Is a 401k Worth It Anymore?

In several conversations lately, I’ve been mentioning the phrase, “You don’t know what you don’t know” quite often.

Take for instance, a 401k or any type of retirement plan that we’ve been told is the BEST investment strategy for retirement.

If this is the ONLY option you’re given, then that’s it, right?

When we’d eat out when our kids were younger, they’d ask us what they could drink. Their options were either water or water. That’s it. No other option. No cokes, sprites, or sweet tea. 

We didn’t want their teeth to rot out (even though I could fix them).  🙂

What retirement planning options were you given when you started working? I had a financial adviser try to set me up in a 401k along with other non-retirement accounts when I first started practicing.

No other options were given. 

He assumed that I was like his other dental clients. I’d work until I was 70 (or until my fingers couldn’t straighten out anymore).  In his mind, he had 40 years of charging fees for setting up accounts up front and them “managing” them my entire career.

It’s not a bad gig, it sounds like a “set it and forget it” commercial. But again, no other options were given.

Nothing about retiring early, real estate investments, side gigs, nothing. Why do you think that is? Is it because he wouldn’t benefit from it, or could it be that’s what everybody else does, so that’s what he’s going to recommend?

What do you think?

Before we go too much further, let’s discuss how a 401k works…..

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What is a 401K Plan?

One of the most popular investment options is a 401k. This is a tax-deferred savings plan offered through employers.

It allows employees to save a portion of each paycheck and invest it without tax dollars being taken out first. This tax-deductible contribution reduces the amount you’re taxed on in each paycheck, so the tax savings will partially offset the amount you deduct.

For example, if you contribute $100 from each paycheck, your paycheck will be less than $100 lower than if you didn’t contribute (because you won’t be paying taxes on the $100 dollars you contribute to the 401k).

Taxes are deferred until the money is withdrawn from the account when you reach age 59.5 years or older.

History of the 401k

In 1978, Congress passed the Revenue Act of 1978, which included a provision, Section 401(k), that allowed employees a tax-deferred easy way to receive compensation from bonuses or stock options. 

It wasn’t until the early 1980s when the IRS began allowing employees to contribute to a 401k via salary deductions.

This change created a major shift away from pension plans towards 401k plans when it comes to a retirement strategy.

Pension Protection Act

In 2006, President George W. Bush passed the Pension Protection Act to make sure that workers would receive the pensions that they were promised and to improve options for funding their own retirement. 

According to Investopedia, the act expanded on the protections provided by the Employee Retirement Income Security Act of 1974 (ERISA), which requires plans to keep their participants informed and makes it harder for bad actors to take advantage of people who are trying to save for retirement or earn a pension.

A key part of that legislation was to move employees away from defined benefit pension plans and toward 401k plans.

The goal of this act was to keep existing pension plans from folding, in part by pushing people into 401ks. Because the Pension Protection Act of 2006 allowed companies to automatically enroll their employees into 401k plans, it further facilitated their rise.

Let’s take a look at what some of the millionaire influencers have to say about 401ks…..

Grant Cardone – The 10X Guy

When I met with Grant Cardone last year, one of the topics he brought up had to do with a 401k.

If you’re unfamiliar with GC, he’s a self-made billionaire that, like Robert Kiyosaki, refuses to play by anyone else’s rules when it comes to money. 

One of his books highlights this exact concept called “Be Obsessed Or Be Average.”

He told me that he’d never invest money in a 401k. He said, “Jeff, why would it make sense to have my employer give me an extra $6,000 a year and then send it to Wall Street, where I can’t touch it for another 30 years?”

Cardone feels that retirement plans are nothing more than financial products that are “pushed” on us disguised as traps that prevent us from ever having a lot of money.

We’re always taught to save, save, save, but he feels that you can’t save your way to millionaire status.

In his “Be Obsessed Or Be Average” book, he writes, “Wall Street is telling you to invest early in little bites. They don’t believe in your ability to earn money. They have no faith in you. Instead of people investing first, they need to show their ability to produce more revenue. Why? People get rich because they produce revenue, not because they make little investments over time.”

Cardone’s Retirement Strategy

As you can imagine from someone who’s anti-401k, Cardone’s retirement strategy is a bit different from the norm.

His first step is for us to save $100,000 in good old-fashioned savings accounts. Why? Easy access.

After you’ve reached the $100k level, you can start investing to build real wealth now rather than later.

One of his companies, Cardone Capital, acquires high-end multifamily properties. At the time of our meeting together, he’d just purchased one for almost $300 million in Fort Lauderdale. 

Robert Kiyosaki and 401ks

Rich Dad Poor Dad author Robert Kiyosaki, like Grant Cardone, also thinks we should avoid investing in a 401k. He claims that most Americans have zero financial education.

So, what do they do because of this? That’s right. They blindly hand their money over to people who claim to be financial experts. Bad idea.

My soap box moment: Speaking of financial experts, a few years ago I saw a guy I went to high school with. He was the type that couldn’t hold a job longer than a few months and was back living with his parents.

I asked how he was doing and he told me he was excited as he recently was hired to begin his new career: a financial planner. 

Financial advisor? What? That statement literally sucked all of the oxygen out of my lungs. This showed me that there was ZERO regulation when it comes to the financial advising industry. Do they not perform background checks? 

This is like allowing a 500lb, donut-eating person to train Olympic athletes. Talk about a wake-up call!

Ok, I’m off my soap box now. 

Here are 4 reasons why Kiyosaki thinks 401ks are terrible for retirement:

#1. Taxes work against you.

Typically, the long-term capital gains are taxed at 15-20%. But with a 401k, you’re taxed much higher at the ordinary earned income tax rate. For many of us, that’s 37%+.

#2. The early withdrawal penalty.

Want early access to your 401k money before age 59.5? If so, then you’ll have to pay a 10% penalty. It appears that our government doesn’t trust us enough to manage our own money without having to pay to play.

#3. You can’t insure against a market crash.

In order to drive in Louisiana, I have to purchase car insurance. It’s the law. The same goes with real estate investing. When I invest in a property, I must have insurance in case of damage. Yet, the 401k investor has no insurance to prevent losses from market crashes.

#4. 401ks are for people who are planning to retire poor.

Why do you think financial advisors typically say, “When you retire, you’ll be taxed at a lower tax rate.”

They assume you’ll make less money when you retire and thus will be in a lower tax bracket.

Is a 401k Worth It Anymore?

Pros of 401k plans

#1. Easy to use

Most of the time, your employer can automatically enroll you.

#2. Potential company match

The majority of companies offer some sort of matching contribution for an average of 4.3% of a person’s pay. The most common match was 50 cents on the dollar.

#3. Decrease your tax liability

Each time you invest in a 401k, you may receive a small reduction in your tax liability which reduces what you owe to the IRS.

#4. Tax deferral

If over the course of your career, the value of your 401k increases, then you’ll be able to defer the taxes on those gains until making withdrawals.

Remember, this is one of the main reasons Kiyosaki feels that 401k plans are bad news. The 401k fund disbursements will be treated as ordinary income under whichever income tax bracket you fall into at that time the money is taken out.

If you’re a full time practicing 61-year-old doctor in the highest tax bracket (37%), then any withdrawals will be taxed at that top rate. 

Unfortunately, the IRS treats your entire 401K account (both the original contributions and any investment gains) as ordinary income. And don’t forget that you’ll also owe state taxes income taxes too.

How’s that for your financial future?

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Cons of 401k plans

#1. Access at 59.5 years

A big problem with a 401k is that you can’t access your funds until you’re at least 59.5.

Think about when you’re going to need money the most. Usually, during the years that you’re raising kids, right?

This is typically when living costs are highest, yet a 401k won’t be able to help out with any financial stability during this time.

#2. Delayed matching and vesting schedules

One of the main strategies employers implement is they delay their 401k matching for the first year of an employee’s time with them. Also, typically their vesting schedules are spread out over 4-6 years (six is the maximum allowed by law).

For example, Wells Fargo states that they match contributions, dollar for dollar, up to 6% of an employee’s pay on a quarterly basis after completing one year of service.

This works out great because the average length of employment is now only about 4 years.

If a company such as Wells Fargo delays 401k matching for one year when their employees stay only an average of four years, they eliminate the need to provide matching for approximately 25% of its workforce.

With regards to a vesting schedule, this means that an employer may require a certain number of years of service before its matching contributions belong to the employee.

Depending on your 401k plan terms and whether it has a vesting schedule, your employer may be able to recover some or all of its matching contributions. In short, it will take back money from you if you leave your job too soon.

#3. Limited investment options

Another con regarding 401k plans is that you’re restricted with what you can invest in. Your employer will provide a list of approved mutual or index funds and/or exchange-traded funds (ETFs).

Access to real estate, which is my favorite wealth-building tool, is nonexistent. 

The only way to do this would be to roll your plan into a self-directed plan if your employer would allow it.

#4. High fees

According to a TD Ameritrade survey:

• 37% of people don’t believe they pay any 401(k) fees
• 22% didn’t know about fees
• 14% don’t understand how to determine what fees they pay

Typically, 401k plan fees can range from 1-3% each year and fall into three main categories:

• Administrative fees
• Investment fees
• Individual service fees

Usually, the amount you’re paying is hard to find unless you read the different mutual fund prospectuses with a fine-toothed comb. 

#5. Not used by wealthy people

If you take a look at the Forbes list of The Richest People in the World, how many think they got there via a 401k plan?

That’s right, none.

These people take a much different path to building wealth. One of the more popular ways is via investing in income-producing investments.

Grant Cardone states that wealth is acquired by:

• increasing your income
• investing in income-producing assets
• protecting as much of your income as possible

Tony Robbins once said, “Success leaves clues.”

This means that you should focus on finding people you want to be like and model them. If your goal is financial freedom, then seek out those who have already accomplished this and use a similar approach yourself.

Bottom Line

Now that you’ve learned about how the 401k plan was started, the pros and cons, and how the wealthy really get rich, what do you think?

At best, these plans will provide a moderate retirement nest egg when you finally reach age 59.5.

But for those that strive for true wealth and financial freedom these are terrible investment vehicles.

There are plenty of other options that can make a big impact and provide cash flow to replace your income to free up your time. 

It’s now up to you to find the best option….

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FAQs

How does a 401k compare to other retirement savings options like Roth IRA and Traditional IRA?

A 401k is an employer-sponsored retirement plan, while Roth IRA and Traditional IRA are individual retirement accounts. One main reason people choose a 401k is the potential for “free money” through employer matching. However, Roth IRAs offer tax-free growth and withdrawals, while Traditional IRAs provide tax deductions on contributions. It’s essential to consult financial planners to determine which is the best fit for your retirement goals.

With the fluctuating stock market and past performance of mutual funds, is investing in a 401k still a good option?

While the stock market has its ups and downs, 401ks, especially those with target-date funds or diversified mutual funds, aim for long-term growth. The good news is that many plan sponsors offer a range of investment options, allowing you to adjust based on risk tolerance. Remember, past performance doesn’t guarantee future results, but consistent contributions and tax-deferred growth can be beneficial.

What are the tax advantages of contributing to a 401k, and how does it affect my taxable income?

One of the main benefits of a 401k is its tax advantages. Contributions reduce your taxable income for the year, leading to immediate tax savings. Additionally, the money grows tax-deferred, meaning you won’t pay taxes on gains until you withdraw them in retirement. This can be especially advantageous if you expect to be in a lower tax rate during retirement.

If I switch to a new job, what happens to the amount of money I’ve saved in my 401k?

If you change jobs, you have several options. You can leave the money in your old employer’s plan, roll it over into your new employer’s 401k, transfer it to a Traditional or Roth IRA, or even a SEP IRA if you’re self-employed. Rolling over avoids immediate tax consequences and penalties, and it’s essential to consider fees and investment options when making a decision.

Are there any catch-up contributions available for those closer to retirement, and how much money can they contribute?

Yes, if you’re 50 or older, you can make catch-up contributions to your 401k. This allows you to contribute more than the standard limit, helping you boost your retirement savings. The exact amount can vary yearly, so it’s good to check current limits and consult with financial planners to maximize your contributions.