I’ve heard all the arguments about why everyone should take advantage of their 401k and at a minimum match their company’s contribution. If you don’t, you are losing out on ‘free money’. The ‘free money’ idea is based on the fact that when you put in $300 per month and your employer matches your $300, than you are giving up $300 in free money.
The 401k plan was created by the government with good intentions to help encourage people to save more money for retirement. The plan included several financial incentives and trade-offs for both employers and employees. The reason employers are willing to contribute to your 401k is because they can avoid many taxes that they would have had to pay if they directly gave you the money and they can still include the full amount in your benefits package. In fact, companies save so much money with these plans that they encourage everyone to sign up for them.
The true cost of investing in your 401k cannot be known until you retire, which is sometimes 30 or 40 years away. I find it ironic that people so easily trust their hard earned money to a savings plan in a nation that is only 220+ years old and has had several major financial meltdowns.
Here is a list of reasons not to contribute to your 401k plan:
- Loss of opportunity for 30-40 years
- Inflation (the dollar lost 2/3 of its value just during the 70’s recession)
- Taxes are likely to be higher when you withdraw your money
- False sense of security, which increases a tolerance for debt and promotes bad spending habits of living beyond ones means
- Many plans are littered with hidden fees
- Loss of control with limited investment choices
- Stock markets are risky and shouldn’t be invested in without a financial education
A Better Option
A better option would be to pay off debts and create a savings account at your local bank. There is a good chance that you will need an emergency fund someday when your company decides to downsize or your job gets outsourced. If you have a savings of 6-12 month of your income, you will save a lot of money just by not having to borrow from your 401k or suffer a major financial loss like a foreclosure.
Saving for retirement before getting out of debt is a foolish idea - even with a company match - that will likely be gone by the time you take the money out anyway. The only good that the government created 401k savings plan has brought is that it provides the stock market with a base that cannot be quickly sold. That base, which is missing from foreign markets, is why the market cannot dive 50-70% very quickly.
They Always Say - Start Early
When you ask a financial adviser when you should start investing for retirement, what do they always say? ‘Start Early.’ Well, this is bad advice and here is why. When you get out of college with 50K in loans and a 10k car loan and you start looking at a new house, you are broke. Investing for retirement when you are this far behind is not a good idea, because all it does is help you live with your debts.
At this point, most financial advisers show you a graph of compounded interest to prove to you the earlier you start the better. But, what they don’t tell you is that your debt interest is also compounding against you. If you save 100k in your 401k with 100k in debt, both interests are compounding and you are not getting anywhere.
A better idea is to first get out of debt, second build a savings account and then carefully consider your options for saving for retirement.
Besides, if the biggest advantage to a 401k plan is that your income tax is deferred until you withdraw the money in retirement, then doesn’t it make more sense to wait until you have a higher income and are in need of a tax shelter? When you start investing in your early years of work, your income is low and your tax burden is small – especially with tax deductions from your kids and mortgage interest. Your largest income will be when you are in your 40’s and 50’s. That’s when you will need a tax shelter and will likely save the most money by investing in your 401k.