Managing Partner of Max It Out Retirement | Big-picture thinker driven by helping people who work hard for their money keep more of it
Long-term savings plans, by definition, are plans that help employees and employers meet savings goals that are five or more years away. The goals are typically retirement, college education or saving for a house. Common long-term savings vehicles for meeting these goals are 529 accounts for college savings and 401(k) accounts for retirement. Seems pretty simple, right?
As most savers know, with a 401(k), funds are contributed from your paycheck and not included in taxable income in the here and now. IRS rules limit access to the plan prior to age 59 ½, and distributed funds before that time are heavily penalized then taxed. Your nest egg will also be heavily taxed at retirement. Because tax rates are at an all-time low, it’s almost a guarantee that hard-earned savings will be taxed significantly more at distribution, allowing you to take home even less.
Of course, 401(k) plans aren’t necessarily bad, but there are four common misconceptions that are worth exploring before you blindly contribute.
1. 401(k) plans must always be utilized.
Perhaps you’re in the market for a new job, and you’re comparing the merits of joining one company versus another. Maybe the salary is the same, but one company offers a 401(k) plan and the other does not. Prevailing wisdom would say: “That’s a no-brainer. Take the job with the 401(k).” This counsel is wise, but only if the said company offers a match which, essentially, is free money for you. But hear me out. I believe 401(k) plans do not need to be utilized. Not utilizing one doesn’t make you a poor planner, uninformed or “bad” with money management. There are other beneficial and flexible long-term savings and retirement plans to consider that might even be better.
2. The 401(k) is the gold standard of retirement savings plans.
This is another misconception I encourage folks to challenge. The IRS began to allow 401(k) plans in 1978. Back then, a middle-class earner was paying effectively 55% of their income to taxes. With tax rates so high, it made sense to put a percentage of their salaries into a 401(k) where taxes were deferred to later. Today, with effective tax rates in the teens for the same middle-class earner, it is a near guarantee that tax rates will be higher at retirement time, meaning well-intentioned 401(k) holders will take home significantly less at retirement time.
3. Work hard, and your job will take care of you.
At my company, we often tell clients that their savings plans are not their parents’ retirement strategies. Why do we say that? Because, quite simply, young professionals aren’t living in the same financial environment their parents did when they were growing their families. Our elders had benefits packages that included health insurance and pensions, essentially guaranteeing security through the end of life. Most jobs of today — unless you’re a cop, firefighter or teacher — don’t have a benefits package for life, certainly don’t offer pensions and rarely even match a 401(k). It’s up to employees and employers to ensure they’re saving smartly for their family’s future. The job won’t do that anymore.
4. Retirement dollars aren’t needed until retirement age.
The current, full retirement age is 66+ years, and that age is increasing. Very few people plan to work that late into life or want to work that late into life. Even 59 ½ is a long way off for those who have been working hard since the age of 21 (or younger). Retirement money that’s been saved in the form of a 401(k), additionally, can only be used for retirement, but life is long and monetary needs can vary. Employees can look at other options that will allow them to use their money before retirement. For example, my company suggests individuals put 401 and 529 together to create the 930 Plan.
Employees and employers want smart, tax-advantaged savings plans that eliminate risk and optimize the sequence of returns for taxation. I encourage all individuals to do a deeper dive into 401(k) plans to determine if that’s what’s right for them or if there is another way to safeguard their financial future.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.