Financial planning
401(k)'s : panacea or problem?
For many years, Americans relied on two basic forms of retirement; pensions and social security! The former was tied to your job, the latter a federal program enacted after the great depression in 1935.
In 1978, a new retirement vehicle was born; the 401k. In essence, the 401k changed the retirement landscape by shifting the burden (risk) from the employer to the employee. As a nation we went from a defined benefit plan to one of a defined contribution.
Many baby boomers are now beginning to retire. Pensions are slowly becoming extinct (expiring) and social security, combined with the 401k, make up the lions share of most peoples' retirement. Sadly, the 401k has not lived up to the hype of the massive Wall Street marketing machine.
Why?
Market volatility, high fees, lack of liquidity and onerous taxation is the short answer.
What exactly is a 401k?
Named after the Internal Revenue code section 401, paragraph K, the 401k allows an employee to set aside earnings on a pretax basis. These contributions are then invested, usually in mutual funds and hopefully grow into a sum that can be accessed after age 59 1/2. Some companies will match up to a certain percentage of the employees contributions, although the stated match is usually much lower if the fine print is read.
So "Where is the problem" with 401k's you might ask?
There are more than a few! First for employers, the United States Department of Labor (DOL) is now evaluating 401k's and in 2013 a remarkable seventy five percent of plans audited resulted in plan sponsors being fined, penalized or forced to make reimbursements for plan errors. The average fine was $600,000. per plan. Fidelity one of the largest 401k providers in the industry recently settled lawsuits totaling $12 million after being sued by their own employees! The DOL in 2014 hired an additional 1,000 enforcement officers.
For employees, the major drawback is the high fees that over time can usurp tens of thousands from your account. In a recent study 67% of respondents assumed that there were no fees in their 401k, while nearly forty percent did not realize they would be taxed once distributions begin; currently at 30%. Most 401k's are cleverly crafted so the investment "choices" in your plan maximize profits for the brokers, vendors and managers. Market volatility can erode retirement in a harsh manner. The market correction in 2008 is a good example and remember 401k fees are still subtracted even when the market declines.
Are there better options?
Yes. There are financial vehicles now available that allow an individual to set up their own private retirement plan. Unlike a 401k these plans entitle participants to capture market gains with no downside risk. If the market goes up you get the gains; if the market is down there is no loss! Additional benefits of these plans are absolutely no taxation ever, plus the fund is liquid. You can make withdrawals for any reason and use those funds in any manner you choose. There are fees in these plans but the combination of no risk of loss and zero taxation trump the modest fees. The cornerstone of these plans, when properly structured, will provide the participant with a guaranteed, lifetime, tax free income for as long as you live!
In conclusion these plans are not new. Their inception began in 1998 and are gaining in popularity every year. From 2009 thru 2012 Americans poured billions into them and in 2013 the total contributed exceeded the previous four years combined. If you are serious about self funding your retirement in a plan that has no risk of loss, yet market returns, no taxation ever and a guaranteed income for life, they may be a perfect way to ensure a quality retirement!
For questions, call John Haggerty at (615) 563-3334 or email at haggerty@dtccom.com