The Terrible Truth About the 401(k)

October 5th, 2007 • Related • Filed Under

Fed heavy handIn 2004, 92 million individuals in the United States owned mutual funds. That’s almost half of all U.S. households compared to only 6% of all households in 1980. 92% of those 92 million said they invested in mutual funds to save for retirement. The advent of tax-deferred vehicles like IRA’s and 401(k) plans helped encourage this growth of ‘forced savings’. But for young professionals, tax-deferred savings plans do not make sense. In fact, they don’t make sense for anyone but the government and financial institutions!

Why would a 20 or 30 something year old professional with a bright future want to put off paying taxes until retirement? Right now, most of us are in one of the bottom tax brackets (nothing to be ashamed of, it’s just the truth) where most of us pay less than 30% to the federal government in taxes. But I’m willing to bet that most of us, given the demographic of this site, will eventually be toward the top before retirement. In the top tax bracket, we can expect to pay upwards of 50% of net income. By investing in tax deferred vehicles right now we are saying that we plan to be living on less and living a lower relative lifestyle at retirement age than we do now. I don’t know about you, but I plan to be ballin’ by then. By deferring taxes, we will end up paying more in taxes later than if we were to just pay them now and get them over with.

The financial institutions want you to pay your taxes at retirement as well. That way they can charge you 30% or more in fees because there would be more cash in the acount. Right now, we are paying management fees on Uncle Sam’s money! And that is not tax deductible. I bet most of you don’t even know how much you’re paying in fees. I bet you just picked one of the funds your employer offered you and haven’t look at them since. Hey, there’s no shame in that, the only shame is in not doing anything about it.

Get educated, get involved and take control.

And stay tuned for some low cost alternatives! Part 2

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    I'm not so sure I agree with anything you wrote. The problem with not contributing to a tax-deferred retirement plan is twofold. First contributing to a tax-deferred retirement plan lowers your current taxable income(which you acknowledged) secondly and probably more importantly is that if you put the money into a regular taxable account you would have to pay taxes on the growth of those dollars every year. So you get the double tax whammy. Also without forced savings, most people would not contribute at all. Our national savings rate is already negative and we ALL know that social security probably won't be there for us. Advising people to not contribute to a retirement plan is just bad, bad, bad. I'm not even sure what you were talking about when it comes to the 30 percent fees??
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    greg, i think i understand what you're implying. essentially, since tax is based on a percentage of your income, it makes sense to want to pay the least amount over your lifetime. you won't be doing that if you defer taxes when you make less and pay taxes when you make more.

    the other half of this story, which is something i'm sure you'll touch on, is that the best alternative for ybp's is a roth. you pay taxes now for the money that you contribute to the plan, but when you retire, all of the income from that plan is tax free. assuming you're in a higher bracket, you'll actually be paying less taxes.

    umo, i agree. savings accounts get the double, but roth ira's don't.

    the only dilemma with not utilizing your 401k is that you're missing the free money aspect of your employer match.

    maybe the analysis of taxes early vs. taxes later vs. dividends from free 'employer contributed' dollars is the third part that can be analyzed. maybe that is what you're alluding to at the end of the article?
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    I think the point everyone is missing is this. When you retire and take out money it is taxed as income--just like if you were working. The difference is that you get taxed on the amount you take out for that year. For example: I may have $500,000 in my retirement account when I turn 60. If I take out $50,ooo to pay my expenses for the year then I am taxed on that $50,000 not on the $500,000 in my account. So the $50,000 you take out for that year determines your tax bracket. NOT the $500,000 in your retirement account. Ya dig?
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