It’s not surprising that mutual fund companies want you to max out your 401(k) plan contributions. The more you invest, the more fees they generate.
Fidelity Investments is the biggest fund family in the 401(k) business. It wants you to invest as much as you can in its 401(k) plans—preferably in one of its funds. Is this a good idea?
Most financial experts believe you should invest the minimum necessary to obtain the maximum corporate match. This makes sense. But what if your employer no longer matches? Many employers dropped the match as the economic crisis deepened.
On balance, I see little benefit to participating in most 401(k) plans absent an employer match. Remember, most of these plans have high costs and fees and an unattractive array of investment options. Instead of trying to overcome these obstacles, set up your own deferred retirement plan directly with a low-cost provider like Vanguard. Open a traditional or a Roth IRA (if you qualify). You can contribute up to $5,000 a year to either of these IRAs (or up to $6,000 if you are 50 or older).
By taking control of your own deferred retirement plan, you can reduce costs dramatically and invest intelligently, following the basic principles I describe in The Smartest Investment Book You’ll Ever Read. I also recommend specific mutual funds that you can purchase directly from fund families like Vanguard, Fidelity, and T. Rowe Price. No broker or adviser is needed.
When debating whether or not to contribute to your 401(k), there are other issues to consider. These factors are rarely discussed in the financial media.
Your 401(k) contributions are tax-deferred, not tax-free. That means when you make withdrawals, you’ll have to pay taxes on the full amount withdrawn, at your marginal ordinary income tax rate on the date of withdrawal. While predicting future tax rates is risky business, many experts believe ordinary income rates will rise in the future. If this happens, the benefit of tax deferral could be seriously lessened.
Even if tax rates stay the same, don’t assume you will be in a lower tax bracket when you’re required to start taking minimum withdrawals from your 401(k) plan. The tax law requires you to annually withdraw designated amounts from your 401(k) plan starting at age 70½, regardless of whether you are actually retired. If you’re not retired, the addition of these withdrawals to your other income could place you in a higher tax bracket.
Finally, there is the risk of retroactive tax legislation that could reduce, or even eliminate, the benefits of 401(k) plans. The U.S. Supreme Court has sanctioned retroactive tax legislation going back as far as ten years, referring to it as “customary practice.”
If the government continues to print money, it is simply deferring its obligations. For tax revenues to satisfy its debts, it may look for an easy target. The roughly $3 trillion sitting in 401(k) plans might be irresistible to Uncle Sam.
Finally, here’s a noneconomic reason for avoiding these plans: the system is rigged against investors. It benefits primarily advisers, brokers, and mutual fund families. You might feel good about taking a principled stand and just saying no until the system is totally reformed.
Dan Solin is a Senior Vice-President of Index Funds Advisors. He is the author of the New York Times best sellers The Smartest Investment Book You’ll Ever Read, The Smartest 401(k) Book You’ll Ever Read, and The Smartest Retirement Book You’ll Ever Read. His latest book is Timeless Investment Advice.
Watch Dan on YouTube.
Asset Allocation: Maximize Your Returns and Minimize Your Risk
Avoid Exchange-Traded Funds (ETFs) as Part of Your Investment Strategy
How to Maximize Your Investment Returns with Your Cash Reserves
Investing As A Couple Can Lead to Marriage Stress
Equifax maintains this interactive forum for education and information purposes in order to allow individuals to share their relevant knowledge and opinions with other members and visitors. We encourage you to participate in discussions about personal finance issues and other topics of interest to this community, but please read our commenting guidelines first. Equifax reserves the right to monitor postings to the forum and comments will be published at our discretion. Do you have questions or comments about your Equifax credit report or customer-service issues regarding an Equifax product? If so, please contact Equifax directly. All opinions and information expressed or shared in blog comments are solely those of the person submitting the comments, and don't necessarily represent the views of Equifax or its management.