Wednesday, July 31, 2013

The Problems with Your 401K

Over the years I've written numerous articles and made posts regarding qualified retirement plans and the problems associated with 401(k)'s. These articles are based on research and real life experiences. Primarily these problems reside in the fact that the IRS and Congress are constantly changing the rules regarding qualified plans, so it makes it difficult to plan.

However, when you investigate how the 401(k) operates, you'll find there are many other problems. While the list could be long, I've narrowed it down to 3 major problems.

The Problems with Your 401(k)

1. Control - not only do you not have control over the performance of the financial vehicle your 401(k) is invested in, you have no control of the rules regarding the plan itself. The IRS makes the rules and they change the rules... regularly. Along with Congress, the IRS makes changes to the tax code and the rules associated with contributions and distributions on a regular basis. Since its' inception in 1978 there have been changes practically every year regarding contributions, tax thresholds and plan administration. Here are the basic rules from the IRS website for 2013.

2. Fees - the fees associated with the 401(k) have been hidden from the public for years. These fees come in many forms, some are hidden and some are disclosed. There are management fees, portfolio management fees, administrative fees, trade commissions, sales charges, record keeping and many more. In the past, many of these did not even have to be disclosed, so you may never have known that you were being charged. In recent years congress has passed legislation that was supposed to add transparency and force the financial institutions to disclose such fees. But, as they usually do, the financial institutions have found ways around the rules. For instance, Target Dated Funds which have become the "default" investment for most plans, can charge as much as 25% in fees! Target date funds are complex, risky, hard to understand and have no guarantees. In fact, we could devote this entire post to TDF's, but I'll save that for another time. For additional reading, a recent article in Forbes highlighted some of the problems associated with target dated funds: 

3. Risk - while there are many risks involved with a 401(k), perhaps the most relevant is the risk of losing your investment. Since the majority of 401(k)'s are invested in mutual funds, there is the risk of loss. Most people would be upset if they lost a $100 from their wallet, yet they can have tens of thousands vanish via the stock markets and barely notice. More often than not when the statement comes in, it is neatly filed away somewhere without much attention. And, because of the regular contribution to the plan, most people will think their plan has increased. But, on closer examination there may have been losses. These losses can be devastating to anyone trying to plan for retirement, and they can come at any time. For example, in 2008, 2009 many investors lost up to 50% of their balances in their 401(k)'s. Can you recover from a loss that big? Depending on you where you are in life, this is not the kind of risk you likely want to take. Unfortunately, the Federal Reserve has made things even more difficult. By purchasing bonds through "quantitative easing", the Fed has added more volatility to the already unstable stock markets. Read more: 

In the big picture, 401(k)'s are qualified plans, along with IRA's ROTH's, 403(b)'s, ESOP's, SIMPLE's, SEP's and others. The illusion of these plans, or how they have been sold to the public, is that they save taxes.

In reality, Qualified Plans do two things. First, they defer the tax (but they do not necessarily save taxes). Second, they defer the tax calculation. Since the taxes are deferred, it is misleading to use the phrase “Saves Taxes” in conjunction with Qualified Plans. Since the calculation of taxes is deferred (until withdrawals start), qualified plans will work great if the you retire in a lower tax bracket than your current tax bracket. However, if you retire in a higher tax bracket, then the qualified plan has cost you money.  This is because you pay more taxes in the higher tax bracket. Do you want to make more money in the future or less? When you make more money, what happens to your tax bracket? Do you think tax rates are going up in the future?

After you ask yourself those questions and come to grips with reality, you can make a decision on whether or not you feel your 401(k) or other qualified retirement plan is a smart way to save money. The more important questions may involve some deep thought.

When considering your contribution to your 401(k), there are primarily 3 questions you should ask.
1. What tax bracket will you be in at retirement?
2. What deductions will you have when you take your money?
3. What is your exit strategy?

Since the government is constantly changing the rules, it's hard to determine your tax bracket or your deductions. And, many people are just planning on their money being there according to the nice prospectus given them by the plan administrator, so the exit strategy is "give me what's left."

Then consider these very important questions. What amount of your total contributions (cost basis) will be yours to spend net of taxes? This number may surprise you and there are NO GUARANTEES. Are you comfortable having your entire life's savings locked-up in a government plan for 30+ years and administered by a financial institution that needs your bailout money to prevent them from failing?

You do have alternatives. Once you take responsibility for your own financial future, you can make informed decisions based on your desires and abilities. You don’t have to be victimized by government rules, financial institutions, a volatile stock market or any of the other uncontrollable "ifs, ands, or buts". By educating yourself and following through on a course of action, you can change your financial forecast from gloomy to sunny. And, you'll be in charge of directing the course of your financial future.

Follow this link to learn more about your alternatives:

Until next time,
Barry Page
Legacy Insurance Agency, PLLC
Shield Financial Consulting
Family Bank Business

Barry Page is recognized as a leading expert on finance, life insurance and private banking. He is a financial consultant and independent life insurance agent who helps clients with tax advantaged investment alternatives. He specializes in showing families how to protect their assets, income and lives utilizing a macro-financial approach to planning.

His specialized knowledge and services help consumers find alternatives to traditional investing and the stock market that not only safely protects their savings, but also provide tax advantages. His business is based in Ocean Springs, Mississippi and he services clients throughout the United States.

Legacy Insurance Agency

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