and their negative impacts to consumers.
1. Excessive Fees
401(k) plans come with all kinds of fees. Not all plans charge all fees and some fees the employer pays and others the employee pays. Some of the more well known fees are: Sales Charges (mutual fund loads or ETF commissions); Management Fees (investment advisory fees, account maintenance fees, etc.); Record keeping Fees; Transaction Fees; Activity Fees; Plan Administration Fees; and so on. And this doesn't include the fees within the mutual fund investments themselves such as: Marketing Fees; Sub-Accounting Fees; Transaction Fees; Management Fees; and so on. Oftentimes these fees are asset-based, meaning that the amount of the fee is determined by the account value, so as your account grows, the fees increase as well. 2% of a small amount isn't a very large number, but 2% of an account worth $1 Million is $20,000 per year! Just think of the opportunity cost to your retirement balance of those fees.
2. Lack of Control
Most 401(k) plans limit your investment options to a handful of mutual funds that someone else has chosen to be offered in the plan. Many times the funds are limited to only one fund family since mutual fund companies often provide administration services to 401(k) plans. So an American Funds administered plan would be heavily weighted towards American Funds with a few token other options. So if you want to invest in Vanguard funds, you may not be able to. Or if you want to invest in individual stocks, the only option you may have is stock in the company you work for. What if you wanted to own physical gold or silver? What about cash-flowing real estate? If your only investment exposure is in the stock market, you can easily lose half of your retirement savings in a market crash like what happened in 2008. And when you turn 70 1/2, the U.S. Government mandates that you start withdrawing a minimum amount every year whether you want to or need to or not.
One of the "selling" points of 401(k) plans is that you get to defer taxes on the amount of money that you contribute to the plan and the money grows tax-deferred. The idea is that you will be in a lower tax bracket when you retire, so don't pay taxes now, pay them later. What about someone early in their career that is only in the 15% tax bracket? Will their taxes in retirement be lower? Oftentimes people retire at their peak, or close to their peak income level. Do you want to maintain that lifestyle in retirement or do you want to retire at a lower lifestyle? In fact, in retirement, you will not have as many tax deductions as you do during your working years, deductions such as for dependents, home mortgage, contributions to tax-deferred plans etc., so it will be tougher to lower your taxes without reducing your income. With the massive unfunded liabilities and debt that the U.S. government is running, are you confident that taxes will be lower in the future? How much are you willing to bet on that?
4. Restricted Access to your Money
When you put money into a 401(k), you cannot access that money under normal circumstances until you are 59 1/2 without paying income tax PLUS a 10% penalty. What happens when the unexpected hits? Or when an investment opportunity comes your way or if you want to start your own business? Using 401(k) money is an expensive option, yet the 401(k) and other qualified plan accounts (IRA etc.) is where the bulk of personal savings is directed.
So while most people believe that 401(k) plans are the ideal retirement savings strategy, we believe that minimizing fees, having control over your money, minimizing taxes both now and in the future, and having unfettered access to your money are the characteristics we should be looking for in our saving and investing. While nobody can predict what income tax rates will be when you are ready to retire, we believe that having all of your retirement money in tax-deferred accounts is taking a one-sided bet on the future that doesn't have the odds in its favor. There are alternatives. Non tax-deferred retirement accounts such as Roth IRA and Roth 401(k) let you have tax-free money in retirement, but they have many of the same problems as tax-deferred accounts that we highlighted above.
Another option you should consider is dividend paying whole life insurance. While many financial "experts" dismiss this as a "terrible investment", it really is not an investment at all but rather a place to store your money in a safe, guaranteed account that is not exposed to stock market risk and can never lose money. You can access the accumulated cash value at any time for any reason tax-free, and gives you greater control over how you spend and invest your money. It can also provide a tax-free stream of income during retirement and gives your loved ones protection in the unfortunate event of your early death. No other vehicle provides so much safety, certainty and protection. Banks, corporations and wealthy individuals have used this alternative for over a century and can provide the foundation for greater financial freedom in your life. Let me know if you would like to know more. I am happy to help.