For a lot of working Americans, the 401(k) is the go-to investment vehicle when it comes to retirement planning.
We’ve been told from a young age to put away money into a 401(k) so that when retirement comes, we will magically have enough to live on. But that’s not how the story goes for a lot of Americans.
The problem with the 401(k) retirement savings plan today is most of us don’t have the luxury of a pension plan. We might not work our entire lives for a company that holds its promise to take care of us when we retire.
Why is that a problem as far as the 401(k) goes?
Here’s the ugly truth about the 401(k) retirement savings plan
The 401(k) retirement savings plan was never built to replace pensions.
As Time points out: “the provision was never intended to be a broad-based saving incentive that would serve as a foundation for financial stability in retirement.”
While everyone talks about 401(k)s, fewer and fewer Americans have pensions or are able to put money aside to contribute to their retirement plans.
If you’re trying to save up for your retirement, here’s why you might want to rethink a 401(k) retirement savings plan.
1. You have little control over your money
You hand it over to someone and hope they don’t lose it all. If the market crashes and that ‘someone’ put all your eggs in the wrong basket; unfortunately, you’re out of luck. There is no insurance to cover your losses.
2. You can’t access your money
If you’re thinking about taking some of those 401(k) savings out for a down payment on a house or for an emergency; think again.
You won’t be able to get your hands on it without a HEFTY fine.
The IRS will impose a 10% penalty on amounts withdrawn before the age of 59½.
On top of that, each dollar you take out is taxed at your income rate. NOT at the lower capital gains rate of about 15% (which you benefit from in an IRA).
Depending on your income tax bracket, that could be up to 37% federal tax (+ state tax). That’s twice as much more taxes than you should be paying!
That’s not even the end of it.
You’re also taxed at your income rate when you retire (even if it’s on or after the age of 59½) and NOT at the capital gains rate (which you would benefit from in an IRA).
3. Hidden fees buried in legal paperwork
According to a 2018 TD Ameritrade Investor Pulse Survey, 37% of 401(k) contributors believe they don’t pay any fees, 22% don’t know their plan has fees and 14% don’t know how to determine the fees.
Why is it that no one seems to know they are getting charged fees?
All though, your account administrator is required, by law, to send you quarterly statements with the fees, many of these statements end up getting overlooked in the chaos of our inboxes.
Then there’s the issue of those 90-page booklets (called prospectuses) that no one wants to read because of their sheer size. The problem is, those unbearable booklets contain fine print for additional fees.
All in all, fees can vary widely from investment to investment. Some of the lowest cost under 0.10%, whereas more expensive ones can be over 2%.
A few percentages here and there don’t seem like a big deal if you look at it on the short run but take those fees and fast forward 20 years from now, that compounding effect cuts down your returns more than you realize.
If you have $10,000 in your 401(k), a 2% fee is $200 a year. With inflation averaging at 3%, that means you need at least a 5% return on investment each your just to cover those losses.
But what about matching contributions?
Yes, in theory, the 401(k) is a great retirement plan because most employers match contributions.
In practice, if your employer did not match contributions then that money would come directly to you through your paycheck. That’s a problem because you’re giving up money over which you had control to have it locked up in an account where you can only hope it will grow.
According to Steven Gandel, a study issued by the Center for Retirement Research indicates that, “All else being equal…workers at companies that contributed to their employees’ 401(k) accounts tended to have lower salaries than those at companies that gave no retirement contribution…In fact, for many employees, the salary dip was roughly equal to the size of their employer’s potential contribution.”
Jack Bogle, the Founder of Vanguard, puts it like this: “Do you really want to invest in a system where you put up 100 percent of the capital, you take 100 percent of the risk, and you get 30 percent of the return?”
The biggest problem of all is that most people who put their money in a 401(k) don’t know a lot about money or investing. They’re happy to take other people’s advice assuming that advice is right.
So why the heck are people still signing up for these?!
People don’t know a lot about money, investing or taxes and it’s easy to believe the advice given to you by a “professional”. After all, why would you ever think you know better than they do?!
Sadly though, these “professional” may not have your best interest at heart. For instance, did you know that your broker charges you a commission on each transaction? That means it’s in your brokers best interest to recommend you make changes to your portfolio (whether or not those changes are in your best interest).
If you want wealth, you need a financial education so that you can take control of your money. Here are a few resources to help you get started:
- 7 unusual tax deductions that could save you money
- check out the Freedom Framework program where I teach you EVERYTHING you need to confidently start investing (you’ll know how to read financial statements, screen stocks, minimize your taxes, pick winning stocks and much much more).
Bottom line – think twice before you contribute to a 401(k) retirement savings plan.