In the modern American economy, it’s become a common place practice for people to save for retirement using a 401(k) and for employers to offer a percentile match to that 401(k) rather than setting up a pension for their employees. Naturally, there are hundreds of companies who advise funneling money into a 401(k) account and letting it ride the market waves so that when you retire, you’re sitting on a nest egg that you can ride through the twilight years of your life. There is only one problem with this process: it’s broken. It might seem appealing to put your money into a tax deferred account that’s supposed to earn guaranteed returns and grow your wealth safely so you can retire, but the truth is that a 401(k) is not the golden egg that wealth advisors try to tell you it is. Factum Financial has compiled a list of six 401(k) basics that no money man is telling you.
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- The Fees Don’t Outweigh The Benefits This is one of the 401(k) basics that should be obvious, but a lot of money managers will not tell you. Many people that have a 401(k) just see it as an added benefit of joining a company, especially if that company promises some kind of match on the contributed funds and they don’t question what happens with the money they deposit into it every month. Indeed, like many things in the digital age, people have a tendency to automate the contributions out of their monthly pay before they ever see their pay check. What most people don’t realize is that money they are investing into their retirement plans changes hands several times and every person takes their cut. Like sharks waiting for the chum in the water they line up and before you know it they are skimming nearly 2% off the top of every $1000 dollars invested, which adds up to a nice little nest egg for them over the life of a 401(k). Now think about how many people use this method of saving for retirement and you will realize why people get into the money management business in the first place. It’s definitely not to help you.
- You Can’t Use Your 401(k) As An Emergency Fund Here is one of the 401(k) basics that they will tell you, but only because they don’t want you to take any money out of their pool of cash. Life happens to us all and sometimes the money just isn’t there when you need it. Perhaps you have a major medical emergency or a sudden layoff or even a sudden death with costs that need to be covered. If your bank account is looking a little thin, you might be tempted to turn to your 401(k) where you have funds saved up. Unfortunately for you, that money is pretty much locked up unless you want to pay exorbitant fees. If you are younger than 59 ½, it will cost you 10% as a tax penalty of whatever amount you take out, plus that money now has to count as income. That means that even a small 401(k) loan could put you into a new tax bracket and mess up your finances for even longer.
- You Can’t Access Any Of Your Funds Building on the last point, let’s say that there is not an emergency in your life, but there is still some expense that you would like to have money for. Perhaps you want to remodel the kitchen, build a swimming pool or buy that dream car you want. You should be able to use your money the way that you want, but 401(k) basics dictate that money is not going to be readily available to you even though it’s yours. Most companies might let you take a 401(k) loan, but they are often restricted to 50% of your vested interest, meaning that if you have $40,000 saved up, the maximum you could borrow is $20,000. While your loans are in repayment, you won’t be making contributions to your retirement plan, which could have a big effect on your savings, even if it only takes you two years to pay off the loan. If for some reason you do take a loan and then fall on financial hard times and can’t make your payment, that counts as a distribution and that money becomes taxable with that 10% penalty discussed earlier. And if that’s not enough to make it clear that your not allowed to use your own money when you need it, most plans require you to pay policy loans back before you can change jobs.
- Future Taxes Are Going To Cripple You One of the selling points that 401(k) believers try sell you on is that all funds you deposit are tax deferred. That’s one of the first 401(k) basics that financial advisors bring up. You might think that’s the government being benevolent, but it’s not they. They know the secret that no one else is pointing out to you: You’re still going to have to pay taxes on that income and it’s likely going to be more than you would have to pay now. When you retire and pull money out of your retirement savings, that becomes part of your income and if you saved substantially, that along with your social security could bump you into a higher tax bracket and cripple you with tax debt when you are no longer making a wage.
- Returns Are Never As High As They Promise The financial gurus will try to promise pie-in-the-sky returns of 8%, or more on the money that you invest in the market, which sounds like an awesome annual growth rate if there was any consistency. The trouble with the market is that it almost never pays out what people predict. If you pay any attention to the stock market on a daily basis, you know that it’s always shifting. If you tried to tell people that a pony at the race tracks that loses races 50% or even 30% of the time was a sure thing, they would come looking for you in the parking lot after the race, but these financial sharks have convinced people that 401(k) growth is a sure thing, but it’s just never that consistent. Often times investors are barely competing with inflation and sometimes they are falling way behind.
- Your Money Is Always At Risk While markets have been stable for some time, past data has shown that every four to eight years, the market dips and were due for some level of recession. It’s been ten years and as the market looks stronger and stronger, more and more economists are pointing to the warning signs that a recession is on the horizon. Millions of people lost 30% or more of their retirement savings in the last market crash. If you’re nearing retirement age, that’s a hit you don’t have time to absorb. That’s provided that the economy can ever make back those losses.