View your 401k as insurance!

I agree with Financial Samurai’s basic sentiment, which is to effectively ‘write off’ your 401k and Social Security:

Every month I contribute $1,375 to my 401K so that by the end of the year, the 401K is maxed out at $16,500.  Unfortunately, $16,500 a year is a ridiculously low amount of money to save for retirement if you really do the math.  After 10 years, you might have $200,000, and after 30 years you might have $600,000 to $1 million depending on the markets and your employer’s match.  Whatever the case may be, the 401K is simply not enough money to retire on, especially since you need to pay tax upon distribution.

CNN Money and other advisers showcased super savers who to my surprise include 401K and IRA contributions as part of their percentage savings calculations.  In other words, if you make $100,000 a year, save $4,000 a year in cash, and contribute $16,000 in your 401K, you are considered by financial advisers as saving 20% of your gross income.  Your $20,000 in “savings” is woefully light because in reality, you are only saving $4,000 a year. With the stock market implosion of 2008,  your 401K has proven itself to be totally unreliable.  Like Social Security, contribute to it like any good citizen should, but in no way depend on Social Security or your 401K to retire a comfortable life.  I

Depending on Social Security is depending on the government doing the right thing.  There’s no way that’s going to happen.  Depending on your 401K is depending on people choosing the right stocks consistently over the long run, which isn’t going to happen either.

Because Social Security is a burden on governments and society, it’s always at risk of being watered down or eliminated … this is less of a risk the older your are (hence closer to receiving the payments).

But, not so your 401k: while governments can (and, probably will) water down – instead of increase – the contributions and benefits of your retirement program, the money that you contribute (and, your employer match) is still yours!

I don’t think you’ll ever lose what you contribute + whatever gains the flawed investment choices available may bring.

I look at my retirement plan (which I haven’t contributed to in years!) as insurance: if all else fails, when I reach whatever age the government of the time lets me access MY money, I’ll have something to keep me one step away from homeless … just.

So, I agree with Financial Samurai’s closing advice:

The only person you can depend on is yourself.  This is why you must save that minimum 20% of your gross income every year on top of contributing to your 401K and IRA if you can.

You’ve heard of Paying Yourself Once? Well, I think you need to Pay Yourself Twice™ … once inside your 401k (there’s your ‘insurance policy premium’), and once outside of your 401k.

It’s the money that you can put aside OUTSIDE of your 401k that will drive your wealth, because you can put it to MUCH BETTER USE (e.g. investing in business, real-estate, value stocks, etc.) than that money locked away inside your 401k and in the hands of grossly under-performing, fee-driven mutual fund managers 🙂

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10 thoughts on “View your 401k as insurance!

  1. Curious what your thoughts are on cashing out the 401K & Roth IRA in order to invest it in other things.

    Obviously there is a hit on the 401K, probably 30% after tax and penalty. But I would have had to pay the tax anyway, had i never contributed those dollars. So only a 10% effective hit, to be free of their restrictions and the limitation of having to invest in the market.

    I currently save about 50% of my net income, so spending the money isn’t an issue.

    It would immediately increase my war chest towards the next piece of rental RE.

  2. I say have 2 buckets of retirement money. Liquid money that you can use now for businesses and investing. And have a safe bucket that can protect you from lawsuits

  3. in canada you can borrow against your rrsp (our 401K equivalent) to buy a house, up to $20K. I did this. The problem is you have to pay it back at some rate. If you don’t make the payments then you get to pay tax. So I pay the tax, which is much higher tax then I would have paid if I had’ve just kept the money to begin with instead of investing it in the RRSP. Sounds stupid because it is! It makes sense for me to take the additional income that I have and invest it in places other than the RRSP– like education or just basic stuff I need. Saving for retirement by stuffing cash into an RRSP makes no sense to me — it is basically leaving your life planning to the hands of someone else.

  4. @ Ryan – I’m basically a scaredy cat (as opposed to Steve’s “Merengue dog”) so, I am not a great fan of pulling money OUT of my 401k (case in point: I still have mine, as mentioned in this post), except in case of a true emergency.

  5. Hi Adrian,

    Glad you agree with my premise. As I’m completely knew to your site, I’m just wondering, if you have $7 million bucks, does money and retirement savings even matter to you?

    $7 million X a 4% interest rate you can get at for a 7yr CD is $280,000 a year forever. Not bad yeah?



  6. Yes you need to save outside of the 401K and that is the only way to make your number in any respectable time span.


    I’m not convinced the government will change the 401K program that much. They lower their debt risk significantly by getting out of the defined benefit entitlement programs.

    I just ran the numbers, and came up with a different conclusion for my family. My wife and I both work, we both contribute the maximum each year, and both have matching (not 100% alas). Yes, we are in a painfully high tax bracket, which makes tax-free investing more attractive, especially since there are few deductions for salaried/bonus income.

    If I lump our current IRA saving in with the 401K amounts, assume we will invest the maximum each year (which gets less painful as we get a raise), I come up with a total of $3,200,000 assuming we get a 5% annualized return for the 21 years until 65.

    Sure you have to consider inflation and there are a lot of assumption, but I still think it is an awesome safety net.

    Here are the reasons to kept the 401K (or RRSP, I didn’t include my Canadian account in this calculation):

    – Immediate tax savings
    – Some employee matching
    – Forced savings
    – And in my case (not my wife’s) my 401K can be completely managed by me as a brokerage account

    But the big one that people forget (and yet is more used as we change jobs more often)
    – Ability to roll into an IRA when you leave the job at which point you can do whatever the heck you want with the money, including buying horse carriage futures or tulip bulb options. This money isn’t locked at all.

    The 401K is a great tool in your arsenal and I think it gets praised by too many and slighted by too many others. When I left Canada the tax advantages on the RRSP were even better.

    I will continue to contribute the maximum each year and ensure that we are saving/investing another 20% of our income as well.

    In the US we can pull the money out for a home loan as well (if we haven’t bought a home in the last 5 years). I did it, but paid the amount back within a year.

  7. Returns in A 401 K have been typically lower than what you could get out side your 401K. For this reason alone., I think these are terrible places to park your money. Add to the fact that most places give you limited options(i.e.higher management fee related offerings)where you can invest your money.In many cases, what is offered to you in your 401K is offered to others at a reduced management fee. Identical offerings(lower fees for others).This smells of corruption to me.Never liked the 401 K.s and feel you have many other potions that give you better returns ,lower fees,and who cares about the tax savings. Everyone assumes your getting away with something by saving a little now in taxes,but are you really? Taxes typically do not go down(sure in rare cases yes) but when you retire,you will pay taxes on these investments,and most will pay more in taxes then ,than if they had just invested in today’s tax environment ,getting a larger return that is available in any 401K.

    does a 6 to 8% return in your 401 K plus a little tax savings amount to what you could have made investing in ,say Real Estate? I think not.What if you had put all that 401 K money into a Business (grew that business) and sold it for millions in a few years time,then reinvested it again? Can your 401 K do that for you? I think not.

  8. lost opportunity is your biggest enemy in these 401 K’s and other so called safe haven investment vehicles.

  9. @ Sam – Inflation and Longevity are the Two Fears Of The Rich.

    That $280k will only be ‘worth’ $140k in 20 years and $70k 20 years after that.

    How am I going to be able to play ‘dirty old man’ with all the pretty nurses in the Private Nursing Home (as opposed to the ugly, toothless ones in the public facilities) on $70k a year? 🙁

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