April 11, 2002

1:19 PM

A 401(k) is not a Pension!In a pension plan, your employer invests some money and gives you some of it when you retire. In a 401(k), they, um, don't. Congress seems a little confused on this issue, however. It turns out that the 401k might be more boondoggle than boon to average people planning to retire before they die.
posted by ilsa (21 comments total)

"In 2001, fewer than 7% of 401(k) participants contributed the maximum allowed amount to their plans"

I contribute the absolute minimum I can in order to get the maximum matching funds from my company. (I invest 6% of my pre-tax salary, they match it dollar-for-dollar. If I contributed ten percent, they'd still only match the first six.) Anything beyond that isn't a possibility right now, and I suspect most people are in the same boat. I could theoretically contribute 25% of my pay, but I prefer to have groceries in the house.
posted by mr_crash_davis at 1:58 PM on April 11, 2002

Pensions are fine if you plan to stay with the same employer for 30 years. That's not a current reality in the US labor market though. People will typically change jobs multiple times. 401(k)'s offer more portable benefits.

Yes, they are cheaper for employers (although mine and many others offer some matching). Yes, somebody has to actively manage their own financial affairs and take advantage of the benfits to get the most out of them. Credit card debt does a hell of a lot more harm that a move from pensions to 401(k)'s though. Is that the fault of the credit card companies or the people who can't be bothered to become even marginally informed with respect to their financial futures?
posted by willnot at 2:03 PM on April 11, 2002

I get both. I torque the hell out of the 401k and consider whatever comes my way from the pension and Social Security (hah!) gravy.
posted by NortonDC at 2:10 PM on April 11, 2002

The reall problem with 401(k)'s is not the plan itself (they're great) but that people don't know what the hell they're doing investment-wise. Often as not, they're too lazy to educated themselves on their own risk tolerance, and the company is too liability-conscious to provide investment advice. If you want to maintain your standard of living during your retirement, plan on spending 80% of your top salary per year. Otherwise, you're going to be eating salad bar at Sizzler a LOT. That means you should be dumping as much money into your 401(k) as you can (crash had it exactly right - at MINIMUM take full advantage of your company's matching contribution), then take some of your after-tax dough and start dumping it into mutual funds (look for tax-free and no- or low-load funds - I have my kid's college fund in a tax-free corporate bond fund, I love it). Don't bother buying individual stocks unless you know what you're doing, and "I heard this was a great stock that's going to skyrocket from my buddy" is not knowing what you're doing. Then go find yourself a competent stock broker who will tell you the truth, and that includes the truth about what they make. There is no shame in getting a fee for services rendered, and a stockbroker that doesn't want to tell you his commission rate is going to shunt you into shit investments that you don't need (i.e. annuities if you're 25 year old).

Good advice is the best investment ever. If you know your tolerance for risk and you are getting good investment advice, your are 2 steps further down the road to financial security in retirement than most people ever get.
posted by UncleFes at 2:24 PM on April 11, 2002

UncleFes - Dumping all you can into the plan isn't necessarily advantageous. I can contribute beyond the tax-deferred dollar cap (not percentage cap) into the same plan, but everything over that carries none of the tax benefits, so for that portion it's just an especially cumbersome investment plan. No thanks.
posted by NortonDC at 2:31 PM on April 11, 2002

everything over that carries none of the tax benefits

You need to ask your employer about instituting a nonqualified 401(k) (deferred compensation) plan. They're sometimes called "excess 401(k)'s". They're basically a "trick" plan that uses hypothetical dollars to informally fund a 401(k)-like plan for your over-the-gov't-limits bucks. The company does some accounting tricks (typically using life insurance) to take the benefits off the table tax-wise. Often as not they come out zero sum for the company, which is nice, and the government gets zilch.

How nice for you that you're in that earnings category, btw :)
posted by UncleFes at 2:40 PM on April 11, 2002

shh!
posted by NortonDC at 2:43 PM on April 11, 2002

A 401(k) is a defined contribution pension. Traditional plans are defined benefit (defined, that is, if the administrator doesn't underfund and then go bankrupt, convert to cash accounts, have strange restrictions to prevent vested-ness, etc.).
posted by gdog at 2:56 PM on April 11, 2002

If a couple together contributes the max to a 401K every year from age 30 to age 67, getting a real (post-inflation) 3% tax-exempted yield, they'll have about $1.45MM at age 67. The annuity value, assuming one lives to 95, is about $67,000 a year (once again, assuming 3% real return). Add in Social Security for the couple and its surviving member, and they should be at about $100,000 a year gross. This is pretty good, and doesn't take into account home equity and other valuables most people accumulate.
posted by MattD at 3:39 PM on April 11, 2002

What about taxes on the way out?
posted by Mid at 3:45 PM on April 11, 2002

I have to say that this does not bode well for plans to privatize Social Security.
posted by jaek at 3:45 PM on April 11, 2002

What about taxes on the way out?

Taxed as income. The idea is that you'll probably be in a lower income bracket when you're older.
posted by yerfatma at 4:15 PM on April 11, 2002

I know, I know. But what about MattD's calculations. I'm wondering if he has even a low tax bracket figured in.
posted by Mid at 4:49 PM on April 11, 2002

"Taxed as income. The idea is that you'll probably be in a lower income bracket when you're older."

I don't understand. I would assume that you'd be making more money towards the end of your career. You've either stayed at the same place and gotten raises or you've changed to higher paying jobs because you're more experienced. That was my theory for putting money into a Roth IRA, so that I'm taxed now and get to take it out when I retire (and I'm in a higher tax bracket) tax free. What am I missing?
posted by jaden at 5:03 PM on April 11, 2002

What am I missing?

You retire. Then your income's lower (zero). Then you take distributions from your 401(k) as income, and you're taxed on that.
posted by kirkaracha at 5:25 PM on April 11, 2002

kirckaracha beat me to the punch.
curses, if it weren't for those meddling kids...
posted by juv3nal at 5:29 PM on April 11, 2002

I contribute the absolute minimum I can in order to get the maximum matching funds from my company. (I invest 6% of my pre-tax salary, they match it dollar-for-dollar. If I contributed ten percent, they'd still only match the first six.)

The real problem with that method is that the more money you put in early, the better your investment return will be. You're far better off maxing your contributions early and allowing them to compound than to wait until later. The company which manages my 401(k) (Principal Financial Group has a nice page depicting this which is, unfortunately, in a secure area. Basically, they depict two 401(k) investments over 30 years. One has $20,000 invested over the first 10 years only, the other has $40,000 invested over the last 20 years only (both invest $2,000 per year.) At an equalized rate of return, the $20,000 investment yields a $235,000 return while the $40,000 investment only yields a $126,000 return.

Early investment is THE key to 401(k) success. That and keeping your cash out of internet stocks...

My method has thus far been to invest 10% of everything I make and, if the caca hits the old ventilador, take out a loan from my 401(k) to make ends meet - you pay the loan interest back to yourself anyway!
posted by RevGreg at 5:30 PM on April 11, 2002

RevGreg - Tread carefully because there are many downsides to borrowing from your 401k, even when you avoid penalties.

You have only two repayment options: stick to the plan established at the start or pay it the total remaining balance in one lump sum. There is no in-between.

Leaving your employer means you have to pay back the entire loan immediately. ouch

Yes, you pay the interest to yourself, but what you take out does not participate in the market and you are buying your own money at a 9% (if memory serves) premium, on top of replacing money that sidestepped taxes with post-tax money.

Save it for last ditch efforts only.
posted by NortonDC at 5:45 PM on April 11, 2002

From the article:"The boom largely benefited the rich, but it hasn't really filtered down that much."

Well, now there's a big surprise for you.

My own personal retirement plan is an early death, so I don't worry too much about this stuff.
posted by briank at 8:00 PM on April 11, 2002

"The boom largely benefited the rich, but it hasn't really filtered down that much."

Not true:

Real wage gains for private-sector workers averaged 1.3% a year, from the beginning of the expansion in March, 1991, to the apparent end of the recession in December, 2001. That's far better than the 0.2% annual wage gain in the 1980s business cycle, from November, 1982, to March, 1991. The gains were also better distributed than in the previous decade. Falling unemployment put many more people to work and swelled salaries across the board: Everyone from top managers to factory workers to hairdressers benefited. Indeed, the past few years have been "the best period of wage growth at the bottom in the last 30 years," says Lawrence F. Katz, a labor economist at Harvard University.

posted by Mick at 7:24 AM on April 12, 2002

Mick, I think the commentator was speaking in terms of 401(k) benefits, not overall wage growth. Seemed that way to me from the context of the article.
posted by briank at 12:55 PM on April 12, 2002