401Ks Not for Everyone

[Free To Canoe]

401Ks Not for Everyone


I have been preparing taxes during the season for a few years now. During my 2013 tax season, a large percentage (about 15%) of my customers have cashed in their 401k accounts with penalty this year. We live in a poorer, rural area. Most of my clients are lower middle class income range.
Some were desperate for money because of the severeness of the economic downturn but most I cashed in due to poor money management skills. Many think of the 401k as an emergency fund and therefore don't have a real emergency fund established. It is discouraging.


Another observation new to me. Most older retirees would be considered disabled if they were of working age. For many of my older clients, it is an effort to make it into the office to have their taxes done, especially in the bad winter weather. I worries me to watch them walk.


One is mistaken if they think the workforce (at least as I view it here) is going to retire on 401k and other retirement plans alone. Most Americans with poor money management skills are relying on the Social Security program for old age survival. What happens when they lose their job because they are not healthy enough to compete? SSA. No SSA, disability. No disability, welfare. Do we really want to talk about no welfare? Better to have them fund SS and at least pay for part of their own retirement than to be a complete burden to society.


I contend that a 401k, even with some matching by the employer is the wrong choice for some people. Unless a person has some saving ability and money management skills, it is usually a losing proposition. I never hear anyone discuss this aspect of retirement saving.

 

[RunningBum]

For someone without saving ability and money management skills, what do you think they would have done over the years with that money they didn't put in the 401K? My guess is that they would've spent it rather than save it for an emergency fund. The penalty stinks, but at least they had that money to tap into, rather than no savings at all.

For someone who contributed up to the employer match, that match probably more than covered the penalty.

 

[RunningBum]

More thoughts:

Just before I went to Boston, a running friend posted on facebook that he had to cash in part of a 401K for major credit card debt. He was aware of the 10% penalty, but then also got socked with AMT, and probably an underpayment penalty. Some of his friends were sympathetic, and ragged on the dirty rotten government for taxing us.

One friend posted that she wouldn't go to Boston under those circumstances. I silently agreed. I don't know the guy that well so I didn't want to nose into his business. He did go, and joined us at a dinner that was about $35/person, plus drinks. He also joined us post-race for beers (though considering he was about 100 yards ahead of the blasts I can't really begrudge him that).

Point is, what strategy is going to work for someone like that? Tapping the 401K with penalty is just a symptom of the bigger problem.

 

[nun]

DB plans would be better than 401k plans for may people.

The UK has implemented automatic DC plans for everyone in full time employment with minimum employee and employer contributions and you can't get at the money early. The default income option is an annuity. The worker can opt out, but it's a lengthy and difficult process.

 

[travelover]

DB plans would be better than 401k plans for may people.

The UK has implemented automatic DC plans for everyone in full time employment with minimum employee and employer contributions and you can't get at the money early. The default income option is an annuity. The worker can opt out, but it's a lengthy and difficult process.

This seems to make sense to me, especially if the annuities are properly funded and the fees are not excessive. Of course, to some, it smacks of Big Government or nanny state, but my observation is that the average person is lousy at looking after their own retirement. The posters here are mostly on one far end of the distribution curve with regard for taking individual responsibility for themselves. This approach also ends the current practice of having one generation fund the retirement of the generation before them - and the political abuses that encourages.

 

[heeyy_joe]

Forrest Gump stupid is - YouTube

 

[Free To Canoe]

More thoughts:

Just before I went to Boston, a running friend posted on facebook that he had to cash in part of a 401K for major credit card debt. He was aware of the 10% penalty, but then also got socked with AMT, and probably an underpayment penalty. Some of his friends were sympathetic, and ragged on the dirty rotten government for taxing us.

One friend posted that she wouldn't go to Boston under those circumstances. I silently agreed. I don't know the guy that well so I didn't want to nose into his business. He did go, and joined us at a dinner that was about $35/person, plus drinks. He also joined us post-race for beers (though considering he was about 100 yards ahead of the blasts I can't really begrudge him that).

Point is, what strategy is going to work for someone like that? Tapping the 401K with penalty is just a symptom of the bigger problem.

Amen to that.

This seems to make sense to me, especially if the annuities are properly funded and the fees are not excessive. Of course, to some, it smacks of Big Government or nanny state, but my observation is that the average person is lousy at looking after their own retirement. The posters here are mostly on one far end of the distribution curve with regard for taking individual responsibility for themselves. This approach also ends the current practice of having one generation fund the retirement of the generation before them - and the political abuses that encourages.

I guess Nun's UK solution would work, too. The problem is no one likes to be told what to do.

 

[clifp]

There is no perfect system. A DB pension system like the automakers ended up with resulted in GM, being called by one analyst a retirement home with a side business of making cars.

I really like the concept behind Federal's FERS, small pension, social security, plus a 401K-like saving vehicle with the option to annuitize some or all of your TSP. How we translate that to the private sector is mystery.

I don't have a problem with UK system or the Australian system. I must say the longer I look at retirement options for the masses the more I think trusting people to do the right thing is probably our worst option.

Essentially I'd want every American to show that have guaranteed income, via SS, a pension, or an annuity, that gets them to the Federal poverty level at retirement. Once they can demonstrate that level of financial means that I am fine with them doing whatever they want with their money. But if they fall below the poverty level than more likely than not the rest of will have to bail them out.

 

[ERhoosier]

There is no perfect system. ...
I don't have a problem with UK system or the Australian system. I must say the longer I look at retirement options for the masses the more I think trusting people to do the right thing is probably our worst option...

Agree there's no single perfect system, but I look at southern Europe (e.g. Greece) & think trusting a gov't to "do the right thing" has often not worked out well either.

 

[clifp]

Agree there's no single perfect system, but I look at southern Europe (e.g. Greece) & think trusting a gov't to "do the right thing" has often not worked out well either.

I agree, trusting the government "to do the right thing" is also bad. I actually think pensions that are tied completely to a persons final wage and length of service is probably the worse possible system. The employee be it for a public or private employer must have a stake in how well the employer is doing. The higher up in the organization the more control you have over the outcome and the more dependent you should be on the organization's success for your retirement.

This is easier to do with a private company, (i.e. profit sharing) but can also do be done with a public employer. E.g. increases in pension tied directly to the investment funds returns, require pension funds to invest X% of their assets in a cities, states bonds, or student loans.

On the other hand you don't want to complete hose the poor maintenance g, who spends 30 years working for wrong employer

 

[jollystomper]

Tapping the 401K with penalty is just a symptom of the bigger problem.

+1

The root cause IMHO is that we "preach" savings but we "perform" spending. We have (in the U.S.) an economy that depends on folks spending to the degree that personal debt spending is encouraged. When folks start saving then all one hears is how the economy will suffer because people are not spending.

Having a DB plan provides the illusion of not needed to save, and you never know what will happen in the future. When 401ks came out, if let to my own devices I would have ignored them since my view was "why lock us this money that I can't get to for 30+ years, besides I have a pension anyway". It took older co-workers "beating" me about it on a daily basis for almost a year to convince me to get into a 401K, and I do regret that for more than a few years I more "stuck my toes in the water" for contributions instead of doing more LBYM and building up my 401k more. With a reduced pension and no real health insurance when I retire, it is going to make a difference for me.

 

[nun]

There is no perfect system. A DB pension system like the automakers ended up with resulted in GM, being called by one analyst a retirement home with a side business of making cars.

Underfunding or the expectation of excessive returns point to a failure of GM management and the Unions rather than the DB plan itself. As a way of funding retirement a sensible and well run DB plan would be good for many people. Problems with portability and the employee owning the benefit would have to be addressed.

 

[pb4uski]

I disagree that 401k's are not for everyone. The problem is that too many people have poor money management skills. I would rather have us address that problem than have a nanny-state solution of required contributions to DC plans or requiring employers provide DB plans. That said, I would favor limits on ERs on 401k plan investment options and a requirement that index funds be offered.

 

[ziggy29]

I really like the concept behind Federal's FERS, small pension, social security, plus a 401K-like saving vehicle with the option to annuitize some or all of your TSP. How we translate that to the private sector is mystery.

+1

I have long held up FERS as a model for what I think a retirement system should be. We've long been sold the idea that retirement income is a "three legged stool" of Social Security, pensions and personal savings, and the FERS model pretty much accomplishes exactly that. I think CSRS and many other state and local public pension plans were unsustainably generous, and I think a retirement system with NO defined benefit component is doomed to make "retirement" an increasingly impossible concept for the masses. And it's not in our best interest to keep people holding on to their jobs until the day they die out of economic necessity, given how many younger folks can't find any jobs at all.

The problem in rolling out a FERS-like retirement plan to the masses are two-fold:

1) As already mentioned, the problem with overcoming resistance to "big government" and being told what to do with an additional chunk of your paycheck;

2) Ensuring portability in the "pension" component. Most people don't have "jobs for life" any more, particularly in the private sector, whether they voluntarily change jobs or get repeatedly laid off. And a DB pension really does require many accrued "years of service" and contribution to the plans in order to provide enough income to be a significant component of retirement. In the new economic reality, any pension component that isn't portable is not a feasible solution. That would mean paying money into some pool rather than having it subject to the whims and financial stability of your own employer.

If such a thing were ever implemented in the US (highly doubtful, IMO) it would also be nice if they gave an option for folks to use part of their deferred retirement savings to buy into the pension component of the plan if it were deemed economically viable to do so. This might provide another option besides an SPIA, which are currently a lousy deal because of pathetically low interest rates. That wouldn't be a requirement to make it work, but it would be a nice touch to some who have toiled for decades without any DB pension component accruing for them.

And frankly, in this day and age I don't think we can decouple any talk about retirement systems from the 800 pound gorilla in the retirement room, health care. It *may* be after 2014 that PPACA makes health care a less insurmountable "hump" to get over for retirees of less than considerable wealth, but it remains to be seen in practice.

 

[travelover]

I disagree that 401k's are not for everyone. The problem is that too many people have poor money management skills. I would rather have us address that problem than have a nanny-state solution of required contributions to DC plans or requiring employers provide DB plans. That said, I would favor limits on ERs on 401k plan investment options and a requirement that index funds be offered.

Interesting proposition (bolded above). While we are at it we could eliminate all other behavior problems like excess drinking, domestic violence and homelessness.

 

[heeyy_joe]

Interesting proposition (bolded above). While we are at it we could eliminate all other behavior problems like excess drinking, domestic violence and homelessness.

Hmmm....5th grade or 6th grade?

 

[meierlde]

+1


If such a thing were ever implemented in the US (highly doubtful, IMO) it would also be nice if they gave an option for folks to use part of their deferred retirement savings to buy into the pension component of the plan if it were deemed economically viable to do so. This might provide another option besides an SPIA, which are currently a lousy deal because of pathetically low interest rates. That wouldn't be a requirement to make it work, but it would be a nice touch to some who have toiled for decades without any DB pension component accruing for them.

.

So should the taxpayers make up the difference? That is the only source because a buy in would likley be based upon the interest rates when you buy in thus no different than an SPIA. Some one needs to make up the difference. Note that a number of DB plans are changing to a cash balance plan where you have $x at retirement not $y per month, all be it most seem to take the lump sum anyway.

 

[Sniggle]

I don't see a problem with a system that rewards those that demonstrate money management skills and spending discipline.

The alternative is a government run system that rewards government, encourages poor decision making and punishes the frugal.

No thank you.

 

[Free To Canoe]

Another observation from tax season. Only about 10-15% have implemented some sort of 401k plan or equivalent.

 

[ziggy29]

So should the taxpayers make up the difference?

I knew someone would have to take it there. Sigh. I'm surprised it took as long as it did, really.

I never said what you are suggesting here, and I intentionally avoided getting into the political nuts and bolts (there are plenty of other full-contact sites for people to pursue that). I never even said I supported doing this as a result of federal legislation. I'm just saying these would be the concerns of doing it, and IF it were done, this is how I'd like to see it.

That said there are probably ways to do it if the guarantees aren't too generous and may "slide" a bit depending on economic trends and life expectancies, which would only require "help" in cases so dire that taxpayer fund injections were the least of our problems. Whether or not you think that's a good idea is left to your own ideology; I don't want to get into that here.

 

[samclem]

The advantage of private vs public pensions is that private pensions are not subject to direct raids conducted on behalf of the electorate by those they elect.

Decades ago, when the US Government spent just 5% of our national production, it was probably harder to see that safety net program started with good intentions might threaten the prosperity of our children.

Seeing what we've seen in the US and abroad, I think people will increasingly trust their future to things they actually own and control. The government now assists us (through tax breaks) in acquiring retirement assets that we actually own, but it's true that many folks aren't taking responsibility for their future. Maybe it will take the retirement "failures" of a generation for the lesson to be learned by their children.

 

[nun]

The advantage of private vs public pensions is that private pensions are not subject to direct raids conducted on behalf of the electorate by those they elect.

We need to be careful here. SS is not a pension and can be change at will by the politicians. Government and state pensions are the property of the individual. I have a state mandated DC plan and there is no way the state can get at my money, the same goes for the parallel DB plan.

 

[ziggy29]

We need to be careful here. SS is not a pension and can be change at will by the politicians. Government and state pensions are the property of the individual. I have a state mandated DC plan and there is no way the state can get at my money, the same goes for the parallel DB plan.

I would add that this also includes plans like a 401K or a 403B. Legally these are treated as pension plans under federal law -- unlike an IRA. This is why there are federal protections for 401Ks, for example, that don't exist (or exist to a limited degree) for IRAs. A 401K is protected by federal pension laws and an IRA isn't.

We often don't think of a 401K as a "pension" because usually, when we say "pension" we mean a defined benefit pension. But in the eyes of the law, a defined *contribution* pension plan like a 401K is very much a pension plan.

 

[Hamlet]

Private pensions still get raided. They are just raided by management/shareholders/private equity.

Ultimately, I would never truly trust a DB plan unless I had a lot of faith in the specific people running it.

The advantage of private vs public pensions is that private pensions are not subject to direct raids conducted on behalf of the electorate by those they elect.

 

[samclem]

Private pensions still get raided. They are just raided by management/shareholders/private equity.

Oh, yes, that can happen. That's why I wrote:

. . . I think people will increasingly trust their future to things they actually own and control.