The 401(k) has long been considered the automatic, no-brainer retirement plan of the people.
“Pay less in taxes,” they say…
“We’ll take care of the hard stuff for you,” you’re told…
“Stay in it for the long run, and it’ll pay off,” they promised.
After millions of people lost 30-50% of their life savings a few years back, people started to take a closer look at the well-hidden facts behind 401(k)s.
Shows like CBS’s 60 Minutes ran specials talking to people and asking questions like “what kind of retirement plan allows this kind of catastrophic loss to happen?”
What did they find?
Well, it certainly wasn’t good.
See, unlike other investments that are protected from losses, your 401(k) goes up and down based on the stock market. You have no control whatsoever.
And far from the nice story retirement planners tell you about averaging 8-11% per year, the market was up just 8.4% total when adjusted for inflation from January 2000, to January 2015 (that’s just 0.56% per year).
That was after a substantial market rally…
And we still haven’t talked about the hidden little fees and tax issues that crush your measly 0.56% return per year even further.
Hidden Way #1: Lose Up to 66% of Your Gains to Administrative Fees and Compounding Costs
Most people don’t know this, but 401(k) and associated mutual funds usually have more than a dozen undisclosed fees that can eat up more than half your investment gains.
- legal fees
- trustee fees
- transaction fees
- stewardship fees
- bookkeeping fees
- finder fees and more.
And that’s just to start. Here’s an example:
Mutual funds inside 401(k)s often take a 2% fee right off the bat. This means that if a fund is up 7% for the year, they take 2% and you get 5%.
It still sounds ok, right? But look closer, and we see that in the end, the mutual fund wins.
Let’s say you’re 25 years old and you contribute $5,000 per year for the next 40 years, until you’re 65.
You’re lucky, and the fund miraculously manages to go up 7% every year (even though we’ve shown that’s NOT what happened the past 15 years).
Your money, in this scenario, would turn into around $1,143,000. However, you’d only get to keep $669,400, which is less than 60%.
Well, the 7% compounding returns hundreds of thousands more than a 5% compounding return, but that doesn’t go to you.
The 2% fee cuts the return so much so that – in this example – by the time you turn 75 the mutual fund may have taken two-thirds of your gains.
Jack Bogle, founder and retired CEO of the Vanguard Group puts it like this, “Do you really want to invest in a system where you put up 100% of the capital, you take 100% of the risk, and you get 30% of the return?”
Hidden Way #2: Tax Deferral Actually Leads to Paying More Tax
You’re told that one of the benefits of 401(k)s is that they’re tax-deferred, meaning you get to avoid paying taxes today by committing to paying them later.
But does this really work out in your favor?
Let’s take a closer look…
First of all, taxes are historically low compared to previous marginal rates of 50, 60, or even 90 percent. And odds are, with record national debt, taxes are only going up from here.
Secondly, if you have achieved any measure of success, it’s probable that you’ll actually be in a higher tax bracket at retirement than you are now.
So granted: Paying taxes today isn’t fun. But why would you want to avoid taxes today so that you can pay more taxes in the future?
Hidden Way #3: Become a “Sitting Duck” for Estate Taxes.
Frankly, 401(k)s are easy targets for predatory estate taxes.
There’s no clear exit strategy without major penalties or taxes. So, 401(k)s often end up being a pile of cash at the end of a person’s lifetime.
That pile of cash – unfortunately for you – looks very tempting to the government. Therefore, when it’s passed on to the next generation, it’s likely to be hit by an income tax as well as an estate tax, leaving your legacy less well off than they could have been.
If you have a 401(k) or are considering getting one, we recommend you do some serious research, and then have a serious sit down with your financial advisor.
After all, as millions of people found out the hard way, your life savings are on the line.