I think everyone, at sometime or another, has heard that they should max out your 401k. Well I’m here to give you a few reasons to think about that. At the very least, think of who profits from that message. The investment companies profit, the administrators of the plans profit, and I’ll even argue that the government wanted you to do it. I say wanted because I think times have changed and so they have adjusted. With record governmental debt I think they now want your money sooner so they offered the Roth 401k. I hate to tell you but I think the government puts their own interests ahead of yours.
Now I’m not telling you to not contribute to a 401k I’m just saying not to max it out. I usually tell people to contribute up to the company match. That’s it. So here’s my reasons…
1. Government Rules
I don’t like anyone telling me what I can do with my money. I don’t like them telling me at what age I can access it. I don’t like them telling me that I have to take it at a certain point. I’ve worked hard for my money, I want to dictate what I’m going to do with it. I can get tax-deferred growth in other accounts. At least in a Roth IRA I can access contributions.
2. Plan Documents
Have you ever read your 401k’s plan documents? Did you know they can further limit the access of your money? They can dictate how you access your money. This paper work is long and full of legal jargon and essetially governs your money including access, fees, contributions, investments and more. Yes, the government controls plan documents in some areas but they also give a lot of leeway in other areas.
3. Fees
Do you even know what your 401k fees are? Chances are your company doesn’t either. The government is working on trying to make these more transparent. The bigger the company you work for the lower the fees, probably. The tricky thing about 401k fees are that they can come right off the performance. The fund earns 8% and your account is only credited 7% because you just paid 1% in fees. That doesn’t show up as a line on your statement. Also these fees can change at any time, see number 2. Maybe in tough times the company doesn’t want to pay a penny for the 401k so they pass all the costs onto the participants(you). Maybe you see a line on your statement that comes out of the account or maybe you never see it. Are you getting the picture?
4. Tax Saving Fallacy
By contributing to a 401k you do not save taxes, you defer taxes. That means that if all things are equal you will have the same amount of money in the end with a traditional 401k as with a Roth 401k. Ever dollar you put into a 401k has an IOU associated with it. When you access that dollar the IRS wants a percentage of it as an IOU. As your dollar grows, so doesn’t their IOU. So then what are the tax variables: tax rates & tax brackets. Who controls this? The government. Where do you think taxes will go in the future? Up or down?
5. Tax Management
This brings me to my next point. Take control of your taxes. You can manage your taxes. Manage them today, tomorrow, in the future and especially, in retirement. If all your money goes into your traditional 401k then it is all taxable in retirement. That means everything you withdraw is reported as taxable income. My guess is you will be out of deductions. No dependents, no work expenses, smaller mortgage if at all. That could easily mean more taxes on a smaller amount of taxable income. Then your social security, if it’s still around, can be taxed as well.
6. Diversification
Is this a dreaded word now? I’m hearing people say diversification is dead. I think that’s funny because bonds have outperformed stock right? So if you were diversified between the two you shouldn’t have lost 60% right? The problem in 401ks is that you get very limited options within an asset class. Yes, your plan might have every asset class covered but who knows how good the funds within an asset class can be. 401k companies tend to favor certain fund families especially if it’s a mutual fund company that handles the investments. Fidelity wants their funds in the plan and so doesn’t every other fund company. Yes, Fidelity has good funds but not in every asset class.
That’s my list, what do you think? As a side note on diversification, maybe you want to diversify outside of traditional asset classes. Most 401ks don’t give you the option to. Let’s not forget the two biggest advantages of a 401k, the match and payroll deductions. Take the match. It’s great that the money comes out of your paycheck automatically without you ever getting to touch it. So if you aren’t going to rely on just your 401k you will have to use some self restraint. Is that plausible for you?
Don’t forget the first principle of the Evolution of Wealth: The power of LUC (Liquidity, Use and Control)!
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Very good article! And, I couldn’t agree, more, with your position on the tax issue. With the national debt at $11.734 TRILLION dollars, taxes have nowhere to go but up in order to keep inflation at bay while keeping the U.S. solvent.
I’m going to forward this to my wife (who was already of this opinion.)
John Scott Smith
@JohnScottSmith
Sorry, I disagree. Yes, you give up liquidity – but you gain sooo much because of the power of tax savings and tax deferred growth. Obviously you should have other liquid assets too.
401Kplans have more investment options to choose from than ever before–if you want wealth —-fast and without having to risk everything- then max out on your 401K.
Thank you for your comment. You are welcome to disagree. I’m actually a supporter of 401ks when used properly. I just find so many people only use a 401k. They put all there money into it thinking it will be their retirement savior. It’s marketed by all the financial companies as the best thing for retirement and it can be when used properly. The financial companies just want your money because that’s how they make money.
I do have to really disagree with your last statement because a 401k does NOT necessarily help you grow wealth “fast and without having to risk everything”.
Great post! keep them comin… thanks for all your hard work.
Thank you for giving me the idea for the post. I’m glad you enjoyed it. Let me know what your wife thinks of it. I love hearing people’s take.
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