Garrett B. Gunderson
You don't think you're playing with your money when it's in a 401(k), but your 401(k) money may definitely be toying with you. In fact, that supposedly dependable 401(k) is not your best choice for retirement. Not by a long shot.
I've worked with hundreds of health professionals, and most of them diligently save in a 401(k). But once I explain its risks, they're eager for alternatives.
Consider these 13 dangers of a 401(k):
- No Cash Flow. The theory is that the money compounds, but this really means it stagnates. Most people will not choose to utilize these funds even when a compelling opportunity will make them far more money than the 401(k) would, even when you account for the penalties. Numerous legitimate opportunities are passed by as people stay "in it for the long haul."
- Lack of Liquidity. The money in a 401(k) is tied up with penalties attached for early withdrawal, unless you know how to safely navigate specific, obscure IRS codes for penalty-free withdrawals.
- Market Dependency. The performance of the funds depends on uncontrollable market factors. As a result, your retirement plans are based on unknowable projections. Do you want to live your ideal life only if the market cooperates?
- Lack of Knowledge. How much do you really know about your 401(k)? Do you know the funds in which you're invested? Do you know the details of the companies inside those funds? Do you know the fund manager's philosophy, history and performance? How can you expect to gain a return from something that you know so little about? And how can this be called investing? It's not investing. It's gambling.
- Administrative Fees. The funds are subject to various (and usually hidden) administrative fees in addition to expense ratios and 12-b1 fees. This fact is ignored by most contributors and advisors.
- Underutilization Because of Tax Deferral. If you don't like paying taxes today, why would you want to pay more taxes in the future? The tax deferral aspect of the 401(k), which is touted as a great boon, is actually a primary factor contributing to its underutilization. Most retirees let the money sit for fear of triggering burdensome tax consequences.
- Higher Tax Brackets Upon Withdrawal. It's ironic that people anticipate that they'll have healthy returns on their qualified plan, while at the same time they figure that at retirement they'll be in a lower tax bracket. If you have achieved any measure of success, you should actually be in a higher tax bracket at retirement. Most advisors, however, assume the opposite. Do you think taxes will be higher or lower in the future? Deferring your taxes results in a far greater tax burden than you'd incur if you used different products and strategies.
- Estate Taxes. Frankly, 401(k)s are sitting ducks for predatory estate taxes. Much 401(k) money is never utilized because contributors don't make withdrawals because they fear paying taxes. Yet when the money is passed on to the next generation, there is not only a likely income tax on it, but also an estate tax.
- No Exit Strategy. Getting into a 401(k) seems simple enough. But how are you going to get out of it? Do you understand the penalties and tax consequences?
- Subject to Government Control and Change. You may be surprised to learn this, but your 401(k) does not even technically belong to you. Read the fine print and you will find "FBO" (For Benefit Of). It's technically owned by the government, but provided for your benefit. It's essentially a tax code. Judging by history, 401(k)s are in great jeopardy. What will keep the government from changing the rules and taking your hard-earned money?
- Disinvesting. Suppose you've retired and begin taking interest payments from your 401(k). You project you can withdraw 6% a year, based on an average annual return of 8%. But what happens to your principal when the market is volatile? If in one year your fund is down 10%, you're tapping into your principal to take your interest withdrawal. At that point, you have only two choices: start withdrawing principal or leave the money alone until your account is up again. You're at the mercy of the markets.
- No Comprehensive Plan. I've witnessed many people whose finances are in shambles, yet who continue to contribute diligently to their 401(k) plans. It's like someone with a slit wrist tending to a scraped knee. You need a macroeconomic plan (that is, a big-picture plan) that identifies, prioritizes and manages all pieces of their financial puzzle, with all pieces coordinated and working together.
- Neglect of Stewardship. Their 401(k) plans cause contributors to abdicate their responsibility. They think they can just throw enough money at the "experts" and somehow, 30 years later, they'll end up with a lot of money. When things don't turn out that way they blame others.
Interestingly, traditional media is now finally realizing the risks as well. For example, see the "60 Minutes" special, "Retirement Dreams Disappear With 401(k)s" and the Time magazine article, "Why It's Time to Retire the 401(k)." Saving for retirement is wise and prudent, but other investment philosophies, products, and strategies will meet your financial objectives much more quickly and safely than a 401(k).
