Blog | Paper Assets

The Argument Against 401(k)s

These investment accounts were supposed to help us retire wealthy and happy — unfortunately, many Americans are learning that this dream is actually a nightmare.

meet your own rich dad - start your quiz now

A while back, Robert wrote an article for Yahoo!Finance about 401(k)s that hit a nerve with many readers, generating over 800 comments. The heated responses to this topic show just how entrenched most people are in the old ways of thinking — especially since those old ways of thinking are still being peddled today by many of the financial “experts” on TV and social media.

Mainstream financial experts continue to sing the praises of 401(k)s despite the massive losses so many people — many of them close to retirement — have experienced in their 401(k)s. According to these experts, 401(k)s still make sense because of the “free” employer matching funds. To most people, this argument makes sense — after all, why would you turn down free money?

The ugly truth about 401(k)s

What most people don't realize is that in return for the “free” employer matching funds that go into a 401(k), they are giving up almost all control over their investments and putting themselves at the mercy of a volatile stock market, paying much of their gains to management fees, and paying taxes on “gains” even when the value of their fund decreases.

  1. Taxes: Yes, when it comes time to take distributions from your account when you retire, that 401(k) money will be taxed at the highest rate. Also, you will probably have less tax deductions when you retire (no dependents, your mortgage will probably be paid off, that sort of thing). And then there's the unknown answer to the question: Will tax rates have increased by the time you retire? Sure seems like it’s heading in that direction.

  2. Limited options: Another thing I don't like about government-regulated retirement plans is that the government limits what you can invest in. In the U.S., you are limited to certain “qualified” investments. This not only limits your investment options, but it also means the government can change the law about what you can invest in through your retirement plan.

  3. Risk: One last reason why 401(k)s are risky: The government also controls when you can and must take money out of the plan. With a 401(k) you are charged a 10% penalty to withdraw money before the age of 59-1/2, in addition to the taxes you must pay. Then you are required to withdraw money after age 70.

    Even in a self-directed IRA — which gives you more options than a 401(k) — there are still serious limitations, such as the fact that you can't benefit today from your investments or take the money out of the IRA before you are 59 1/2 years old without paying taxes plus a 10% penalty.

What this all boils down to is that your control in a 401(k) is severely limited by the government. Generally speaking, if the government sets the rules for your retirement plan, then the government is in control, not you. When you add to this the fact that in most retirement plans you put up 100% of the money, take 100% of the risk, and only get 20% of the returns — yes, the other 80% goes to fees and commissions — 401(k)s just seem like a lousy option to me.

Why 401(k)s should make you angry

Don’t just take my word on the pitfalls of 401(k)s — Andy Tanner, Rich Dad Stock Advisor, has plenty to say on the subject as well:

Almost every working American has a 401(k) account. These investment accounts were supposedly created to help us retire wealthy and happy. After all, that's part of the 401(k) sales pitch to employees. But now that dream is becoming a nightmare for millions of people.

Based on my research for my book, 401(k)aos, I have identified at least three ways we have been misled about these 401(k) retirement plans:

  1. Broken Promises. Many of the promises that are part of the 401(k) sales pitch are actually dangerous lies. And these lies are causing serious harm to millions of unsuspecting victims. For example, they promised a retirement of abundance yet retirees are now discovering they have far less than is needed. And they promised valuable tax benefits, yet the surprise of having your 401(k) funds taxed as income will be a shocking surprise to most people. As a result, it is difficult, if not impossible, for the vast majority of people who have 401(k) plans to have enough money to retire with the standard of living they always envisioned.

  2. Unbridled Greed. The 401(k) system is a very simple machine that consistently transfers money from your account to the financial institutions that sponsor the retirement plans in which you are enrolled. They sold you on the idea of investment ownership, when in reality it's a funnel that pours money into their coffers. And the result is they are legally keeping a huge chunk of your account's earnings. This thievery is 100% legal, so it's vital to be aware of what's going on right under our noses.

  3. They're Not Smarter Than We Are. Investing in the stock market isn't that difficult. In fact, it's easy for even the most average person to outperform most of the 401(k) and mutual fund managers. Yet somehow they have convinced us that it's too complicated for us. They want us to feel powerless without them. For anyone interested, it's relatively simple to learn how they do it and how you can begin to take the power back for yourself.

But time is running out. We only get one chance at retirement, so the time to focus on this is right now. Whether you are just starting your first job or looking at your retirement date coming up fast, you can learn how to get your investing on track to achieve your goals. You are the person who cares most about your retirement, and you are the only one who can make the best decisions for your situation. My advice for anyone in a 401(k) is simple: get educated!

What should I do with my 401(k)?

After losing huge amounts of retirement money in the stock market, many people are asking: Should I stop contributing to my 401(k)? Should I take money out of my 401(k) and invest it in something else, despite the tax penalties for doing so?

There are certainly better investments than 401(k)s. But for people who have little financial education, a 401(k) may be the best investment. I do not advise people to get out of their 401(k) if they don’t have the financial education needed to find and wisely manage a good investment.

So if you want to get out of your 401(k), set aside some time now to increase your financial education a little bit every day — that is one investment that is sure to bring you good returns!

And if you want to take back control of your retirement funds, I encourage you to make sure you have a good alternative investment plan in place first. Find an investment vehicle that works for you and then plan how to maximize the returns on the money you have.

I also encourage you to consult a tax advisor, who can explain your options and help you navigate the tax code. Investing outside a 401(k) can bring much better returns, but it also requires greater financial knowledge. Learn what you need to know, then take action.

Original publish date: December 10, 2009

Recent Posts

Three Investment Values
Personal Finance

The Rich Dad Guide to Investing Values: Defining Your Path to Financial Success

It’s important to know which core values are most important to you, especially when it comes to the subject of money and financial planning.

Read the full post
Risky vs. Safe Investments
Paper Assets

Smart Investing: Understanding the Difference Between Risky and Safe Options

What you may think is a “safe” investment, I may see as risky. For example, many financial planners advise their clients to get into so-called “safe” investments — such as savings plans, mutual funds and 401(k)s.

Read the full post
Mastering Money
Paper Assets, Personal Finance

Mastering Money: The Key to Achieving Financial Freedom

Begin the path to making money work for you today, not the other way around.

Read the full post