One thing that puzzles me after my explorations in NetWorthIQ and PFBlog space is the obsession with retirement accounts. Many people write about getting financial freedom and are saving but they are stuffing the maximum into retirement accounts. In the US you generally can't touch these until age 59 1/2 and then the money withdrawn is taxed at your marginal rate of federal and state tax. If you touch the money before then you pay the marginal tax plus a 10% penalty (in Aus it is almost impossible to get the money out of a Superannuation account before age 60). Yes I know that a 401(k) defers tax to the future and the profits on a Roth IRA are tax free (if withdrawn after age 59 1/2 or in special cases - see below) and Roth contributions can be withdrawn at any time. But the federal long term capital gains tax rate is now 15% and the qualified dividend rate is also 15% (with 5% rates for lower income earners). And you can use the money to achieve financial freedom at any time....
If you are nearing 60 it certainly makes sense to stuff the maximum into a Roth as you will soon be able to get it out again (a 401(k) or traditional IRA will convert potential investment income though to ordinary income). But if you are in your 20s as many bloggers are - 60 is a long time off. Of course it makes sense to make contributions in order to get an employer match - even after paying a 10% penalty to withdraw the money that can usually be worthwhile.
I have about half my net worth in retirement accounts. Most is in an Australian Superannuation account. I had no choice on the level of contributions as a condition of my employment at a university in Australia. We put in 8% of our salary and the employer contributed 17%! That is the deal the unions had negotiated (I didn't join the union - but had to accept the same pay deal). All employers in Aus must contribute a minimum of 9%. There is no system like the US Social Security in Australia. Instead real savings must be made by employers and there is a flat rate welfare payment for poor retired people called the Age Pension. Here in the US I have to contribute 1% and my employer contributes 8% to a 403(b). I don't have any choice there either, but if I did I would do it - it is an excellent deal. However, we can make extra contributions, which I don't do.
I did open a Roth IRA recently with the sole purpose of creating $10,000 of tax free profits towards a first time purchase of a house, which is one of the special uses allowed. I will likely withdraw the contributions once that goal is achieved, though that is subject to review. The last thing I think I am going to need is more money at age 60.
6 comments:
1st, thanks for the plug. Second I couldn't agree more on the after 401K savings problem. In a nutshell it is the problem of our nation. No one saves in a regular account because they are in denial about how much it will take for a comfortable retirement. If people focused on plain old savings as well as retirement savings, we'd all be better off.
You take is really valid. A particular worry is not knowing what the politicians will come up with in 30-40 years. How is one to know that the tax on those accounts will not be some obscene %. One only has to look to 1933 and the confiscation of gold to become worried. Not that I think that the government/politicians would be so foolhardy as to confiscate savings, however given the current state of public debt I do not put it past them to put taxes up at some point. Also come to think of it did the Supreme court not rule recently that private property could be appropriated for public good “eminent domain”.
www.cnn.com/2005/LAW/06/24/scotus.property
Having said all that and though I agree with you that more people should save more in regular saving accounts, if the other alternative is not saving at all then I would say they should use the retirement accounts.
One other account out there which is the best of both worlds is a 457 account (available to some government workers) basically it is a tax deferred account but unlike the 403b there is no penalty if you withdraw early. So theoretically you can save as much as you want and at some stage move the money out and just pay your taxes. Don't you just love this country!
I guess diversification is not limited to asset allocation, it should probably include assets division in retirement/ non retirement accounts.
Thanks for your feedback. For many or most people retirement accounts like home mortgages (at least in the past) enforce savings behavior by making it difficult to withdraw the money. The government has a system of incentives and penalties because they know that people are irrational. Behavioral economics recently became popular but a lot of that stuff has been known for a long time. Also if you are planning on being an employee till 60 then putting all your savings in retirement accounts might make sense too (though having alternatives is nice).
Mainly I was commenting on the gap between stated goals of many bloggers - financial independence, early retirement etc. and the vehicles being used.
Moom: I don't disagree with your overall characterization of retirement accounts, but I look at it this way: If people are diligent and max out their retirement accounts, the limits imposed on such accounts (e.g., $15,000 on a 401(k)) are soon exhausted. Then one can turn to a non-deductible IRA and put in $4,000. After that, the only alternatives are regular non-retirement investment vehicles, in which one can put a limitless amount. So once a person gets established, the retirement plan contribution limits are so modest that he or she ends up socking away a lot in regular investment accounts anyway. In short, for many diligent savers/investors, a whole lot of money ends up in non-retirement accounts in any event, and there is de facto diversification between the retirement bucket and the regular-investment bucket. On a related note, when I was younger and less disciplined, it was the retirement account (with its penalties for withdrawal) that built a lot of my net worth. With younger investors, a retirement plan can be a great vehicle because it is a formalized program that they can hopefully be lured into. The real problem in my view is that in the US, there's no real program to force savings. Given the horrible negative-savings rate out there, forced savings may be an answer. Regards. -- Edgeworth.
Edgeworth - yes - I could have added a caveat that if you have a salary that is extremely high in the top few percent of people in the economy then what you suggest makes sense. The $15000 in the 401(k) is a lot of money for most people. For people near the average salary it is almost half their take home pay. Even for people near the top of the second quintile like me - earning $75000 a year it is $30 or so of take home pay and will be more than most can save (a bit less than what I save from earned income). So the limits only look modest when you are in the top 5% or so of the population.
An added thought for Stealthbucks: I think some PF Bloggers may overestimate what they need for retirement. My mother doesn't spend very much - basically a couple of government pensions (like social security) and a very small one from my father's former employer seem to cover it. I keep telling her she should spend more, give she has a lot of savings. And most older Americans seem to get by OK - poverty levels are low compared to the number of children in poverty.
thanks for the plug!!
1stly, putting money in a 401k has its tax advantages now! that in itself is worth something. Then you get to compound your money tax free for many years. after that when you retire and move to a state with no state tax, your withdrawals come state-tax free!
and if you've been doing a lousy job of saving for retirement, you're probably in a lower tax bracket!
But apart from that i agree with your general point. my 401k is a tiny part of my networth, of which 25% is cash or somewhat liquid.
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