Are you Pro or Against 401(k)?

197 Replies

@Account Closed   great question.  Yes, the referenced example comes from a book by Andy Tanner "401(k)aos How Our Dream of Retirement Became a Nightmare of Chaos" forward by Robert Kiyosaki - Chapter 10, pages 127 - 134.

Disclaimer, I am not an investment expert, nor claim to know all the fees associated with 401(k).  I read to improve my personal financial education and share information I believe is helpful that hopefully provokes thought to ask the right questions of your personal financial goals and of your 401(k) administrator.  I am glad you have a no fee 401(k) plan offered by your employer, I would bet not all do.

One of the most enlightening things that I had learned, and you many find interesting, and frankly I found upsetting because I was never explained this by my CPA/Investment adviser, is that:

401(k) plans are savings plans not investment plans. When the money is withdrawn upon, the 'bait & switch' being sold by the government is that the 40l(k) is an investment vehicle; when in fact 401(k) plans are taxed at ordinary income (35%), not 15% as would be an investor who is investing for capital gains.   That's a significant monetary difference for my goals, whether that is taxed at the beginning of the 401k plan or at the tail end upon withdrawal.

@Scott Trench  

I am pro 401k.

Long term, dollar cost averaged, deferred tax, S&P 500 index fund investment seems a fine way to build a stream of wealth on the effort of American industry that one can not touch day to day and should worry little about.

Set it and forget it, as I learned from late night TV.

I see it as insurance and likely as a way to estate plan.

I hope not to use more than its required minimum distributions when I am in my 70s.

By then I'll have rolled it in to a Roth IRA, paid the necessary taxes, and set it up as my grandchildren's inheritance.

If the rules are the same then as they are now, they will have a small, annual, tax free, required minimum distribution to take over their lifetime, after my passing, with which to enjoy life and remember their grandparents.

I also agree with @Dawn A.  

We are also pro real estate. 

We'll invest more time in building our real estate business for sure.

Real estate should be the larger portion of our estate.

But I see no reason to avoid a 401k.

We'll just enjoy both streams of wealth generation.

Thanks for asking the question,

Jonathan

Originally posted by @Jonathan Cope :

@Scott Trench 

I am pro 401k.

Long term, dollar cost averaged, deferred tax, S&P 500 index fund investment seems a fine way to build a stream of wealth on the effort of American industry that one can not touch day to day and should worry little about.

Set it and forget it, as I learned from late night TV.

I see it as insurance and likely as a way to estate plan.

I hope not to use more than its required minimum distributions when I am in my 70s.

By then I'll have rolled it in to a Roth IRA, paid the necessary taxes, and set it up as my grandchildren's inheritance.

If the rules are the same then as they are now, they will have a small, annual, tax free, required minimum distribution to take over their lifetime, after my passing, with which to enjoy life and remember their grandparents.

I also agree with @Dawn A.  

We are also pro real estate. 

We'll invest more time in building our real estate business for sure.

Real estate should be the larger portion of our estate.

But I see no reason to avoid a 401k.

We'll just enjoy both streams of wealth generation.

Thanks for asking the question,

Jonathan

 Jonathan - thanks for the reply.  I agree with your line of thinking - the 401(k) really would be an awesome form of insurance!

@Scott Trench so are you saying when you make a 20% return your saving all of that money in what? Or are you reinvesting it into another deal and making another 20% and so on. If so, how long have you been successfully making 20%+, seems like the best ROI I've ever heard. Your net worth must be astronomical. Please write a book, I'd love to hear your story.

@Vince Beusan 

Have you done further reading about expense ratios, or are you just trusting the percentage used in the book example?  I did a quick Google search and found a research report that states the 2013 average 401k expense ratio for an equity mutual fund was .58%!  The 2013 average expense ratio for equity mutual funds offered in the US was 1.37%.  So 401k plan participants are, on average, paying less than half in expenses!

http://www.ici.org/pdf/per20-03.pdf

Also, where are you coming up with the tax rates?  35%?!!!!  That rate doesn't come into play until taxable income (2014) exceeds $405,100!!! 

On top of that, you are comparing it to a rate for an investor using AFTER TAX dollars. 

@Account Closed   all good questions.  Yes, expense ratios will vary, as will income tax brackets of individuals will also vary.  While not all fees are charged by a fund are included in the expense ratio, it's a good place to start.  The expense ratio is the amount of money the fund takes from you each year as payment to run the fund.

The expense ratio of the funds I had were .5%-1% of the fund assets, some charge more.

What I found alarming is the fact that investors pay a capital gains tax today at 15%, and a 401(k) is taxed as ordinary income.  Ordinary income can be taxed up to 39.5%.     

Funds can be advertised as no-load funds, and en educated investor will check for other fees like purchase fees, redemption fees, exchange fees, and account fees.  None of these fees fall under the definition of a sales load, so the fund is legally correct in advertising they are a 0% no-load fund.  

As Milton Friedman once said, 'There is no such thing as free lunch.'   These financial institutions will not give anyone anything for free, and they know how to get one's money from them.   Food for thought in understanding how the 401(k) works.

For more information I suggest picking up a copy of the book on Amazon.  I didn't help write it, nor do I get anything from promoting it.  For those interested, it is worth the read.

@vince

You are responding to but dodging the questions.  The fact is you are using extreme numbers to try to support your point.  I haven't looked up this stat, but there is no doubt the majority of 401k contributors will ever reach the 35% bracket let alone the 39.5%.  

@Vince Beusan  is using extreme examples because he read an extreme book and believes it.

My expense ratios are around 1% - my 401k is at Vanguard.

Account Closed your tax rates are right on.

Extreme arguments are useful to shake people up - to get us thinking.  I started reading this thread as a very strong 'tax deferred traditional 401k' proponent, but the debate got me thinking, and researching.  It seems like being married, most years I'm dodging a 28% tax, and I expect to be in a 25% tax bracket when I retire.  That tax rate delta is pretty small, but there is the additional benefit of tax-free compound growth.  My risk is: what if things keep going well for me?  if my business does well and grows and my wife gets back to work, we could easily have 10 years of $80,000/year 401k contributions ahead of us.  Another 800,000 dumped on top of what's already there, plus some mediocre stock performance - and suddenly I may be looking at a high retirement tax bracket.

The examples in the books will compare a 401k vs. a single buy and hold stock that you never sold for 40 years, but that's a straw man, even dedicated investors very rarely stick with an investment for that long.  The world changes.  People sell stocks, and pay taxes, all through their life.  Inside the 401k investments can be shifted and rebalanced without taxes.  You can even use that to your advantage to prevent selling taxable investments.  If your mix gets out of whack, move 401k assets until your overall mix matches your goals.  Each part of your assets is out of whack, but in total you are better off.

The other straw man will be: if you want to plan for a low-income retirement you are a loser - so we have to use 39% as the retirement tax rate.  That's just silly.  These message boards have a survivorship bias - the folks who lose $20k on their first flip and never try again disappear.  Only the lucky and skilled stick around to sell how its possible.  For most people, putting 10,000/year into a tax-deferred 401k for their career will put them in a fairly nice place when they retire.  By doing it tax-deferred - the week-in/week-out bite to their paycheck is smaller.

@Vince Beusan  

Fallacy #1 - the 2.5% rule. My solo 401(k) pays 0% fees. Total. Sure, I had setup fees, and I have to do the managing, but it costs me nothing to run, or invest. I invest in whatever I wish, pretty much.

Fallacy #2 - The tax rate. I paid the taxes on most of my 401(k) investments (Roth plan), and therefore will not pay anything on the average of 15% annual earnings, compounded each year. My standard plan will pay my tax rate at retirement, true, but I have kept most of it as Roth, though it costs more taxes now. 

Food for thought on how a 401(k) can REALLY work for an investor.

@David C.   You are right, tax deferred will work best for the average investor or wage earner who plans on getting by on less than their current salary. And many do that. I plan on enjoying life when I retire.

Putting your money in a 401K with an employee match is a no brainer. A better question is whether to put your profits from REI into the stock market vs Buying more property vs some hybrid approach. It might be an age dependent question, as in the closer to retirement the more conservative strategy is more attractive.

@Walt Payne  

I was liking your post until the "getting by" and "enjoying life" parts.  You are implying that those that need less than their current salary during retirement won't be enjoying life. 

Originally posted by Account Closed:

@Walt Payne 

I was liking your post until the "getting by" and "enjoying life" parts.  You are implying that those that need less than their current salary during retirement won't be enjoying life. 

That assumption is not necessarily true, I agree. And not one I was making. Just that there are activities and travel destinations that I have delayed until after retirement. So for me, the additional income is part of the plan and compensation for pleasures not indulged in yet. 

That said, too many people do just "get by" in retirement. Not by intent, but because of choices made before retirement. My choices will allow me to live without financial restrictions inhibiting my preferred activities.

@Walt Payne  don't sacrifice too much, you never know how long you'll live. If you are in the position where you might face very high tax rates in retirement, I'd say you have saved too much ;)

I sat next to a guy who did his pension calculation every day.  He died about a year before retirement from his government job.  A life spent calculating something he never saw.

@David C.   The anticipated tax rates are more because of recent investments going very well, and a business that I plan on phasing over responsibility to my son in exchange for a nice percentage of the profits. 

I have not given up a lot, just a few expensive indulgences. Things like a month long trip to Australia and New Zealand, a few expensive camera gadgets that I want, etc. But that is also why I am retiring at age 58, rather than the way most do it. I want to retire while still young enough to enjoy life.

I would say Pro.  I was contributing long before I had a need for the money for RE, and my company matches 6%, so that's a good deal of money.  I have taken multiple 401k loans to fund RE deals, I think I get 4% or so, which is kind of silly considering I'm paying interest to borrow my own money, but oh well.

Originally posted by @Marcus Johnson :

Scott Trench so are you saying when you make a 20% return your saving all of that money in what? Or are you reinvesting it into another deal and making another 20% and so on. If so, how long have you been successfully making 20%+, seems like the best ROI I've ever heard. Your net worth must be astronomical. Please write a book, I'd love to hear your story.

I'm somewhat confused here. Not sure what you're referring to here. Could you please be more specific? I certainly point out that the 401(k) contribution immediately reduces your tax bill by 20-25% in the first year. That is an instant ROI that you can repeat every year AND you can still invest 401(k) funds intelligently - there is no reason you have to invest in a high fee mutual fund like others have inferred in this thread. If I could find an investment that could beat a 25% instant reduction in expenses (which I consider to be an ROI) that consistently, I'd definitely want to invest in that!

I am sort of pro 401K at least up to the company match.  However, I am at a different point as I am 60 and retired.  My problem now is how to get the money out in the best way that will minimize my taxes.  Owning real estate is helpful since I can help reduce my taxable income to some extent (improvements, necessary expenses, etc.).  

Originally posted by @Eric Taylor :

Putting your money in a 401K with an employee match is a no brainer. A better question is whether to put your profits from REI into the stock market vs Buying more property vs some hybrid approach. It might be an age dependent question, as in the closer to retirement the more conservative strategy is more attractive.

Eric,

I actually do put alot of my profits from my passive rental income into the stock market. This serves two purposes:

For 1 it is diversifying my portfolio into additional investments such as REITS, utilities, MLPS, Blue Chips and BDCs which are all income generating investments for the most part.

and it also give me a hedge against my RE income portfolio.

As I get older I am looking for TRULY passive income in the form of distributions, dividends and appreciation.

I am still young now and love actively managing my portfolio of rentals but I can see myself at 65 or 70 wanting to either sell some RE and or pass it onto my children and hopefully by that time I will have built up a big enough portfolio of securities that will replace some of the passive income that my Real Estate threw off.

Working full time and having the RE income allows me to really max out the retirement accounts as well as invest in the tock market in a non tax sheltered account as well.

regards,

Chris

@Account Closed @David C.  I appreciate the reply, but please clarify where I used the word 'extreme'?  I did not us that language, you interjected it.   However you may refer to the tax code as 'extreme'.   The example of 35% is from the IRS Tax code, which ranges depending upon earnings, which is true.

I have an employer matched 401k up to 6% fully vested (which I am).  This is an interesting question though.  Pay the tax now, and leverage the money into real estate with a cash on cash return of 20+% or put it in the tax deferred account and earn on average 7-8% a year for 30 years...

I do not like the stock market.  Some say it's rigged, some say it isn't.  I think the market is too large to be 'rigged' entirely, like a puppeteer pulling strings. However, the big money moves markets and if you aren't on the same page you can get killed quickly. 

But the main reason I don't like the stock market is because I have no control on a company I purchase or a fund I own for the dividend.  I can't do much other than choose to buy a  stock or not.  With real estate I have a lot more control over the earnings of my money.  Not complete control, but a lot more than the stock market...

For the record I currently max out my 401k to get the most deduction on income that I can.

EDIT:  Someone mentioned 401k fees.  Slowly but surely the government is forcing banks to reveal more fees.  I tend to think most ordinary people with 401k accounts never look at what's going on with them other than maybe the quarterly statement, and then just look at what the account is worth.  If you research the 12 funds available to you, youwill see how many dollars per thousand you are charged a fee on.  It gets rather ridiculous with some of the funds.  Then the bank running the fund charges annual or quarterly fees.  Mine is through wells fargo, and I guess what's annoying is when the non-transparent fees start becoming transparent.  I thought my company paid the fees for the plan...but as you find out with business, the devil is in the detail.  The plan fee maybe, but not fund fees.

If you have an opportunity to save for a 401k without the company match, I say do it.

If your company provides you with a match, you're earning a risk & tax free rate of return that no investment could match.

If you have enough money for a ROTH IRA, do that too.

Stocks, Real Estate, Bonds, Annuities, and Commodities are all asset classes that tend to implode every now and then. It's ok to have more exposure in one asset class than another, but it's nice to have assets that are not 100% correlated in case the worst happens.

@Vince Beusan  

I used the word extreme because that is exactly what your example was.  You are using a tax rate in your comparison that the majority of 401k participants will NEVER incur.  There have been some posts in this thread from other people that are against 401k plans.  They provided reasons that supported their views.   You are providing a seriously flawed comparison and have no reliable data to support it. 

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