“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 advice that is accepted as “common wisdom,” many begin to realize that 401(k)s might not be the “retirement solution” they were assumed to be.
But should you cash our your 401(k)? There are serious disadvantages as well as advantages, and it’s often not a simple or clear-cut decision.
The Advantages of Cashing Out Your 401(k) Early
There are valid reasons to liquidate your 401(k) for good (or perhaps just put future dollars elsewhere). Here are seven advantages to freeing your dollars (current or future) from a 401(k) or another qualified plan.
- Costs: Layers of hard-to-fund fees that drain profits and slow growth. A fund costs more in a qualified retirement plan than it does outside of one, because of the management and administrative fees that exist on top of the regular (often overblown) mutual fund fees.
- Limited choices: Investment choices are extremely limited and mostly consist of mutual funds, which are comprised of securities and carry the risks of the stock market. Safer choices are less popular, especially as the extra fees of the qualified plan make them less attractive.
- Future taxes: Do you think taxes are going up or down? Many fear (for good reason) that income taxes may rise and increase the future cost of taking income from a qualified plan. If so, that makes either a Roth account or other investments a better bet than anything tax-deferred.
- Rules of Borrowing: Plan participants have restricted access to dollars for limited reasons and cannot leverage against their retirement accounts. Funds cannot be used to start a business, purchase a second home, or used as collateral for other purposes that may be preferable to keeping money in mutual funds.
- The horrendous inefficiency of 401(k) loans: Dollars borrowed from 401(k) have gone into the account “tax-deferred,” but if borrowed, must be replaced with “after-tax” dollars that will be taxed AGAIN upon withdrawal. That can mean a 25%, 28%, 35% or more automatic loss! To prevent this, you should always have adequate liquid savings and/or assets that can be borrowed against without tax consequences, such as life insurance cash value.
- Political uncertainty: There are risks in keeping your money in accounts governed by policymakers and a government in debt. Though rules have been quite stable in the past, Congress has debated all kinds of things they’d like to do with “your” qualified plan funds.
- Consumer debt: Many plan participants have high-interest debts they could pay off with 401(k) dollars to increase their cash flow position and enable more saving. (And if they have high-interest debts, it’s precisely because they tried to “invest” before SAVING!)
It is a common quandary – what should you do with investments you can’t access when you have current bills, debts or other needs? There are no easy answers, but there is a preventative solution: maintaining adequate liquidity in the first place.
The Disadvantages of Liquidating a 401(k)
In spite of compelling reasons to liquidate a 401(k), there are also important considerations and good reasons why cashing out your 401(k) may be a BAD IDEA – or at least, not a good move to make right now.
Before considering pulling your money out of any tax-deferred qualified plan, be well aware of the following considerations:
TAXES: You must be prepared to pay the taxes and penalties – both financially and mentally! Even when it makes sense numerically, it is often very difficult to pay all those taxes at once. If you do decide to cash out your 401(k), you may want to do split the process up over more than one tax year to keep yourself from paying higher-than-necessary tax bracket rates.
TIMING: Cashing out your 401(k) also means pulling out of your current investments. Nervous investors tend to pull their money after large losses – which may be exactly the wrong time. It feels counter-intuitive, but the best time to move your money from the market is usually when it has been performing well!
SAVINGS HABIT: Do you have an alternative structure in place (such as a cash value life insurance policy) to continue your savings habit? As problematic as qualified plans are, too often those who don’t save in qualified plans find themselves not saving at all.
WHAT NEXT? Where will you put the money from your 401(k) or another qualified retirement plan AFTER you liquidate it? Do you have a solid next-step strategy? Are you confident it is a BETTER place for your money than your 401(k)? Liquidating your 401(k) without having a sound strategy for what to do NEXT is not a good plan. 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.
Solving the 401(k) Problem
The limited and rather skewed “investment education” programs from plan administrators won’t solve the problem of teaching people to invest. (Ironically, the plans are designed so that this problem CAN’T be solved, as truly educating employees how to invest would lead them to choose different options than the ones offered in their company plan!)
Qualified plans lead people to INVEST more than they can afford while SAVING too little. It is imperative that people SAVE MORE. We recommend saving 10-20% as a guideline or goal, and some people save even more!
Most people have far too few liquid assets that can be used for emergencies or opportunities, and too many assets in restricted environments. As a result, they are subject to unreasonable risk and also “raid” their qualified plans when emergencies strike – with costly results.
Saving helps you keep control of your money, while too often investing involves giving control to a manager or broker and the whims of the stock market.
Yet there is another issue with the investment options provided in a typical 401(k). It has to do with the limited way many people have come to define “investments” as too often limited to stocks, bonds, and mutual funds.
We’re conditioned to equate “investments” with the limited options a salesperson at a brokerage house, or bank might give us. We’re conditioned to equate healthy returns with higher risk. We’re conditioned to expect that we’ll inevitably lose money sometimes. None of these assumptions needs to be true.
Even if you are looking for an INVESTMENT vehicle (not simply a savings vehicle), there are better choices than the severely limited choices in your 401(k) account.
Get the Facts, Explore Your Options
Contact us at NeeserInsurance.com to discuss the pros and cons. Even if you don’t want to liquidate your 401(k), it may be high time you created another investment or savings vehicle for new dollars.
©Prosperity Economics Movement
