In a relatively free market with no federal income tax, a 401k plan would be meaningless. The 401k plan is essentially a loophole in the tax code that allows you to contribute pre-tax dollars. You can grow your money tax-free until you withdraw it. In exchange for this tax benefit, the government and your employer maintain certain controls (rules) that you must follow.
There are good arguments to be made for contributing to a 401k plan. These include tax deferment, a company match, and an easy way to contribute (payroll deduction). This is not a list to instruct you to not contribute to a 401k plan. These are just reasons on why you might consider not contributing.
Some of the reasons might be similar or overlap, but they are all legitimate reasons on why someone might not want to contribute to a traditional 401k plan, even if their company matches contributions.
Here are 10 reasons not to contribute to a 401k plan.
- If you are still employed with the employer that sponsors your 401k plan, then in most cases you cannot withdraw your money before age 59½. If you really want your money, you will have to quit your job. Therefore, a 401k is completely illiquid for most people. I would rather have $20,000 in the bank than $25,000 sitting in a 401k plan that I can’t touch.
- If you no longer work for your employer that sponsors your plan, then you will still pay a 10% penalty (plus taxes) for a withdrawal if you are younger than 59½.
- Instead of contributing to a 401k plan, you could use that money to start a business or some kind of venture that would generate income. Imagine if Bill Gates or Steve Jobs had taken the little money they had when they were young and put it into a retirement account instead of using it to start their businesses.
- Instead of contributing to a 401k plan, you could use that money to buy a house (either to live in or to rent out). While there are pros and cons to buying real estate, some people would find themselves better off using any excess money to put into real estate.
- You are vulnerable to any changes in the law at any time. Congress could pass a law that raises the age for withdrawal. The government could require that you use a certain percentage to buy U.S. Treasuries. The government could impose a wealth tax that would subject 401k investments to a special one-time tax (or more). This, of course, would all be done in the name of helping the poor or helping the country in a time of need.
- To go along with number 5 above, there could be a change in the marginal income tax rates at any time. The tax code changes at some point with almost every presidential administration. If tax rates are 45% when you retire with your 401k, your tax deferral all of a sudden doesn’t seem that brilliant.
- You are usually forced into buying specific mutual funds in a 401k plan. Perhaps you have a good plan where you can choose almost any mutual fund. Still, you probably can’t buy exchange traded funds (ETFs). You almost certainly can’t buy options. And there is no possible way you are going to buy any physical gold with your 401k funds.
- Some people simply don’t have any money and are living paycheck to paycheck. The government has ruined medical care, as insurance premiums continue to skyrocket. The government spends so much money (misallocates resources) and regulates virtually everything to such a high degree, that lower class and middle class America is basically broke. We are certainly better off in terms of technology, but the reality is that most middle class families are scraping by and have little in the way of savings. It is easy to say that they should save, but life is expensive. It is better to not contribute to your 401k plan than to stress out about how you are going to pay for groceries this week.
- If someone is deep in debt, then that person is likely better off paying off their high-interest debt (credit cards, student loans) than putting this money into a 401k plan. You can easily pay 18% interest on credit card debt. After your company match, good luck getting anything close to a return of 18% (let alone half that) with your 401k funds.
- To go along with several of the points above, there are opportunity costs with contributing to a 401k plan. You are locking up your money that could be used in other ways in the present. You could pay down your mortgage (guaranteed rate of return). You could get a certification that would advance your career and increase your salary. You could buy a piece of software or equipment that would allow you to increase your skills and productivity. If any kind of investment opportunity unexpectedly showed up, you could consider it because you have liquid cash. If your friend shows up at your door and is looking for an investment for his new great software program that is going to revolutionize the world, you can tell him that your money is locked up in your 401k retirement account. Maybe it will work out for you because his software idea didn’t take off. Or maybe he will end up a multi-millionaire while you are waiting another few decades to access “your” funds in the company 401k plan.
Again, these are just considerations to take into account. Every person and their situation is different. You have to decide for yourself if contributing to a 401k plan is the right decision for you.