The Truth About Your 401k

"Invest in your company's 401k plan." That's the one thing I learned about finances when I first came into the workforce. It was the smart financial move that everyone was doing. Since everyone was doing it, it had to be right. Right? Boy was I wrong. What I'm about to share with you will shift your paradigm about the beloved retirement plan.

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The 401k reminds me of a bit that comedian Jerry Seinfeld does about dry cleaning.

Let's get one thing straight about dry cleaning right now. It doesn't exist. There's no way of cleaning with dry... And we walk into these places with the big signs out front, "Dry Cleaning," and somehow never question how they were able to put this absurd concept over on us.

This is how I believe most people approach the 401k plan. Like dry cleaning, most tend to never question what goes on back there. We see the pretty "401k sign" and since everyone's doing it, we assume that everything is OK.

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So what makes this qualified retirement plan look like such a lucrative deal to so many people? Let's look at how it's often pitched to employees.

• Employer Match
  

  To be honest, this was the one that did it for me. "It's free money," you would hear. Who doesn't want free money? I do, of course.

• Tax Savings
  

  You're putting your money in before you pay taxes. So, you're saving all this money by not having to pay taxes. And your money continues to grow faster because you don't have to pay taxes on the gains within the plan.

• Future Lower Tax Bracket
  

  You will access your cash when you retire. Since your monthly income will be less than it was when you were working, you will be in a lower tax bracket. This sounds like a great plan!

• Easy
  

  Once you set up the plan, it runs on its own. The contributions are taken out directly from your paycheck and you don't have to do anything else. So basically, you "set it and forget it." You don't have to worry about funding your retirement anymore since it is all done for you.

Sound familiar? That's the gist of it right? You get free money, tax savings, and it's shockingly easy. But step back, and I mean way back for a minute and look at this plan from a 5,000 foot view. Are these statements true and/or do they really make this plan favorable? Let's see.

• Employer Match
  

  Let's say that your employer will match your contribution by 50%. Many argue that you get a 50% return on your money, but that is not the case. The employer match does not equal the rate of return.

  Here's an example taken from LEAP by Robert Castiglione. Let's say that you put in $1000 per year at 8% for 30 years, totaling $122,345. If you're employer matches 50% of your contribution, that would be $1500 per year at 8% for 30 years, totaling $183,518.

  In the end, with the employer match, you do have 50% more but that doesn't equate to a 50% rate of return on your money. To determine that figure, you must see what kind of rate of return you would need to get to $183,518 contributing $1000 per year for 30 years.
  
  

  Contribution per Year	Years	Rate of Return	Future Value
  $1000	30	8%	$122,345
  $1500	30	8%	$183,518
  $1000	30	9.47%	$183,518

  
  
  

  In the example above, with your employer match, you only receive an additional 1.47 % annually over 30 yrs, not a 50% rate of return.

• Tax Savings
  

  This statement is actually false. The correct term to describe this "feature" is tax deferral. Meaning, you are putting off paying taxes on the money you paid into the plan. There are no tax savings. Let me repeat...

  There are no tax savings.

  What you are essentially doing is delaying the inevitable...paying taxes. Can you remember the last time procrastination was a good thing?

• Future Lower Tax Bracket
  

  This argument is something I just don't get. I admit, I bit when it was presented to me as an advantage. But it just doesn't make sense.

  The goal here is to make you more money, right? Well, if you are in a lower tax bracket in the future, then didn't the plan fail? The plan is providing you less money in your golden years when your intention was to have more.

  Let me ask you a question. Would you rather pay $1,000 in taxes or $100,000? If you said $1000, why? I would love to pay $100,000 because that means I made so much more money than in the scenario where I only pay $1000.

  Are you investing to win or to not lose?

• Easy
  

  Yes, it's easy...painfully easy. Remember, it takes virtually no effort to put your money in, but no one considers the repercussions of needing, or taking out the funds prematurely. It's like those old piggy banks. It's easy to get the money into it but then you have to break it with a hammer to access the cash.

  What worries me here is that people typically turn their brains off when they get into this plan. They have no idea what their money is invested in and don't have an exit strategy.

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If it's not obvious, this retirement plan is not a place where we want our money. I withdrew the entire funds from my 401k from my previous employer (as well as my wife's IRA with her previous employer). We could put those funds to better use rather than locking it up. To us, leaving the money in there was too risky. I bet that's the first time you heard a statement like that to describe a 401k.

A major risk I see with this plan is its lack of liquidity. Have you ever asked yourself, "How could I access the cash before retirement? What are the terms and conditions?"

When I was presented the 401k plan, I was preached about how easy it was to put your money in it. But no one talked about how to get the money out, especially before retirement. Do you know how?

I know there are some of you out there gasping, "But it's for your retirement! You shouldn't touch that money!" Would you rather use those funds than pay 20% and higher on a credit card? Would you want to pass up a great investment opportunity that could make you more money than this qualified retirement plan?

I hope you start asking questions and do some research. What are the disadvantages? Is it really where you want your money invested? Educate yourself on Uncle Sam's terms and conditions, rules and regulations, and the tax implications that surround this product.

If you don't, he may take you to the dry cleaners.