Tuesday, October 28, 2014

Attention All 401(k) Participants ... DO NOT Interrupt Contributions or Withdraw 401(k) Funds Before Retiring ... You're Going to Need Them

Over the past twenty years, things have changed in the employee benefits world. Especially in the private sector, saving and investing for retirement are generally now the responsibilities of the individual employee. It's DIY all the way.

And that DIY way need not be a bad way. In fact, it should be a very good thing for those prepared to reap the rewards derived from a working career which includes ongoing and uninterrupted savings and investing in an individual 401(k) account. It's a MOM (my own money) thing, too.

Today employees in the private sector are largely without employer provided guaranteed benefits from pension plans. They participate in employer sponsored defined contribution 401(k) type plans instead. The difference is that in 401(k) plans, the money in the plan and responsibility both belong to the employee, whereas in pension plans, the money and the responsibility reside with the employer.

In my opinion, the 401(k) provides the employee with a great opportunity to build a bigger nest egg. And an added attraction is that the account balance moves with the employee and stays with him whenever a change in employment occurs, which most likely will happen at least once and probably more than once during a working career.

That said, these self-managed plans are generally misunderstood and frequently either unmanaged or mismanaged by most 401(k) participants.

But first, let's consider some good news for retirees. We're living longer. Now let's look at the bad news. We're not saving enough while we're working.

Rising U.S. Lifespans Spell Likely Pain for Pension Funds summarizes the good news, bad news story:

"New mortality estimates released Monday by the nonprofit Society of Actuaries show the average 65-year-old U.S. woman is expected to live to 88.8 years, up from 86.4 in 2000. Men aged 65 are expected to live to 86.6 years, up from 84.6 in 2000.

But longer lives for retirees may add to a squeeze at many pension funds that are already struggling to plug a gap between available assets and future obligations to retirees. The new estimates released Monday could increase retirement liabilities by roughly 7% for most corporate plans . . . .

“Plan costs could rise simply because people are living longer,” said Dale Hall, managing director of research for the Society of Actuaries. . . .

Longer lifetimes for American men and women could accelerate the movement in American corporations to defined contribution plans, such as a 401 (k), where employees are largely responsible for saving and investment choices."

{NOTE: So whether we depend on a 401(k) or a pension plan for old age income, it's going to take more money. And this brings us to today's topic of discussion --- the pitfalls and problems for employees associated with early withdrawals from 401(K) type plans. To put it bluntly, money deposited in 401(k) and similar plans should remain in those plans until retirement. And if we are going to need those funds prior to retirement, then they should never be deposited in our individual 401(k) account in the first place. Instead we should deposit those funds in in a rainy day or emergency account at the local bank, where it will be immediately and easily accessible to us. In other words, individuals are well advised not to deposit money in a 401(k) type long term investing vehicle prior to saving and setting side sufficient monies for short term needs.}
Combating a Flood of Early 401(k) Withdrawals contains some solid advice for 401(k) participants:

"This week, the Internal Revenue Service announced that people under age 50 in 401(k) and similar workplace retirement plans will be able to deposit up to $18,000 in 2015, an increase of $500 from this year. Those 50 and over can toss in as much as $24,000, a $1,000 increase.

Which is all fine and dandy for the well-heeled and the frugal. But one of the biggest problems with these accounts has nothing to do with how much we can put in. Instead, it’s the amount that so many people take out long before they retire.

Over a quarter of households that use one of these plans take out money for purposes other than retirement expenses at some point. In 2010, 9.3 percent of households who save in this way paid a penalty to take money out. They pulled out $60 billion in the process; a significant chunk of the $294 billion in employee contributions and employer matches that went into the  accounts. . . .

(Vanguard says that) Millions of people are clearly not using 401(k) plans as retirement accounts at all, and it’s a threat to their financial health. “It’s not a system of retirement accounts . . . . “In effect, they have become dual-purpose systems for retirement and short-term consumption needs.”

How did this happen? Early on in the history of these accounts, there was concern that if there wasn’t some way for people to get the money out, they wouldn’t deposit any in the first place. Now, account holders may be able to take what are known as hardship withdrawals if they’re in financial trouble. Moreover, job changers often choose to pull out some or all of the money and pay income tax on it plus a 10 percent penalty.
The breach tends to be especially big when people are between jobs. Earlier this year, Fidelity revealed that 35 percent of its participants took out part or all of the money in their workplace retirement plans when leaving a job in 2013. Among those from ages 20 to 39, 41 percent took the money. . . . “Some people see a withdrawal as an opportunity to pay off debt,” said Jeanne Thompson, a Fidelity vice president. “They don’t see the balance as being big enough to matter.” Or their long-term retirement savings matter less when the 401(k) balance is dwarfed by their current loans. . . .

Account holder ignorance may also contribute to the decision to withdraw money. “There is a complete lack of understanding of the tax implications,” said . . . a professor at the University of California, Los Angeles, and chief behavioral economist at Allianz Global Investors, who has done pioneering research on getting people to save more. “And given that we’re generally myopic, I don’t think people understand the long-term implications in terms of what it would cost in terms of retirement.”. . .

In fact, young adults who spend their balance today will lose part of it to taxes and penalties and would have seen that balance increase many times over . . . ."

Summing Up

Money in a 401(k) or similar plan should be continuously invested and permitted to multiply several times over the employee's working years. That's the magic of saving and investing on an uninterrupted basis over several decades.

Barring an extreme emergency, not one cent of this saved and invested long term earmarked money should be withdrawn prior to retirement.

Neither should contributions be interrupted nor penalties incurred.

A rainy day fund should be in place before setting money aside in a 401(k).

To tap into our 401(k) prematurely is to sacrifice the needs of our 'future self' for the pleasures of our 'current self.'

That's short termism at work and also a very bad course of action.

That's my take.

Thanks. Bob.



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