“I would blow up the system and restart with something totally different.”
– Ted Benna, “father” of the 401k, quoted in MarketWatch.com
As investors educate themselves about the financial advice that is accepted as “common wisdom,” many begin to realize that 401ks might not be the “retirement solution” they were assumed to be. Even Ted Benna, the man who popularized the tax loophole that turned into the 401k program, is very critical of what it has become.
But should you cash your 401k? 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 401k Early
There are some good reasons to liquidate your 401k for good (or perhaps just put future dollars elsewhere). Here are seven advantages to freeing your dollars (current or future) from a 401k or other 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 401k loans: Dollars borrowed from 401k 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 401k 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.
Julie Ann Hepburn, National Private Client Group © Prosperity Economics Movement
