“I would blow up the system and restart with something totally different.”
– Ted Benna, “father” of the 401(k), as told to MarketWatch.com
As investors start to educate themselves about investing, many begin to realize that their 401(k) might not all they thought it was cracked up to be. After all, even Ted Benna, the man who popularized the tax loophole that became the 401(k) program, has all but disowned it.
But should you liquidate your 401(k)? It’s not an easy decision, and there are drawbacks as well as benefits.
The Pros and Cons of Liquidating a 401(k) Early
There are good reasons to liquidate your 401(k) (or perhaps just put future savings and investments dollars elsewhere):
- Highly restricted investment choices.
- Legitimate fears that income taxes are on the rise.
- Layers of never-ending and often hidden fees that drain “your” asset.
- Limited access to dollars for limited reasons.
- The fact that any dollars borrowed from 401(k) have gone into the account “tax deferred” but must be replaced with “after tax” dollars… that are taxed AGAIN upon withdrawal.
- Lack of control over qualified accounts ruled by government decisions and policies.
In spite of compelling reasons to liquidate a 401(k), there are also important considerations and good reasons why you may NOT want to liquidate your 401(k) – or not right now. Before considering such a move, be well aware of the following:
Taking “the Hit”: You must be prepared to pay the taxes and penalties – both financially and mentally! Even when it makes sense numerically, it is often very difficult to pay all those taxes at once.
Timing is Everything: The timing may be all wrong to pull out of your current investments in your 401(k). Under-educated investors tend to pull their money at the exact wrong time – after a large decline. It feels counter-intuitive, but the best time to move your money from the market is when it has been performing well.
The Investment Habit: Without an alternative structure set in place, those who don’t save in qualified plans may find themselves not saving at all.
What Then? What will you DO with AFTER you liquidate your 401(k)? Where will you put the money, and how can you be confident that it is a BETTER investment than your qualified plan?
We agree with Andy Tanner, author of 401(k)aos, liquidating your 401(k) without having a sound strategy for what to do NEXT is not a good plan. In this informative video, he explains why liquidating your 401(k) won’t necessarily solve the “real” problem that your inefficient and limiting 401(k) was merely a symptom of:
As Andy points out, the reason that many employees are in 401(k)s in the first place is that they don’t know how to do better on their own – in other words, they don’t know how to invest.
Solving the 401(k) Problem
In spite of some limited and rather skewed “investment education” programs from plan administrators, a 401(k) won’t solve the problem of teaching people to invest. (Ironically, the plans are designed so that this problem CAN’T be solved, as truly educating employees how to invest would lead them to choose different options than a 401(k)!)
“We will never teach 40 million participants to become highly skilled investors,” Ted Benna told MarketWatch.com, after noting, “A 20 percent drop on your account value feels a lot different when your balance is more than $100,000 at age 56 than when you are 29 and have a $10,000 balance.”
But the problem goes much deeper than teaching people how to get a better rate of return.
One problem is that qualified plans have led many people to under-save and over-invest. (We use the term “invest” loosely, as we wouldn’t recommend mutual funds in a qualified plan in the first place, even if an investor did wish to be in a stock market environment.)
It is imperative that people SAVE – safely, aggressively, early and often. (“Aggressively” in terms of percentage of income – we recommend 20% as a guideline or goal.) Most people have far too few liquid assets that can be used for emergencies or opportunities, and too many assets in restricted environments. As a result, they are subject to unreasonable risk and many end up “raiding” their 401(k) when the unexpected strikes, with costly results.
Interestingly enough, when Benna tells the history of 401(k) plans, he reveals that they began with a mere 2 options: one for saving, and another for investing. An insurance company would offer a fund at a guaranteed rate, and the other option would be a broad, generally growth-oriented mutual fund, though sometimes the company stock plan (which, as we all know, can be risky business.)
As Benna recounts, most participants chose to split their contributions between the two 50/50. Now, that didn’t solve the issue of having the employee’s savings locked behind the qualified plan wall, but it DID offer them some security and protection against market swings.
Yet there is another issue with the investment options provided in a typical 401(k). It has to do with the limited way many people have come to define “investments.” Too often, they are equated with the stock market and mutual funds.
“Investing” – as opposed to “saving” – is commonly thought of trying to chase and hopefully obtain a higher rate of return that someone can obtain in a guaranteed account or whole life cash value, when in reality, the best true “investments” allow the investor a level of ownership and control.
While earning an attractive rate of return can be very important in cash flow investments, Prosperity Economics also champions a different type investment – namely, assets and businesses that the investor can OWN or CONTROL or BUILD EQUITY in.
Real estate fits this definition. Business ownerships and partnerships can fit this definition. And cash value accounts within life insurance policies fit the definition as well, although they are not classified as “investments” and are more properly compared to other savings vehicles.
In the Prosperity Ladder (a concept described further in Kim Butler’s book, Busting the Financial Planning Lies) WORK is what lifts people from poverty to subsistence, SAVING is what lifts people from subsistence to comfort, and OWNERSHIP is what takes people the rest of the way up the mountain to true prosperity.
A Better, Safer Alternative to Mutual Funds for Growth
There is another type of alternative investment can sometimes be used within the qualified plan environment.
Formerly a best-kept secret amongst corporate investors until the doors opened for individuals to benefit from them as well, this investment allows investors to have an equity position in an asset that is literally guaranteed by the most stable financial companies around! It is a “hands off” investment and it generally produces double-digit returns with almost no risk when properly managed.
The investment I am describing is Life Settlements. We wrote about them in more detail in a recent article, “Life Settlements: Pros and Cons and Facts.” They can be purchased through a self-directed IRA (sometimes 401(k)s can be converted to self-directed IRAs without liquidation). They can also be purchased apart from an IRA. And if you do choose to liquidate a 401(k) – or a portion of one – they can be an excellent place for newly-freed funds.
Most investors have never heard of life Settlements, but we believe they may be “the best investment you’ve never heard of,” as far as a safe, growth-oriented investment for those who do not need their money liquid for 7-10 years.
Would you Like to Get the Facts?
Not all investors can qualify to invest in life settlements (they are for Accredited or Suitable investors only), but we invite qualified investors to contact us personally so that we may review your situation and, if appropriate, potential options for investing in life settlements.
We can also discuss options – if appropriate – for freeing your money from a qualified plan or simply creating alternative investment or savings vehicles for new dollars. We can even review your situation and make recommendations if you wish to liquidate your 401(k) early (or perhaps a little at a time.)