WHY YOUR 401K WON'T CUT IT: A COMPREHENSIVE GUIDE TO MAKING UP FOR LOST RETIREMENT SAVINGS"
Introduction:
For many Gen X and Early Gen Y individuals, the prospect of retiring at the age of 62 is no longer realistic. With stagnant wages, high living costs, and a changing economy, individuals in this age group are realizing that they will likely have to work until the age of 70 or beyond. However, for those who haven't been able to save enough for retirement, the idea of working an additional eight years can be daunting. In this guide, we will explore the shortcomings of traditional retirement plans such as 401k and offer solutions to help individuals make up for lost retirement savings.
Background of 401k:
Before we dive into the shortcomings and solutions, let's quickly explain the background of the 401k and Ted Benna's role in it. The 401k was introduced in 1978 and was intended to supplement traditional pension plans. Ted Benna is credited with creating the first 401k plan in 1980. However, the 401k was not built for the benefit of employees. Rather, it was created because businesses did not want to pay benefits (pensions) for employees who were no longer with the company. Additionally, there are huge tax incentives for businesses that offer 401k plans.
Lack of Return from 401k:
The Lack of Return from the 401k Many individuals, myself included, have experienced the frustration of seeing their 401k grow at a slower rate than expected. Despite contributing the maximum amount allowed and receiving matching funds from their employer, the returns on their investment seem lackluster. The reality is that fees associated with 401k plans can eat away at returns, leaving individuals with much less than they anticipated. Additionally, market fluctuations can wipe out any gains made, leaving individuals with little to show for their years of saving.
Despite the tax incentives, the average 401k only holds about $150,000, and most people only contribute 3-4% of their salary. The problem is that the 401k system is built for the benefit of the business, not the employee. The fees associated with 401k plans can eat away at your savings, and the market fluctuations can wipe out any gains you might make. For example, in every Bull Market run, the subsequent Bear Market has wiped out gains from the previous Bull Market. After taking into account fees and market fluctuations, you may only be seeing a 2-3% return on your 401k investments.
After looking at my history, I discovered that my personal 401k was growing at 12 to 14%, which seems good. But it never seemed to really grow at that rate. Why? Let's take a closer look.
Through my 30s and 40s, I took advantage of the $18,000 I could save per year and the matching the company would provide. For example, let's say I saved 8% and my company matched 4%. That's a total of 12%. If the market gains some points and loses some, say 4 to 6%, that would be 18 to 20% returns in total. However, it never seemed to be that. Why? Let's break it down.
If we take out the money I and the company are putting in every year, I'm only seeing a 4 to 6% return on my money. Not great. Additionally, the system takes 1 to 3% in fees, which takes me to really only 2 to 3% in returns. Finally, in one of these articles, the explanation is told that, for every Bull Market run, up to 2008, and up to 2020, the Bear Markets wiped out the gains…so in reality, the only money I've ever made in my 401k was the money I and my matching company money put in. This scenario is true for many people, and it highlights the dire situation of the 401k in total.
The average 401k holds about $150,000. Most people put in 3 to 4% and have their company match what they can. No one really saves 10%. Earners over $150,000 a year only, on average, have $350,000 in the 401k. Whether you're making $50,000 a year and have $100,000 to $150,000 in the 401k, or if you make $200,000 a year and only have $350,000 in the 401K, life at retirement will look a whole lot worse than the life the customers are leading with a steady income.
When the 401k works best:
While the 401k may not be the ideal retirement plan for everyone, it does come with some useful features that should not be overlooked. One of the main benefits is the ease of use. Many employers automatically enroll their employees in the 401k plan and provide a matching contribution up to a certain percentage. This makes it easy for individuals to start saving for retirement without having to take any additional steps.
Additionally, the 401k offers tax benefits to those who contribute to the plan. Contributions made to the 401k are made with pre-tax dollars, which reduces the contributor's taxable income. This can result in a small decrease in the contributor's tax liability, allowing them to keep more of their hard-earned money. Furthermore, any growth in the 401k plan is tax-deferred until the individual reaches the age of 59.5 years, at which point they can start making withdrawals. While there are tax implications to consider when making withdrawals, the tax-deferred growth can help the individual's retirement savings grow faster than if they had invested the money outside of the 401k plan.
Where the 401k falls short:
We’ve identified 12 points worth reviewing on why the 401k falls short;
You Can’t Access Your Money until you are 59.5 Years Old
Myth of the Employer Match
Oh, The Games We Play (Delayed Matching and Vesting Schedules)
401K’s Don’t Produce Income (Violates the Definition of an Asset)
Limited Investment Options
Only Paper Assets (No Hard Assets)
You Can’t Predict Your Future Tax Rate
Hefty and Hidden Fees
401k’s Can Plummet in Value
401k’s are Tied to Your Employer
You Give Up Control
The Wealthy Don’t Use Them
401(k) plans, however, also have a major drawback in that you cannot access your funds until you reach the age of 59.5 or older, which means they cannot provide you with financial stability during your lifetime. This is particularly problematic during your child-rearing years when your costs of living are at their highest.
Falling short explained:
Many people also assume that a 401k offer "free money" through employer matches, but this is a myth. In reality, companies that don't match 401k funds can pay higher salaries. A study by the Center for Retirement Research found that for every dollar an employer contributes to a 401k match, they pay 99 cents less in salary. This means that the employer match is simply a reallocation of an employee's compensation package, based on their skill set and what the company can afford to pay. Therefore, the myth of employer matching as a benefit is debunked.
Employers often use delayed matching and vesting schedules as strategies to reduce costs. Delayed matching is when the employer only starts matching an employee's contributions after they have completed one year of service while vesting schedules require a certain number of years of service before matching contributions belong to the employee. These strategies are profitable for employers because the average length of employment is only around four years. This means that some employees may not receive any matching contribution at all. Additionally, employers may recover some or all of their matching contributions if an employee leaves the job before completing the vesting schedule. As such, it is essential to understand the terms of your 401k plan to avoid any financial loss.
According to the financial expert & author of Rich Dad Poor Dad; Robert Kiyosaki, an asset is something that generates income, but 401(k) plans don't provide any income until the account holder reaches 59.5 years old. In contrast, there are several other investment opportunities, such as real estate, crowdfunding sites like Fundrise and Lending Club, peer-to-peer lending, tax lien certificates, and income-producing businesses, that can provide steady cash flow during an investor's lifetime. Dividend-paying stocks, mutual funds, and ETFs held outside of the 401(k) account are also sources of income. Therefore, 401(k) plans may not meet the definition of an asset.
The limited investment options offered by 401(k) plans concern many investors. Typically, 401(k) plans restrict investors to a list of approved mutual funds and ETFs, preventing them from investing in specific stocks or bonds. Investing in real estate is also not possible within a 401(k) plan, and the closest option would be to roll the plan into an IRA. However, with an IRA, you cannot manage the property actively. 401(k) plans also make it difficult to invest in private placements, IPOs, and precious metals like gold and silver. As a result, investors are limited to "whitewashed" investments deemed suitable for the masses, which can lead to average results.
The 401k plan was designed to replace pension plans, but it has limitations compared to pension plans when it comes to investing. Pension plans pool money from multiple contributors, giving them more capital to invest and access to better investment options. For example, they can invest in commercial real estate, which is a high-performing asset class with tax advantages that are hard for individuals to access. In contrast, 401k plans typically limit investments to paper assets like mutual funds and ETFs, which may not be as stable during economic downturns.
Another issue with 401k plans is that it's hard to predict future tax rates. While some people argue that deferring income taxes to the future is better, 401k withdrawals are taxed as ordinary income, subject to state and federal taxes that can be as high as 13.3% and 37%, respectively. For example, the highest U.S. income tax rate jumped from 15% in 1916 to 67% in 1917 to 77% in 1918. You know, war is expensive. In the 1950s, 1960s, and 1970s (30 years), the top federal income tax rate remained high, never dipping below 70%. The investment gain portion of a 401k is not treated as a long-term capital gain, which has lower tax rates ranging from 0 to 20%. Additionally, income tax rates may be higher in retirement than when someone is young and just starting a career. It's also possible that tax rates could be raised in the future, as has happened in the past.
Again, 401k plans only provide small tax savings upfront, but individuals may have better tax write-offs when they are young or middle-aged. Overall, it's uncertain whether someone will save money on taxes with a 401k plan or not. What is certain is that they will have to pay fees and have their money managed by others for several decades.
401(k) plans come with hefty fees that are charged by Wall Street firms. These fees fall into three categories: investment fees, administrative fees, and individual service fees. Unfortunately, these fees are often not clearly disclosed, making it challenging to determine how much you are paying. In fact, a survey from TD Ameritrade found that many people are not aware of the fees they pay or how to determine them. According to Ted Benna, the "Father of the 401(k)," this retirement plan has opened the door for Wall Street to make even more money.
Another disadvantage of 401(k) plans is that they can potentially lose value when you need them the most. This was evident during the 2008 financial crisis when Target-Date Funds experienced losses of over 20% for investors nearing retirement. Those with retirement dates beyond 2020 experienced even greater losses, exceeding 30%. Unfortunately, with the current Coronavirus-induced market plunge, 401(k) plans are also likely to suffer.
A significant drawback of 401(k) plans is that they are tied to your employer, making it difficult to transfer your funds when you switch jobs. When leaving a job, you have limited options for your 401(k), including leaving it at your old job, transferring it to your new employer's plan, rolling it over into an IRA, or cashing out and incurring a 10% penalty and taxes owed. Additionally, employers are obligated to withhold 20% of your money in taxes if you request a check. This has resulted in billions of dollars in unclaimed 401(k) funds.
Another disadvantage of 401(k) plans is that you give up control of your money, placing it into the hands of fund managers on Wall Street. It can be challenging to trust these managers to act in your best interest, particularly when they collect fees from you. With the recent market downturn due to Coronavirus, many people are now questioning the unbiased advice and management provided by their 401(k) managers.
Lastly, If you had the opportunity to speak with a wealthy individual in an elevator and ask them how they built their wealth, they wouldn't attribute it to simply contributing a small percentage of their earnings into a 401k and relying on others to manage it until retirement. Instead, the wealthy take a different approach by investing in assets that generate income throughout their lifetime. According to financial expert Grant Cardone, building wealth involves increasing your income, investing in income-generating assets, and protecting as much of your earnings as possible.
In essence, the wealthy utilize three key strategies that don't involve relying on a 401k plan. These are:
Continuously improving their skills to increase their income, as money comes from scarce, high-demand resources.
Regularly investing cash in income-generating assets.
Understanding business and tax laws, in order to reduce tax liabilities while staying compliant with IRS tax codes.
As Tony Robbins once said, "Success leaves clues." Therefore, if you want to achieve financial freedom, it's beneficial to model the actions of successful wealthy individuals and follow a similar approach.”
Review:
After our review, it's clear that a 401(k) plan is not an effective tool for building wealth.
At best, it can provide a moderate nest egg for retirement, but this approach is fragile. The push for 401(k) plans reminds me of how sugar-packed cereals were marketed as healthy breakfast foods in the 1970s and 1980s, which is now confirmed to be detrimental to long-term health and a major factor in the rise of childhood obesity.
Currently, there are 55 million workers contributing to 401(k) plans with over $5 trillion in assets, but the majority of Americans are still struggling financially. The fact that 40% of Americans do not have $400 for emergency expenses and 60% would be unable to pay for an unexpected expense of $1,000 raises serious concerns.
The 401(k) plan is a poor investment vehicle for most Americans, and there are better alternatives for building wealth. But what are they?
In conclusion: Owning multifamily real estate can be a rewarding and profitable investment strategy. With the potential for steady cash flow, diversification, property appreciation, and tax benefits, it stands out as a compelling option. However, navigating the multifamily market requires expertise, and this is where The Placement Companies excel. By leveraging their experience and commitment to investor success, they serve as a trusted source for finding, performing, and protecting multifamily real estate investments. With their guidance, investors can unlock the full potential of multifamily real estate, enjoying better and safer returns.
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