July 24, 2020

Is the 401(k) Still Working?

The 401(k) plan, like all retirement plans, was meant to incentivize people to save for retirement.  It accomplished this by officially offering some big tax incentives. Put money into the plan and reap the benefits. What happens, though, when the tax environment changes and those benefits disappear? In a recent Bloomberg Op-Ed, Aaron Brown details the 401(k) shift and explains why investors might want to reconsider. 

What has changed with the 401(k)?
A lot of the high taxes that made the 401(k) structure so appealing have drastically dropped since its inception. Marginal federal tax rates have dropped by 72%, capital gains tax rates have plummeted to 0% for low wage earners, and interest rates have similarly declined. Mr. Brown calculates that in 1980 the 401(k) structure added an additional investment return of 9.2% while in today’s marketplace it comes out to 0.6%.   

That’s (obviously) a huge drop. So much so, the 401(k) structure is now costing participants rather than earning for them. The cost stems from the fact that a 401(k) is not a free enterprise. Rather, like all things financial, you have to pay (drumroll please) fees. Typical 401(k) fees are based on the plan’s assets and they run between 1-2%. Not bad, but still much higher than the 0.6% that the plan is adding to your account. In other words, if you did the same investments as a regular investor, and not as part of a 401(k), you’d come out with more money at the end.  

Adding additional pressure to the 401(k) platform is the emergence of really competitive index funds. Regular people (i.e. non-financial professionals) can now easily invest in a no-cost and tax efficient fund. Point and click and you’re most of the way there. 

Is the 401(k) still your best option?
If you’re in a 401(k) now, these are important factors to consider. If you’re getting an employer match, (which you can’t get outside of the plan,) then chances are it’s still more profitable for you to remain in the plan. However, if you’re exploring your options, then run the numbers! You can also get involved in some political activism that would benefit your bottom line. Engage your politicians on the really boring topic of retirement savings. Tell them to drop the taxes on 401(k) plans or else allow workers to easily roll over their plans into a Self Directed IRA. That would provide the free market forces necessary to make the 401(k) competitive – and profitable – once again. 

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