Why You Shouldn't Max Your 401(k)(ofdollarsanddata.com)
ofdollarsanddata.com
Why You Shouldn't Max Your 401(k)
https://ofdollarsanddata.com/should-i-max-out-my-401k/
32 comments
This article makes a major mistake when addressing the benefits of a traditional 401k. When you contribute, you avoid paying taxes at your marginal rate and when you withdraw (for most people at least, who will fund their retirement primarily through 401k withdraw) you pay taxes at your overall rate. The article also treats tax uncertainty as if it only applies to income taxes while it's completely plausible that taxes on capital gains could be increased in the future as well.
Aren't 401k withdrawals still taxed as ordinary income? Therefore part or all of it could still be taxed at your marginal rate during retirement, it's just that the marginal rate should in theory be lower during retirement since you have less income.
The article mentioned the last point:
> I understand that you can make the same argument about taxable accounts and a rising capital gains rate. However, I would bet that capital gains rates will remain below ordinary income rates for the foreseeable future.
> I understand that you can make the same argument about taxable accounts and a rising capital gains rate. However, I would bet that capital gains rates will remain below ordinary income rates for the foreseeable future.
For 99% of people having money that is a) difficult to touch and b) never shows up in your bank account is actually an order of magnitude (or two) more important for retirement than 0.34% annualized return.
And his point on which path to take misses the point that for some people (and me at least) - my "annual pay" when I'm retired will be 50% or less than what I make now. When I'm not paying a mortgage, paying for college, or saving for retirement I'll need much less pay. Can I predict what the tax rate will be in 20 years at half my current pay? No. So I hedge and do both options.
And his point on which path to take misses the point that for some people (and me at least) - my "annual pay" when I'm retired will be 50% or less than what I make now. When I'm not paying a mortgage, paying for college, or saving for retirement I'll need much less pay. Can I predict what the tax rate will be in 20 years at half my current pay? No. So I hedge and do both options.
401ks are federally protected from creditors. If you’ve maxed your IRA(s), and you have discretionary income you want to invest further, it absolutely makes sense to fully fund your 401k annually. Yes, the funds are tied up but they’re also protected against most creditors and judgements.
With that said, the vast majority of Americans would be better served with the 401k being deprecated, IRA limits increased, and IRAs receiving the creditor protection at the federal level 401ks currently have. This eliminates the need for employers to sponsor a 401k plan; an IRA is as easy as opening an account with any discount brokerage (which there are many of). This also eliminates the captive audience problem where 401k plans have higher expense ratios than investment options available in IRA or taxable accounts.
With that said, the vast majority of Americans would be better served with the 401k being deprecated, IRA limits increased, and IRAs receiving the creditor protection at the federal level 401ks currently have. This eliminates the need for employers to sponsor a 401k plan; an IRA is as easy as opening an account with any discount brokerage (which there are many of). This also eliminates the captive audience problem where 401k plans have higher expense ratios than investment options available in IRA or taxable accounts.
Creditor protection is a good point, and as for IRAs - Lots of people who read Hacker News can't contribute at all due to income limits.
My serious worry is that if the average American follows this advice they will lease a new car every 2 years and go to Hawaii every year - and when they are 65 will all want a retirement bailout from people who actually saved money. There's nothing preventing Congress from deciding to tax Roth in 20 years in this scenario.
My serious worry is that if the average American follows this advice they will lease a new car every 2 years and go to Hawaii every year - and when they are 65 will all want a retirement bailout from people who actually saved money. There's nothing preventing Congress from deciding to tax Roth in 20 years in this scenario.
You're not wrong. The retirement situation (excuse my french) is seriously fucked through a combination of events [1] [2] [3]. Pensions were great, because you couldn't ransack them as a participant. Social security is great because you can't cash it out. Most Americans can't or don't save enough for retirement (as humans, we suck at planning for the future, at least most of us), and a large proportion if the retired population lives on and is kept out of poverty by Social Security [4]. Pensions could have been sustainable with more realistic return assumptions, greater contributions from plan participants, and strong firewalls between the corporate sponsor and the plan. Instead, 401ks were sold to everyone and things turned out about how you'd expect.
With that said, I think making tax advantaged accounts more accessible to your average person is a net win, even if we have a lot of work left to do to encourage good long term financial planning and behavior. Some policy I've been modeling is if you take an early distribution from a retirement account, the penalty goes towards your social security benefit. You still want to discourage folks from touching retirement savings, but that also requires more robust social safety nets so there are fewer events when citizens are financially bleeding out in the snow and need to tap those accounts.
[1] https://www.cnbc.com/2019/04/01/theres-a-retirement-crisis-i...
[2] https://www.epi.org/publication/retirement-in-america/
[3] http://www.mybudget360.com/pension-death-percent-of-american...
[4] https://www.cbpp.org/research/social-security/social-securit...
With that said, I think making tax advantaged accounts more accessible to your average person is a net win, even if we have a lot of work left to do to encourage good long term financial planning and behavior. Some policy I've been modeling is if you take an early distribution from a retirement account, the penalty goes towards your social security benefit. You still want to discourage folks from touching retirement savings, but that also requires more robust social safety nets so there are fewer events when citizens are financially bleeding out in the snow and need to tap those accounts.
[1] https://www.cnbc.com/2019/04/01/theres-a-retirement-crisis-i...
[2] https://www.epi.org/publication/retirement-in-america/
[3] http://www.mybudget360.com/pension-death-percent-of-american...
[4] https://www.cbpp.org/research/social-security/social-securit...
All long term financial planning is terrible on all accounts - look at people spending $200k to get an English degree at a private college. Fixing human nature is tough.
Most of this country will not be able to save enough for retirement. It might make sense here to just eliminate 401ks and IRAs and use the meet increase in that revenue to expand SSA to actually be a national pension program. But politics kinda prevents this.
I actually see this as a way forward, depending on how dire the situation gets. An alternative, yet more radical path, is the Federal Reserve buying up income producing securities and issuing citizen dividends from those securities directly to citizens using FedAccounts (essentially UBI).
UBI is an ideological conundrum for most of America. We all voted down free $1000/mo and Medicare For All when Yang and Bernie were eliminated in the Democratic Primary. That just shows how much we are driven out of spite and a one-sided mentality.
Also Joe Biden wants to cut social security so good luck with that happening. https://www.youtube.com/watch?v=9X3UiSvgle0
Also Joe Biden wants to cut social security so good luck with that happening. https://www.youtube.com/watch?v=9X3UiSvgle0
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>Pensions were great, because you couldn't ransack them as a participant.
Yes, because they would already be ransacked by the board of trustees for the pension plan. Or future taxpayers would be ransacked by underfunding in the case of taxpayer funded pensions. The government tried to stop the ransacking with PPA 2006, and apparently a properly funded defined benefit pension plan is incredibly expensive (surprise), so of course companies would drop them.
There's no reason for me to give control of my savings to a third party, especially now that I can buy VOO or whatever index fund I want at almost no cost.
Yes, because they would already be ransacked by the board of trustees for the pension plan. Or future taxpayers would be ransacked by underfunding in the case of taxpayer funded pensions. The government tried to stop the ransacking with PPA 2006, and apparently a properly funded defined benefit pension plan is incredibly expensive (surprise), so of course companies would drop them.
There's no reason for me to give control of my savings to a third party, especially now that I can buy VOO or whatever index fund I want at almost no cost.
I would agree with the second half if you could set up automatic paycheck transfers to your IRA from your employer. It has to be that easy, in order for people to save.
Going from your checking account to your IRA brokerage is something only financially savvy people do. You have to make it as easy as possible for retirement savings to happen, and it's totally within the government's interest to ensure people save money for old age when they can't work: it means less reliance on Social Security.
Going from your checking account to your IRA brokerage is something only financially savvy people do. You have to make it as easy as possible for retirement savings to happen, and it's totally within the government's interest to ensure people save money for old age when they can't work: it means less reliance on Social Security.
Absolutely. You should be able to go through an auth flow to add your IRAs as a paycheck deposit destination as part of your employer's payroll platform just as you might for a checking or savings deposit account, and you should be able to make changes to contribution amounts or accounts at any time.
> This also eliminates the captive audience problem where 401k plans have higher expense ratios than investment options available in IRA or taxable accounts.
This isn't true across the board. Large employers get great rates for their 401k funds due to the collective size of investment, better than anything available to an individual. This is similar to employer sponsored health coverage, and the reason both of them won't go away anytime soon.
This isn't true across the board. Large employers get great rates for their 401k funds due to the collective size of investment, better than anything available to an individual. This is similar to employer sponsored health coverage, and the reason both of them won't go away anytime soon.
Better expense ratios than Vanguard or Fidelity? Many of those funds are single digit basis points, and Fidelity has some that are zero.
I have a 401k plan from a large financial services org, and the funds aren't significantly cheaper (in my case, BlackRock LifePath Index 2045, with an ER of 0.09%) than what I can get through a discount brokerage (FIOFX, Fidelity Freedom Index Fund 2045, with an ER of 0.12%). We're talking 3 basis points, even less if you're selecting less "automatic" (versus a target date or other aggregator) funds like VTI (0.03% ER), BND (0.035% ER), etc.
I have a 401k plan from a large financial services org, and the funds aren't significantly cheaper (in my case, BlackRock LifePath Index 2045, with an ER of 0.09%) than what I can get through a discount brokerage (FIOFX, Fidelity Freedom Index Fund 2045, with an ER of 0.12%). We're talking 3 basis points, even less if you're selecting less "automatic" (versus a target date or other aggregator) funds like VTI (0.03% ER), BND (0.035% ER), etc.
I'd say many plans that use Fidelity already allow access to BrokerageLink which makes it simple to buy Fidelity's zero fee funds.
They don't. There's no reason for there to be a middleman in investing anymore. It should be investor -> Fidelity/Schwab/Vanguard.
>This is similar to employer sponsored health coverage, and the reason both of them won't go away anytime soon.
Employer sponsored health insurance may be cheaper either due to the pool of employee lives being younger/healthier than the general population, and/or because the employer is offering less coverage than the alternative options available on healthcare.gov. The big managed care organizations (UHC/Anthem/Humana/Cigna/CVS) all have better negotiating power than a single employer.
Similarly, no employer is going to be able to negotiate lower pricing than Vanguard/Schwab/Fidelity.
Employer sponsored health insurance may be cheaper either due to the pool of employee lives being younger/healthier than the general population, and/or because the employer is offering less coverage than the alternative options available on healthcare.gov. The big managed care organizations (UHC/Anthem/Humana/Cigna/CVS) all have better negotiating power than a single employer.
Similarly, no employer is going to be able to negotiate lower pricing than Vanguard/Schwab/Fidelity.
This article seems a bit simplistic. It really depends on whether your current and near-future tax rate is less than your tax rate in retirement. Consider that politically, taxes may be lower now than they will be in 30 years. Your tax rate typically increases as you progress in an industry.
In my case, I max out a 401k that is split 2/3 Roth, 1/3 Traditional. I also max out a Roth IRA every year. Additionally, I'm stuffing all excess cash in a taxable brokerage account. The taxable account is growing faster than the Roth IRA because I'm limiting discretionary spending and buying equities whenever I have extra cash.
I expect my tax rate to be higher in retirement since I'm saving like crazy as a 25 year old (and have been for years already) and expect to continue to do so for decades.
(I wouldn't even be surprised if some politicians decide to bludgeon me for being a responsible saver by voiding the tax-free withdrawals of Roths in the future. But that's a bit paranoid and hopefully won't happen.)
In my case, I max out a 401k that is split 2/3 Roth, 1/3 Traditional. I also max out a Roth IRA every year. Additionally, I'm stuffing all excess cash in a taxable brokerage account. The taxable account is growing faster than the Roth IRA because I'm limiting discretionary spending and buying equities whenever I have extra cash.
I expect my tax rate to be higher in retirement since I'm saving like crazy as a 25 year old (and have been for years already) and expect to continue to do so for decades.
(I wouldn't even be surprised if some politicians decide to bludgeon me for being a responsible saver by voiding the tax-free withdrawals of Roths in the future. But that's a bit paranoid and hopefully won't happen.)
As a person of more modest means, I hope that it will happen. Hoarding your own money is not, in any meaningful sense, “responsible.”
I really wish people would stop using ridiculous hyperbole like "hoarding" when describing "a middle-class person saving for a future emergency or retirement".
For starters, in the modern economy, the notion of "hoarding" is mostly antiquated - people aren't storing their wealth by keeping a silo full of grain (which might overall benefit society by being distributed to the hungry now) but instead by owning shares of the business that provide the goods, services and employment that keep society working and allow everyone to live a modern life instead of being hunter-gatherers.
The worker who is maxing out their 401k is not your enemy.
For starters, in the modern economy, the notion of "hoarding" is mostly antiquated - people aren't storing their wealth by keeping a silo full of grain (which might overall benefit society by being distributed to the hungry now) but instead by owning shares of the business that provide the goods, services and employment that keep society working and allow everyone to live a modern life instead of being hunter-gatherers.
The worker who is maxing out their 401k is not your enemy.
One point I don't see mentioned is that in most cases, 401(k)'s are protected during bankruptcy.
https://www.nolo.com/legal-encyclopedia/retirement-plan-bank...
https://www.nolo.com/legal-encyclopedia/retirement-plan-bank...
Not just during bankruptcy, but overall a 401(k) and similar retirement plans that fall under ERISA* rules are pretty heavily protected from creditors (besides the IRS).
Something to consider if you plan on going into a risky area of business in the future.
Something to consider if you plan on going into a risky area of business in the future.
1. Retirement accounts that qualify under the Employee Retirement Income Security Act (ERISA) are generally protected from creditors, bankruptcy proceedings and civil lawsuits.Not a big fan of this headline. Everyone should maximize their employee match. Going up to the max yearly contribution is slightly inefficient, but the few who can afford this already know that.
inefficient in what way? after you meet company match, max out an ira, then what would you do instead of maxing out the 401k? The tax savings are a big deal.
> The tax savings are a big deal.
Seriously - where else can you instantly make dollars worth more than $1?
Seriously - where else can you instantly make dollars worth more than $1?
Oh wow! So a major downside of saving money for the future is, I don't get to spend it now huh? What an eye-opener.
This article uses tax estimates that are likely too low for many who can possibly max a 401k.
It doesn't mention state income tax at all, despite the vast majority of states having one. It doesn't mention that funds can distribute interest and non-qualified dividends, which are taxed at the regular federal rates. It doesn't mention the 20% qualified-dividends-capital-gains rates or the Net Investment Income Tax, which further impact high earners.
In short, most people should do their own analysis because this analysis is not going to be accurate for them.
It doesn't mention state income tax at all, despite the vast majority of states having one. It doesn't mention that funds can distribute interest and non-qualified dividends, which are taxed at the regular federal rates. It doesn't mention the 20% qualified-dividends-capital-gains rates or the Net Investment Income Tax, which further impact high earners.
In short, most people should do their own analysis because this analysis is not going to be accurate for them.
Doesn't the option to withdraw your 401k exist with a 10% penalty (+ taxes)?
If you're including employer match here, it looks like you can still get instant, guaranteed gain.
If you're including employer match here, it looks like you can still get instant, guaranteed gain.
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