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Surprise! Another Stealth Yet Serious 401(k) Hazard

Note to readers: Participants in 401(k) plans face numerous challenges to building a safe, dependable, fully-integrated, and efficient retirement program for themselves. The unfortunate fact is that many – if not most – plan participants use the 401(k) as their primary (or sole) vehicle for savings and investment. In my opinion, they do this at their own peril as they unwittingly increase the odds of a less-than-optimal outcome at retirement – for a variety of reasons, some you’re about to read.

This article mentions 401(k) plans but the points made and questions raised may pertain equally to IRA’s, Roth plans, SIMPLE plans, SEP plans, 403(b) plans, 457 plans, and other similar retirement plans created and controlled by government regulations. Always consult your own documents and advisors to be certain of what you have and do not have.

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All by themselves, the recent broad-based market melt-downs have underscored the fact that YOU DO NOT REALLY OWN YOUR 401(k) PLAN BALANCE until you’ve liquidated it and, even then, you own just a part of it.

“Your” plan is continuously held hostage by a wide variety of potentially restrictive institutional and governmental forces that EACH HOLD A HIGHER LEGAL CLAIM ON YOUR MONEY THAN YOU DO. As long as you participate in their plan, THEY hold the controls and write the rules and YOU are “subject” to play by them.

And, even if you should choose to quit their game, you will be required to pay a 10% penalty to the “keepers” (that is, unless you are over age 59 and 1/2 or you learn how to use the sophisticated loophole that enables you to quit without penalty). The threat of this 10% penalty seems to be a powerful enough incentive to keep most people in the game over the long-haul.

While this unfortunate lack of control will never change, it’s nearly inevitable that – in addition to capricious market forces – the rules, restrictions, penalties, and income tax rates that impact retirement plans will continue to change – just as they have so frequently in the past.

FACT: The unpredictability of change is one of the most serious risks you “volunteer” to take on as a participant in any government/institutionally-sponsored retirement plan.

A valid question to ask about a 401(k) might be; “Whose money is it?” As the old saying reminds us, possession is 9/10th’s of the law and, in the case of a 401(k), the money is held by a trustee and/or other type of plan administrator, not you.

Other serious questions a participant needs to investigate for him/herself BEFORE investing too heavily in such a plan might be:

– Are the REAL RISKS AND UNCERTAINTIES inherent in these types of retirement plans worth the widely-touted but uncertain “benefit” of tax-savings?

– Is there really a current income tax savings since I must completely surrender all access to the money either way – unless I pay the tax?

– Are future income tax rates MORE LIKELY to be lower or higher when I want or need to withdraw my funds?

– What other rules might have changed by the time I retire that may place more restrictions on my funds or, otherwise, not be to my benefit?

– What if I defer my income tax now at, say, the 25% federal tax bracket and, simply due to my success, retire in a much higher tax bracket? Wouldn’t I have made a costly and unrecoverable mistake?

– With all the government bailouts, entitlement obligations, wars, monumental stimulus/spending plans, and myriad other forms of bureaucratic bloating, is there even a “snowflake’s chance in hell” that future income tax rates will be lower than they are right now?

– What impact could utilizing more favorable long-term capital gains tax rates have on my accumulation vs. simply “deferring” into potentially less favorable future income tax rates?

– How might the disallowance of a “step-up in basis upon death” on any 401(k) funds that were left for my heirs negatively impact their inheritance?

– I read that, in the past, if a retirement plan’s distributions grew too large (by government definition) – either due to heavy contributions or large market gains – certain distributions could be hit with an additional 15% excise tax or surcharge on top of the normal income taxes due. Is this really true? If so, couldn’t it happen again?

– Is it paranoia to think that my retirement plan could be confiscated by the government?

…which is, surprisingly, open for discussion as verified here:

Dems Target Private Retirement Accounts

– What else could I do with this same money and would any other options offer similar or even more benefits with fewer potential risks, costs, and loss of control?

As you can see, there’s much to consider. And, obviously, though it’s seldom disclosed, there’s much uncertainty and “extra baggage” accompanying participation in any of these government plans. Ultimately, when you consider that your retirement plan may be a larger lifetime investment than your home – for many, the very largest asset they’ll ever acquire – these questions are worthy of VERY SERIOUS deliberation.

And finally, here’s a link to an interesting article from the Wall Street Journal that illustrates yet another “surprise!” layer of complexity and potential illiquidity that can blindside you with regard to “your” holdings. Just when we thought we’d seen it all! Be sure to take a minute or two to read this:

401(k)’s Hit By Withdrawal Freezes

In an era rife with “full disclosure” mandates, why don’t retirement plans come with a long list of government warnings and precautions? As in all aspects of life; buyer beware. It pays to be an educated consumer.

Footnote: There are other private, non-governmental options you may wish to consider. Though they’re not perfect, you can invariably retain a much greater measure of control over future variables as well as preserving ready-access to your money. This is an area we consult in so please feel free to call or write if you have questions in this regard.

2 Comments on “Surprise! Another Stealth Yet Serious 401(k) Hazard”

  1. #1 Todd DePinto
    on May 29th, 2009 at 8:28 pm

    You’ve got a great blog David! I really enjoy reading what you write and agree with much of what you say.

    Keep up the great work! You’re preachin’ to the choir, my friend.

  2. #2 paul
    on Jun 27th, 2009 at 12:31 am

    the government will have to confiscate to try and save the economy or at least that will be their excuse nothing can save it. good work

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