401k … a means or an end?

There’s still this general expectation that if you earn an income then you will have a 401k … it’s seen as an ‘end’ rather than the ‘means to an end’ that it really is.

Let’s look at the advantages:

1. Tax free on deposits into your 401k … ‘boosts’ your investment buying power by up to 25% to 35%

2. Possible employer ‘match’ … further ‘boosts’ your investment buying power by up to 50% to 100%

Now, let’s look at the disadvantages:

a) Generally, limited investment choices (e.g. managed funds)

b) High fees (both explicit and hidden)

c) Restricted access to your money until government-managed ‘retirement age’

d) A fairly low ‘cap’ on amounts that may be invested

But, similar lists of advantages and disadvantages can be draw up for ANY form of investment, tax scheme, etc. etc. …

… it’s just that we mostly don’t bother. We blindly accept the 401k as the ONLY way to go.

Ryan says:

I share your distaste for 401Ks, and their fee’s and penalties, but I have to believe that there is some advantage to having tax shelters (be them 401k or not). Otherwise, won’t the government just take all of your hard earned (and passively earned!) money?

Ryan’s right … the Government WANTS you to pay tax, but only the minimum that you NEED to pay … they don’t expect a penny more. The problem is, the government is only interested in the tax portion of your personal ‘Profit & Loss’ … YOU should be concerned with all of it!

As Scott says:

Robert Kyosaki states that the wealthy aren’t the one’s paying the lion’s share of the taxes. The middle and upper middle class do.

A 401k, ROTH, ROTH IRA, etc., etc. are all simply methods of protecting assets from taxes to a greater or lesser extent …

… the problem is not with these ’shelters’ in themselves, it’s in their design. You see, they were designed for the ‘average American’ to encourage them to save for retirement.

You and my other readers are probably NOT average Americans – if you are like me, you are aiming for a Number in the millions – and will surely hit the ‘roof’ (i.e. the maximum amount that the Government ‘allows’ you to sock away during any one year) of these vehicles very quickly, as your income starts to sky-rocket from Making Money 201 activities …. then, once you achieve your Number, the limits that you can have socked away will mean little to your Making Money 301 wealth preservation strategies … it’s why I don’t even bother!

It doesn’t mean that you shouldn’t tax-protect your money …

… it’s merely that Scott has hit the nail on the head: these aren’t the ONLY tax shelters available, or even the BEST tax shelters available.

For example, and as Robert Kiyosaki suggests, investing in income-producing assets via corporate structures (LLC’s; trusts; C- and S-Corporations; etc.; etc.) and taking advantage of all the tax deductions available to you (e.g. depreciation, 1031 Exchanges; etc.; etc.) will blow away any ‘tax advantages’ of 401k’s and similar (even WITH the ‘free’ money from the employer match factored in).

So, let’s not put the cart before the horse:

– FIRST look at the types of investments that you need to make in order to reach your financial objectives – be they long term (i.e. your Number) and/or short-term (e.g. flipping a house / trading some stocks and options)

– THEN look at the best ‘vehicle’ to house them in.

As an extreme example, if you decide that a business is the way to go – and, put up 100% of your savings as ’seed’ capital’ – then having a 401k is hardly going to help you, is it?

Blindly setting up a 401k first, then seeing what investments you are allowed to make in them is putting the cart well before the horse!

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7 thoughts on “401k … a means or an end?

  1. A 401(k) is not as tax advantaged as people think it is! You are not truly getting a deduction – you are simply DEFERRING taxable income into the future. The thought that you will be in a lower tax bracket when you retire is esentially saying “I’m not going to hit my number and will be less successful in the future then I am now!” It’s really a big hoax. And you do NOT keep the earnings on the portion you would have paid in taxes now – that goes to Uncle Same upon withdrawal as well! People say how you get to earn interest on Uncle Sam’s money – well, that couldnt be farther from the truth. If you have to pay 30% on $10,000 today…. you are going to still have to pay 30% on $100,000 tomorrow – it’s all relative. Plus, with our new President’s spending spree, why defer taxes into what is almost certainly going to be a higher-tax era (ie. the future!)

  2. True, the tax-deferred retirement savings system is set up for the life of someone that worked for 30 odd years and retires. If your life trajectory, career paths or aspirations strays from the majority of people employed, then one should definitely reconsider the merits of such systems.

  3. @ Dana – … as fits the profile of most of our fellow readers, I hope, after all this blog is titled: How To Make $7 Million In 7 Years 😉

    Thanks for your comments, Dana and DrDollaz

  4. So what if I contribute today while I work, and then just take it all our (paying income tax plus penalty) if a better investment comes along? Is that a good strategy?

  5. @ Brad – It depends on how soon you expect to make these other investments, what return you expect them to bring, and what benefits you get from ‘investing’ in your 401k (e.g. employer match PLUS tax benefit going in MINUS taxes/penalties taking money out PLUS/MINUS market appreciation/depreciation) in the meantime … not an easy equation to solve 🙂

  6. There would be no point to just contribute while you work and then take it out when you need it. That’s the problem with 401k plans – they have HORRIBLE exit strategies! 30 years from now, you wont remember the tax ‘deferral’ you got 30 years earlier. If you’re really planning on being truly successful w/ business & investing along the way, my vote is to keep more CONTROL over your money during the accumulation phase so that you have ACCESS to it to invest in more lucrative ventures – not your 401k!

    Just my 2 cents thought 🙂

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