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What Should I Do With My 401(k)?

If you want to get rich, a 401(k) won’t get you there.

Summary

• 401(k)s are not the key to becoming rich

• 401(k)s work best for the employer, not the employee

• In order to be financially free, you must be financially intelligent

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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?”

Years ago, Robert Kiyosaki had a conversation with a young man about 401(k)s. “I have a question for you,” he said. “I’ve read that you say 401(k)s are the worst investments, but I don’t understand why you say that.”

“What is it that you don’t understand?” Robert asked.

“Well,” said the young man. “Most employers match your contribution. For instance, my employer matches up to four percent of my salary. Isn’t that a hundred percent return? Why is that a bad investment?”

“It’s a bad investment,” Robert began, “because it’s your money to begin with.”

He looked puzzled and perplexed.

“Listen,” he continued, “if it weren’t for 401(k)s, your employer would have to pay you that money as part of your salary. As it is, they still pay it, but only if you give up four percent of your existing salary into a retirement account where you have no control. And if you don’t, well the employer comes out ahead. It’s your money, but they’re in control.”

Thinking like an employee

The young man still didn’t look convinced, but was thinking hard about it. The reason this young man and many others don’t understand this reasoning is that they only think like employees. Employers know that if it weren’t for 401(k)s, they’d have to pay that money to employees in their salary in order to be competitive.

For employers, a 401(k) is an advantage because they don’t have to pay the money unless an employee opts in, and if they leave the company too early, they don’t have to pay because they aren’t vested.

Understand your 401(k)

401(k)’s primarily rely on the time-honored tradition that paying taxes later is better than paying taxes today. In your 401(k), except Roth’s, the taxpayer receives a deduction today for their contribution to the plan, the investments grow tax-deferred while in the plan, and are taxed at ordinary income rates when withdrawn from the plan. Sounds like a great plan, right? WRONG! Here are the complaints regarding these investment vehicles:

1. The tax benefits rely on the premise that when you retire, you will be in a lower tax bracket than you are now. Unfortunately, this is true for many people who use these vehicles, because they will retire poor. However, if you want to retire rich, you will likely be in a much higher tax bracket than you are now. Why? You will have fewer deductions. No business deductions (remember, you are retired), no dependent exemptions, no home mortgage interest. And you probably want to have more income available when you retire than when you are working because you have places to go and things to see.

2. You have very little control over the funds. Who has control? The government. They control what you can invest in, how much you can add to your investment and when you can take it out. This lack of control normally results in lower returns.

3. You can’t take advantage of other tax-advantaged investments. For example, you cannot receive the tax advantages (e.g., depreciation) from real estate to produce lower taxes from your other income. You don’t receive capital gains treatment from dividends and long-term stock gains. And, if you do invest in a business (a very complicated matter within a tax-deferred plan), you are severely restricted as to your operating entity.

A 401(k) steals your money

According to Steven Gandel, a study issued by the Center for Retirement Research indicates that, “All else being equal…workers at companies that contributed to their employees’ 401(k) accounts tended to have lower salaries than those at companies that gave no retirement contribution…In fact, for many employees, the salary dip was roughly equal to the size of their employer’s potential contribution.”

Translation, companies that don’t offer 401(k)s must pay a higher salary to compete with companies that do. Those company’s employees simply get their money as part of their salary rather than having to match it and save it in a tax-deferred retirement plan where they have no control and have high fees.

No financial intelligence? Stick with the 401(k)

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.

We certainly 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.

Of course, it takes high financial intelligence to invest in things where you have control because you have to make a lot of important decisions. This is why being forced into a 401(k) probably isn’t a bad thing for most people. This is because most people have little-to-no financial education and wouldn’t know what to do with the extra money other than save it or spend it.

Control is an important aspect of investing. As mentioned earlier, with a 401(k), you have no control over your investments as you generally invest in funds and indexes controlled by brokers, who are controlled by bankers, who invest in companies that are controlled by boards — all of which you have no control over.

But if you want to be rich, you must have a financial education and control over your money and your investments. Generally a good matrix is the more control you have, the higher your potential return. The less control you have, the lower your potential return.

With a 401(k) you are turning your money over to someone else, which means they get most of the control... and most of the profits. You can do a better job with your money than anyone else. First, however, you need to arm yourself with some financial education.

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!