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Limit Your 401k Contributions



May 12, 2011 – Comments (11) | RELATED TICKERS: EXAS , GMO , SUNEQ

For many Americans, a 401k plan is their main retirement investment vehicle.  Unfortunately, for too many people, these plans fall short of providing the retirement income that they will need. 

Today, Fidelity announced that 401k balances set a new high for average balance since 1998 of $74,900.  Near retirees over the age of 55 with ten years of service or more had an average balance of about $233,000.  While almost a quarter million dollars is no tiny amount of money, that amount will only safely generate an income of  $12,000 to $14,000 per year.  That is hardly enough to finance a long retirement.

Please understand that I am not against 401k (or 403b or other similar plans) investing in general.  However, many plans are simply so weak that using them as a primary or only retirement vehicle falls short.  Complicating the matter is that most people contribute either too much or too little to their employer based retirement plans.

The #1 Rule of 401k Investing

If you have matching contributions from your employer to your 401k, then contribute up to the match limit.  For example, if your employer matches 50% of your contribution up to 5% of your income, then by all means take the free money and invest 5% of your income into your 401k. 

The simple logic here is take the free money.  Beyond that amount of contribution, most people ought to look elsewhere for additional investment opportunities. 

Why?  Because most 401k plans have mediocre investment options, high expenses and limited liquidity.  

A Retirement Investing Hierarchy

If your 401k does not have matching (about 30-40% do not) or you have contributed up to the match already, what should you do?  The first things to do with your income are to simultaneously reduce your debt and build a cash safety net at your credit union or bank.

The next step is more tricky as it depends on what you are most comfortable with. 

In the past six months, I have been talking with younger investors about becoming active in real estate.  There are several ways to do that, from direct ownership to partnerships to real estate investment trusts.  It is my belief that those who acquire real estate assets this decade or shares of real estate assets this decade will profit handsomely from it over the following two decades (2020s and 2030s) as the echo boom generation ages and becomes a major factor in the economy.  

The Roth IRA is also a great place to invest for several reasons:

Upon withdrawal in retirement the income is tax free.

Before retirement, contributions can be taken out tax free as that money has been taxed already, for example if you have an emergency.

Roth IRA accounts (at least with me) using stocks, options and exchange traded fund investments can have lower expenses than most 401k plans.  Just 1% of additional cost in a 401k v another investment can reduce your assets at retirement age by up to about 50% (depending on returns, expenses and time frame). 

You can put almost any type of investment in a Roth IRA vs being very limited in most 401k, 403b or other types of plans.  This control and flexibility is a huge investment advantage in volatile markets.

Inside of your Roth IRA I suggest over several years building a small portfolio of very carefully selected stocks (about a dozen) from a combination of small growing companies (past the speculative stage) and value priced larger companies, combined with a few sector specific exchange traded funds (i.e. alternative energy, natural resource companies or emerging markets).  Historically this type of approach has offered more upside than the markets with about equal risk.

For higher net worth investors, there is now a low cost, fee-based, tax-deferred variable annuity product that offers over 300 investment selections from various managers.  Other products are on the horizon.  For the investor who has middle five figures or greater to invest per year, this vehicle is compelling for those who do not want to own non-transparent investments such as hedge funds or partnership units.

While none of this is earth shaking advice, beyond my clients, it seems to be rare that I find many people following it.  There is a mantra out there that people ought to pack their retirement money into 401k plans (and 403b or deferred comp plans), even though most of those plans are expensive, restrictive and jammed with mediocre mutual fund choices.

Here are some stories about 401k plans people ought to consider before making that their main retirement investment:

Rethinking the 401k If There is No Company Match

The Hidden Costs of Mutual Funds

Don't Let Fees Shrink Your 401k

Don't Lose Retirement Savings to 401k Fees

Is Your 401k Failing You?

The High Cost of 401k Fees

How Hidden 401k Fees Can Sink Your Nest

So, before adding more money to your 401k, ask yourself: is this the best way for me to invest for my retirement?  It could make a huge difference as to when you retire, or even if you retire.

Side note

I know many people will say they can not afford to save for retirement.  I empathize.  Until a few years ago I was stone cold broke while I figured things out and grew my business.  The simple fact is that most employed people can save and invest.  But it requires sacrifice.  

If you are short on cash, a person needs to consider getting rid of cable TV, start a garden to save on produce in the summer and fall, quit buying soda, alcohol and/or cigarettes, drive less often and walk more, stop eating out, not buy that new outfit or shoes, not buy a new fishing rod or golf clubs, not go out to party rather have one at your house instead... There are a host of budget cuts most Americans can and should make.

Budget cutting is easier when you accept that we (the United States) are in a demographically driven economic funk that is going to last for around another decade.  There is no amount of cash that Americans or the government can spend to create growth in the economy without generating a debt that will come back to haunt us.  American households who choose to spend now, will pay for it again later.  The good news, and something to plan for, is that when more echo boomers (children of the baby boomers) enter the work force and become earners as they take retiring baby boomer jobs, the economy will come back in the 2020s and 2030s barring any extreme circumstances.  That growth will be organic, and combined with growth generated by emerging economies, will be large.  Smart people who can control their emotions, while recognizing both the risks and opportunities that are approaching, can plan for the future, without risking today, and prosper from a forward looking approach.

Or as I learned at Camp Enterprise sponsored by the Rotary Club in 1987:

Control Your Emotions

Direct Your Thoughts

Ordain Your Destiny

Your erstwhile Advisor


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11 Comments – Post Your Own

#1) On May 12, 2011 at 1:00 PM, leohaas (30.09) wrote:

Or: find a better job. Resign the old one, and roll your old 401(k) over to an IRA. That gives you full control...

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#2) On May 12, 2011 at 1:13 PM, swank9 (< 20) wrote:


 common sense stuff, but it still amazes me that too few follow advice to save for their future...

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#3) On May 12, 2011 at 1:21 PM, mtf00l (43.11) wrote:

Thanks for the advice! =D

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#4) On May 12, 2011 at 1:24 PM, Melaschasm (< 20) wrote:

I agree that a Roth IRA is generally better than a 401k after the company match has been maxed out.

However, once you have maxed your Roth IRA contribution, additional 401k contributions are a great tax advantaged way to save.  Each time you change employers you can switch this money into a traditional IRA with lower costs.  If you spend many years at the same employer it is possible to transfer 401k money, but you need to talk to your tax accountant and your employer's 401k representative to avoid devastating tax consequences.

Overall a great blog!

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#5) On May 12, 2011 at 1:35 PM, PeteysTired (< 20) wrote:

Great blog!

I think it is unfair that I have such limited fund choices through my employer and I would give up the match if I was allowed more investment choice freedom. 

I think it is a shame that rules exist that "force" people to contribute to the employers 401k as apposed to opening or contributing to their own 401k. I can't even contribute $5k to my own plan if my employer offers a 401k :(

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#6) On May 12, 2011 at 1:37 PM, CluckChicken (< 20) wrote:

You should also check to see if your company has Roth 401k

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#7) On May 12, 2011 at 1:56 PM, chk999 (99.96) wrote:

Nice write up!

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#8) On May 12, 2011 at 6:00 PM, JaysRage (78.86) wrote:

For the record, Roth and 401K are not interchangable.  Roth has a much lower limit than 401K and not everyone qualifies for Roth.    There are income restrictions.   While 401K fees are restrictive, until those fees reach my tax %, which will likely never happen, I'll take the tax deferred accumulation any day of the week over taxable investing.  

In order

1) Get your 401K match free money

2) Max your Roth

3) Max your 401K

4) Invest in taxable environment


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#9) On May 12, 2011 at 9:51 PM, Jbay76 (< 20) wrote:

Something I just learned is that you can use a self-directed IRA to buy real estate.  When the RE is sold, those profits go to your IRA and can be used for standard investing or the pruchase of more real estate.  Gains from rentals etc also go to the self directed IRA. You have to convert your Roth or traditional IRA into a self-directed IRA managed by one of several IRS authorized organizations in order to do this.  I don't think I would ever do this personally, but I am considering some RE to compliment my other investment approaches.



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#10) On May 13, 2011 at 12:08 AM, davejh23 (< 20) wrote:

"The good news, and something to plan for, is that when more echo boomers (children of the baby boomers) enter the work force and become earners as they take retiring baby boomer jobs, the economy will come back in the 2020s and 2030s barring any extreme circumstances."

Do you think these "echo boomers" will be earning as much in inflation adjusted terms as the retiring boomers were earning?  In my industry, I'm seeing lots of retiring boomers being replaced by far less experienced employees...often times for less than half the salary.  The retirees are often staying on as consultants.  I don't see the rising generation of managers ever earning as much in inflation adjusted terms as the current wave of retirees earned.

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#11) On May 13, 2011 at 12:32 AM, kirkydu (91.26) wrote:

Wow, a lot of responses.  I'm glad I wrote something compelling. 

First, while I generally agree with JaysRage for an order of investing, the reality is over the next few years real estate may be a far superior investment buying opportunity than tax deferred mutual funds in an IRA.  Remember, real estate comes with some tax advantages too. 

If a person has the stomach to get into real estate, and I don't see why somebody who can stomach the stock market wouldn't be able to stomach the real estate market, they should.  The next several years will provide a multi-generational opportunity to buy real estate.  A good REIT in a self-directed 401k may be an option.  I would urge employees in companies with no self-directed option to put pressure on their HR or company ownership for a self-directed option by asking for a 401k be set up through a fee-based RIA (which will lower the 401k expenses to boot).

A note about physical real estate in an IRA, you will lose some tax advantages inherent in real estate if you do that.  I haven't found a lot of reason to use an IRA for real estate.  Also, there are very strict rules regarding usage of the real estate if placed in an IRA.

If you read George Friedman's book "The Next Decade", he points out that there will likely be a labor shortage 10-15 years out.  I believe that to be true as well.  While echo boomers are entering the labor force on the cheap, market forces will drive labor costs back up sometime in the 2020s.  Hopefully by then the U.S. has moved towards lower cost alternative energy.  Cheaper energy will be the only thing that keeps Schiff and Rogers from being right about huge inflation in the U.S. down the road.  Getting that cheaper energy will take two things I'm not sure we'll get.  Another jump in technology and political will.

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