10 Sep Should You Cash out your 401(k)?
I would blow up the system and restart with something totally different.
—Ted Benna, “father” of the 401(k), quoted in MarketWatch.com
As investors educate themselves about the financial guidance which is accepted as “common wisdom”, many start to recognize that 401(k)s might not be the “retirement solution” they were supposed to be. Even Ted Benna, the guru who popularized the tax loophole that turned into the 401(k) plan, is critical of what 401(k)s have become.
But should you cash out your 401(k)? There are several advantages in addition to serious disadvantages, and it is frequently not a straightforward or clear-cut choice.
THE ADVANTAGES OF CASHING OUT YOUR 401(K) EARLY
There are a few great reasons to liquidate your 401(k), or simply set future dollars elsewhere.
We’ll discuss seven advantages you should consider to free up your dollars (current and future) from a 401(k) plan.
1. Political doubt: There are dangers in keeping your cash in accounts regulated by a government in debt. Though rules in the past have been fairly stable, Congress has debated a variety of things they’d like to do with “your” qualified plan funds.
2. Consumer debt: Many 401(k) participants have high personal debt that they could pay off with the money in their 401(k) – increasing their future cash flow and allowing for more saving.
It is a common question– what should you do with investments that you can’t access? Especially when you have increasing bills, debts or other financial needs? There is no one easy answer, but the best preventative strategy is to keep your money liquid in the first place.
3. The price: Layers of difficult-to-locate fees slow profits and deplete gains. A fund costs more in a retirement plan than it does outside of one, due to the management and administrative fees which exist on top of the routine (typically overblown) mutual fund fees.
4. Few options: Investment options are very limited and mainly contain mutual funds, which are constituted of securities and carry the dangers of the stock exchange. Safer selections are often seen as unpopular, particularly as additional fees make them less appealing.
5. Future taxes: Do you believe taxes are going down or up? Most often fear that income taxes are likely to increase, in turn increasing the future cost of living. If you think this is likely to happen, then either a Roth account or alternative investments may be a better wager than anything tax-deferred.
6. The rules of borrowing: Plan participants usually have limited access to their money and cannot take money out of their retirement accounts. Funds cannot be utilized to begin a business, buy another house, or for other purposes that may be preferred over keeping cash in mutual funds.
7. The horrible inefficiency of 401(k) loans: Dollars taken out of a 401(k) plan have gone into the account “tax deferred,” but when taken out, must be replaced with “after tax” dollars that will be taxed AGAIN when the funds are withdrawn, at your current tax bracket. You should always have sufficient liquid assets or savings to borrow from without tax penalties.
THE DISADVANTAGES OF LIQUIDATING A 401(K)
Before contemplating pulling your money out of any tax-deferred qualified strategy, be aware of these factors:
TAXES: You have to be ready to pay the taxes and fees – both financially and emotionally! While it is numerically practical, it is still very hard to pay all those taxes at the same time. If you do decide to cash out your 401(k), you may want to split the process up over several tax years to prevent yourself from paying higher-than-needed tax bracket rates.
TIME: Cashing out your 401(k) also means pulling from your current investments. Nervous investors often pull out their cash after big losses – which may be precisely the wrong time. It feels counterintuitive, but when the market is performing well, it is the most effective time to move your money!
SAVING PRACTICES: Do you have an alternative option in place (including a cash value life insurance policy) to continue saving? Too frequently people withdraw their money from a qualified plan and then find themselves not saving money at all later.
WHAT NEXT? Where are you going to place the cash out of your 401(k) or other qualified retirement plan WHEN you liquidate it? Do you have a strong next-step strategy? Have you been assured that the next step is A MUCH BETTER place for your cash than your 401(k)?
Andy Tanner, author of 401(k)aos, makes the point that liquidating your 401(k) without having a sound strategy for what to do NEXT is not a good plan. As Tanner points out, the reason that many employees are in 401(k)s in the first place is that they don’t know how to do better on their own. Individuals leave their money in 401(k)s, possibly selecting a target-date fund or letting their business strategy administrators discover how to proceed with it because they do not understand how to invest.
SOLVING THE 401(K) PROBLEM
The limited and instead skewed “investment education” plans from strategy administrators will not solve the issue of teaching individuals to invest. (Paradoxically, the strategies are designed so this issue CANNOT be solved, as actually training workers how to invest would lead them to select different choices than the ones offered in their company’s plan!)
Ted Benna commented on MarketWatch.com that, “we will never teach 40 million participants to become highly skilled investors,” because “a 20 percent drop on your account value feels a lot different when your balance is more than $100,000 at age 56 than when you are 29 and have a $10,000 balance.”
And the problem is much more than just teaching people how to get better returns. If anything, pursuing high rates of return could possibly be a symptom of larger issues.
People are often led by qualified plans to save less and INVEST more than they can afford. It’s critical that individuals SAVE MORE. We advocate saving 10-20% as target or a guideline, and strive to be able to save even more!
Most people have a lot of assets in limited environments, and way too few liquid assets which can be tapped in to for emergencies or opportunities. Because of this, they may be subject to excessive danger and additionally “raid” their qualified plans when crises hit – with costly results.
Saving helps you keep charge of your cash, whereas investing too frequently includes giving control to the whims of the stock exchange as well as a supervisor or agent.
Benna chronicles the history of 401(k) plans and reveals that they began with only 2 options: one for saving, and another for investing. An insurance carrier would provide a fund at a guaranteed rate, as well as another alternative that was usually more broad with an emphasis on growth-oriented mutual funds, though occasionally it may involve a business stock plan (which, as all of us understand now, is a high-risk option.)
Most players made a decision to split their contributions between the two 50/50, as Benna recounts. But, that didn’t solve the problem of having the employee’s savings locked within the qualified plan. It did, however, offer employees some security and protection against the market’s instability.
Yet there’s another problem with the investment options supplied in a traditional 401(k). It has to do with the narrow way people often define “investments” as it is too frequently restricted to stocks, bonds, and mutual funds.
We are conditioned to equate “investments” as only being the options that a brokerage house or bank might give us. We are conditioned to equate healthy yields with higher danger. We are conditioned to anticipate that we’ll lose money occasionally and that is normal. Yet not one of these premises needs to be true.
Even if you’re seeking an INVESTMENT vehicle (not just a savings vehicle), there are better options than the limited options in your 401(k) account.
GET THE FACTS, EXPLORE YOUR OPTIONS
What if everything you thought you knew about money turned out to be wrong? When would you want to know? At Truvium Financial Group, we show our clients both sides of the coin. Remember, when banks and financial institutions created their products, they did so to help their customers, but also to make a profit. Only by examining and fully understanding the nature of the products and your entire financial picture can you begin to make financial decisions that are truly inline with your objectives. Give us a call to talk about alternative ways of saving and investing as well as the pros and cons of whether you should cash out your current 401(k) plan.
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