124: 5 Reasons Why a 401(K) Might be the Worst Retirement Account
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When it comes to retirement savings, the 401(k) is often touted as a great way to save for your golden years.
But there are plenty of reasons why that might not be the case, and if you’re an investor or real estate investor looking for better options when it comes to preparing for retirement, you’re in the right place‼️
➡️ We are going to examine five different factors that may indicate the 401(k) isn’t the best account type for long-term savings success.
But before we dive into the five major cons, let’s first back up and learn what a 401(k) plan really is. 🤓🤓
We think the history of the creation of the 401(k) plan is pretty interesting. Originally it was created in 1980 and named after a section of the Internal Revenue Code and designed as a supplemental savings option for individuals in addition to traditional pension plans offered by employers.
Over time, many employers began to phase out traditional pension plans and shift towards 401(k) plans as a way to save on costs associated with funding pensions.
While there’s nothing wrong with this, the shift resulted in the widespread adoption of 401(k) plans as the primary form of employer-sponsored retirement savings.
We’re willing to bet that you have one too! 👊
One reason why 401(k) plans have become a problematic alternative to traditional pension plans is that they place a greater burden on individuals to manage and grow their own retirement savings, rather than relying on a guaranteed source of income from a pension plan. 😢😢
While it sounds like this freedom is a positive thing, it has actually resulted in many individuals not saving enough or not investing their funds effectively, in turn leading to inadequate retirement savings and a growing retirement crisis.
Let’s dive into each of the five cons, one by one. 👇
Limited Options
First, you have super limited options. The investment options typically available within 401(k) plans are usually limited to a selection of mutual funds and other investment vehicles chosen by the plan sponsor.
This can make it difficult for individuals to diversify their portfolios and potentially expose them to higher investment risk, neither of which is great.
Quite a bit of research has gone into this; studies have shown that having a limited number of investment options in 401(k) plans can negatively impact an individual’s portfolio diversification and lead to suboptimal investment outcomes. 🙄🙄
One example of this is from a recent study by the Employee Benefit Research Institute, which found that individuals with limited investment options in their 401(k) plans had lower portfolio diversification and higher concentrations in a few specific investments compared to those with a larger selection of options.
Let’s look at an example of how limited investment options in a 401(k) plan can negatively affect a retirement plan.
Take a journey with us down an imaginary path with our friend – let’s say her name is Jane. 🤟🧡
Jane just started a rad new job that she’s super excited about, but her company’s 401(k) plan only offers three investment options 〰️ a money 💰 market fund, a large-cap stock fund, and a bond fund.
While not bad options, these three may not provide adequate diversification for Jane’s retirement portfolio, as they may all be exposed to similar market risks.
For example, if the stock market experiences a downturn, all three options in Jane’s 401(k) plan may decline in value at the same time.
If Jane had access to a wider range of investment options, such as a selection of international stock funds, small-cap stock funds, and real estate investment, this might tell a different story and she could potentially mitigate the impact of a market downturn by having investments in different asset classes that may perform differently in various market conditions.
This would put Jane in a much different and better situation than she is in currently.
To summarize, having limited investment options in a 401(k) plan can limit an individual’s ability to properly diversify their retirement portfolio and potentially lead to suboptimal investment outcomes.
Exposure to the Stock Market Volatility
The second con is exposure to stock market volatility. If you remember, 2021 seemed to be a year for both growth and depletion.
If you look at the data, the story told is very much the latter. According to an article from CBS, 401(k) participants have lost roughly $1.4 trillion when factoring in their accounts’ value at the end of 2021, and people with IRA’s fared even worse at a shocking $2 trillion deficit. 😩😩
We know there are many complex factors in play here with market volatility due to increased global uncertainty being a primary contributor. But one thing is certain: 2021 was rough on investors’ retirement portfolios.
It’s no surprise people have been scrambling to minimize their losses where they can.
We like to keep it educationally optimistic, so we can only hope that these trends will reverse soon enough in order to limit further financial damage!
Taxed at the Highest Level
The third con here is courtesy of our favorite uncle, 👨🦳 Uncle Sam. You might be imagining the day when you head on over to the bank and make big withdrawals from your traditional defined contribution plan. But before you start to celebrate, there are a couple of important points about taxes to remember.
First, money will be taxed at your income tax rate at the time of withdrawal, so there’s no guarantee that it’ll be lower than it is now.
And second, what seemed like a great plan when you put in your contributions and watched them grow through dividends or capital gains can become an unwelcome surprise when those same income streams suddenly hit your taxable income.
Who knew retirement could come with double the amount of paperwork and half the deductions?
Not sure if you should laugh or cry?
Us either. 😅😅
Potential for Double Taxation
Fourth, there’s this little thing called double taxation, which is just about as fun as it sounds. As you probably already know, getting money out of your retirement plan can result in giving a portion of it right back to Uncle Sam.
But did you know that any withdrawals and some distributions from retirement plans can also increase your tax responsibilities when it comes to the Social Security benefits you receive?
That’s right — the more money coming out of the plan, the higher your potential taxes on Social Security could rise. 😦😦
So before dipping into your 401(k), be sure to research the tax implications so that both you and Uncle Sam are satisfied with the result!
Worst Account for Surviving Spouse
Finally, the last detractor is more personal and something that we would never want you to be blindsided by. If you are planning on leaving a large 401(k) account to a surviving spouse, the truth is that it could prove costly.
While this might seem like the ideal choice when looking at financial statements, in terms of tax implications, it’s actually one of the worst decisions you can make.
Your loved one will be subject to the highest-obligation tax status as a single individual rather than being able to enjoy the lower rate granted to married couples filing taxes jointly. 😨😨
If you have an eye on your loved one’s financial security, look into other options before leaving them saddled with a hefty amount of taxable income.
The Alternative
The bottom line is while you may not have an option on what retirement plan your employer offers, you do have the option to limit the amount of contribution you pour into a 401(k).
We’ve empowered you with knowledge, so the next time your employer tries to lure you with a grandiose 401(k), you know you can say, thanks but no thanks! 😏😏
We hope you found today’s episode educational and useful; if you have questions or comments for us, please reach out anytime, subscribe to our YouTube channel – the Kitti Sisters TV 📺 , and tell your friends and family.
We would also like to personally invite you to join the Kitti Freedom Club, for the ultimate insider knowledge to help you meet your financial freedom goals. 😎😘
GET ME ON THE KITTI FREEDOM CLUB
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