By Jason I. Henderson, Ph.D.
To suggest that the 401(k) is not a good vehicle for retirement savings takes a fair amount of courage, considering the intensely fractious response such a statement garners from a lengthy list of “expert” financial advisors. Knight Kiplinger for instance, boldly proclaims “It’s time to make the 401(k) mandatory, with every employer offering a plan and both
employer and employee required to contribute.” (Read more here.)
His basic premise holds that everyone who doesn’t properly plan for retirement will be a burden on others. And while I do think it vitally important that people be financially self sufficient, I could NOT be more adamantly opposed to his supposition that any plan should be mandatory, nor that participating in a 401(k) is “properly preparing.”
So let’s check 401(k)’s against our list from the cover article. Aside from the fact that your money is held hostage (no liquidity) in an account that charges penalties for “early withdrawal” and can not be used for collateral to obtain other money if necessary, there are some pretty major misunderstandings about these types of government accounts.
The first baby boomers to retire with 401(k) accounts are now finding out the truth. Most expected to have at least $1,000,000 dollars for retirement after 30 years of contributions. The harsh reality is quite different. The average 401(k) provides only $60,000 at retirement – just barely above one year’s worth of their annual salary, and certainly not enough to live on for 20+ years.
So what happened? Where did all the money go? Why were these well intentioned folks so unprepared for their retirement years despite the fact that
they have been contributing to “savings” accounts for more than 3 decades?
First of all, because 401(k)’s are tied to the market. If you had planned to retire during the last 11 years or so, you undoubtedly understand all too well why this is dangerous. By investing your savings in a 401(k), you are gambling in stocks that “experts” choose for you, banking on those stocks going up in value in order to reach your retirement goals.
Ask anyone you know what happened to the value of their retirement accounts in 2008. I have not yet met a single soul who didn’t lose at least 10% of their TOTAL savings in 401(k)’s that year. Most people lost closer to 40%. Investing in the market is one thing; it should be done with money you can afford to lose, because that is what often happens. When it comes to saving for retirement, you want certainty (guarantees). A 401(k) can never provide that.
The big “carrot” used to entice people to invest in these types of accounts though, is the money saved in taxes. So, let’s assume for the moment, that you start at age 50 and save $5,000 per year until you are 60. We’ll also assume that whatever stocks your fund manager has chosen for you, perform well and you see a long term growth in your account of 6%. (These are just random, but reasonable numbers.) On the day of your retirement party, your account value would be $69,858.21; but how much of that do you get to keep after paying your “deferred” taxes? The answer: $48,900.75.
Did you get that? You have scrimped and saved and put $50,000 in your account, and even gotten a decent rate of return, only to wind up with LESS than you put in. Thank you Uncle Sam. So exactly who is this account supposed to benefit?
To add insult to injury, those numbers don’t include fees – either those advertised, or the hidden ones. Companies such as Fidelity, John Hancock, Nationwide, advertise fees on such accounts to be .1 of 1% of your total investments. That’s negligible, right? A close investigation however, clearly shows that hidden fees are sometimes as much as 3000 times that amount, or 3.5%. This still doesn’t seem like much to worry about, but do the math – fees of only 2% can eat up more than half your account value.
The truth is, 401(k)’s were designed to make money – for the institutions and for the government. And they do make LOTS of it, whether or not YOU do