Here's a question for you: Did you know that until the 1980s the 401K was meant to be only a supplement to the pension plan offered by your employer, and that it was initially only for top executives who needed a place to stash pre-tax dollars to bring their income tax rate down?
Then in the 1980s - everything changed when someone said, "Hey, we can take the pension monkey (and the cost to the company) off our backs and shift the burden of saving for retirement to the employee by using the 401K (403B for non-profits) as the primary retirement vehicle."
With the stock market on the rise - it seemed like a good idea at the time. Employers, the financial investment industry and a few other folks, namely the government liked the idea. As willing sheep, we went along with it - because after all the market was rising all the time. But, as they say, time will tell - as it always does.
Fast forward to 2013. Now a good portion of the workforce is fa 
cing retirement and they don't have enough money saved. In a recent PBS.org interview with author Helaine Olen, she points out that most people approaching retirement have only $100,000 in retirement savings. Those who are more well off have between $200,000 and $300,000. Financial planners are estimating that you need upwards of $1 million if you want to maintain a similar middle class lifestyle to the one you have now.
Except there's one flaw in the ointment: no one can predict how long you are going to live. The longer you live, the more you need - not just to maintain your lifestyle but to handle the healthcare issues as you age. Very few people are prepared at retirement for long-term care, in-home care or other levels of care that might beset them once they're in the 80s, 90s or beyond.
Feeling Fearful of Your 401K ...
What do you do for a living? Doctor, lawyer, consultant, office worker, software developer - it makes no difference - whatever you do, you're an expert in your field. During the pension days, your company made the decisions about how to invest their employees' money. They hired knowledgeable financial experts to invest and manage the pension fund and employees felt their money was being well managed. The risk for the success of the pension fund was on the back of the company and the financial investment professionals they hired.
Enter the 401K as a mass-market retirement vehicle to replace pensions. With the 401K system, employees have to figure out how much to put into the 401K annually, where to invest the money and whether they are saving enough to manage retirement. Under this simple change, the burden of risk shifts entirely onto the backs of the employees.
Most employees went out and hired financial planners or other financial investment professional to help manage their plans. With the market going up all the time, they didn't mind forking over one or two percent to a broker to manage their portfolio.
But, when the market took a turn for the worse, became sluggish, or you or your broker picked the wrong set of stocks or mutual funds, the value of the 401K dropped. That one or two percent paid to broker began to eat away at retirement savings.
How many of you went to bed one night with a few hundred thousand dollars in your 401K and woke up the next morning broke or close to it? In the past 30 years, there have been three market crashes that turned well-off middle-income people into not so well-off lower income people, with little to show for years of hard work.
Given what we've seen in the past 30 years, why would anyone put money into a fund that ...
- Only allows you to take it out at a certain age;
- Penalizes you twice to use your own money if you take it out before the withdrawal age (59 1/2) because you suddenly need access to the money for reasons like you've been laid off, had an unexpected expense or other financial crisis - you pay the early withdrawal penalty to use your own money, and if you decide not to take it out and you borrow the money elsewhere, you are paying interest to whoever you borrowed from.
- Penalizes you when you finally reach the withdrawal age (59 1/2) because the value of the dollar has decreased making your investment worth less, while the taxes you will now pay on it have gone up from when you actually put the money into the 401K;
- Forces you to take out at a certain age (70 1/2), even if you don't want to or need to, causing you to pay taxes at a higher rate on money that is lower in value???
- Potentially doubles or triples taxes on the same money if you take a loan from your retirement fund with the intention to actually put the money back. It's a bit complicated and we'll do a future newsletter on this conundrum.
This does not sound like a good deal - it sounds like a shell game where the winners are the government and the financial investment firms and the big loser is you. Take a look at this November 2012 article by Elizabeth O'Brien of MarketWatch and find out exactly how much you don't know about your 401K plan and how much they don't want you to know.
Remember folks, for every 401K out there, the government owns 30% or more of that money. No matter what you think you have - the number is a lot lower and the value of those dollars is going down every day.
Nine years ago, the client was unexpected laid off from her job. It took a few months before she could drum up some freelance business, and that combined with unemployment, was not quite enough to handle her monthly nut. So she decided to borrow from her KEOGH account, the equivalent of a 401K for a small business owner. She paid both a penalty for early withdrawal and the deferred taxes for withdrawing early, which ultimately left her very little to tide her over until she could either find a job or restart her small business. She learned her lesson - never again.