I received a question recently regarding investments beyond a 401k. I think this advice might be helpful to others, so I will respond with a post. The question was as follows:
“If I’m currently putting say 6% into a company-sponsored 401k (which is the point at which they’ll match 50%) and am not making any other investments, what would be the best next step? I’m thinking of maxing out my 401k contribution, but I’ve also read recommendations that I should *first* max out a Roth IRA, and *then* (if I still have available money), bump up my 401k contribution. Both of these (401k and Roth IRA) have tax advantages, but if you feel that other types of investments (e.g., Gold) would be even more important before opening a Roth IRA or bumping up my 401k, I’d appreciate that info.”
My opinion on this matter is that you should only contribute to a 401k up to the amount of your employer’s match. If you are contributing up to the match and you have extra money to invest, you absolutely should not contribute more to your 401k plan. The reason is because of all of the uncertainties and inflexibilities that come with a 401k plan. You are subject to the decisions of your employer’s plan along with the government.
First, you have no idea what the tax rates will be when your retire. This would be a reason to favor a Roth IRA or Roth 401k over a traditional IRA or 401k. Second, you are locking up your money until the age of 59 and a half. You cannot withdraw your money before then, unless you pay taxes on it along with a hefty penalty. And this is only if your employer’s plan will even let you withdraw any money.
A third reason against further investing in a 401k plan is that the government could change the rules at any time. The government could change the age for withdrawal. It could even make tax rates higher for retirement plan income. I am not saying that this will happen, but that it can happen. Could you not imagine some politician saying that it is unfair that some retirees have big 401k balances while others have nothing saved? Could you not imagine the same politician saying that we need to tax the big retirement plans to even things out?
An even bigger threat is that the government could try to confiscate retirement plans. It would not happen all at once, as this would cause a revolt. Instead, imagine a scenario where the stock market crashes and the government steps in with special government bonds where you will get a “guaranteed” safe investment with a “guaranteed” rate of return. These special bonds would be optional at first. Then the politicians would slowly take steps to move them from optional to mandatory. While I don’t expect this to happen, anything is possible.
So what should you invest in? First, I am assuming that you have paid off all credit card and other high interest debt. Second, you should put a little money aside as a rainy day fund. This would just go into an FDIC insured bank account.
Next, I would recommend investing in some gold and gold related investments. This is especially important because it is hard to invest in gold related investments in a 401k plan. In addition, we are in a very shaky environment right now where anything can happen. Look at gold investments as an insurance policy as much as an investment.
After all of that is taken care of, you could look at a Roth IRA. While there is still the problem of unpredictability from the government, there are advantages over a 401k plan. With the Roth, you pay your taxes now and don’t have to worry about the tax rates when you retire (assuming the government doesn’t change the rules). Also, another great benefit is that you can withdraw your principal investment (not gains) from your Roth plan and you will not pay a penalty. This gives you more flexibility in case you need money for something important.
I am still a big advocate of Harry Browne’s permanent portfolio plan as laid out in his book Fail Safe Investing. If you are looking for a mutual fund to imitate this, then you can buy PRPFX. You can do this in a Roth IRA or a regular trading account. I hope this information helps.
Thanks for, once again, taking one of my questions and creating a blog post about it. I do wish you had touched upon the immediate tax advantages of maxing out a 401k, and why you think those advantages are outweighed by the risks. On the “risk” front, your concerns are probably valid, but they are speculative (e.g., the tax rate *could* be higher later, the government *could* seize in some way 401k accounts, or increase the eligible age for withdrawals). Let’s face it, the government could do any number of other horrible things: seizing your gold, etc.
One of the reasons why I’ve been thinking strongly about maxing out my 401k contribution (ideally, in *addition* to maxing out my contribution to a Roth IRA) is because of the potential of it bumping down my AGI. The last two years we got hit with the AMT, and the tax advantage of deducting our property taxes (which are significant in our town in CT) were basically lost. I haven’t run the numbers, but I’m hoping that maybe by maxing out our 401k contribution (and increasing contributions to a medical reimbursement account through one of our employers), we might be able to squeak below the AMT limit.
Another thing to consider and one of the reasons I stopped putting money into a 401K several years ago is that in my industry there is high turnover. With the housing bust and economic decline I have been laid off from two different companies after a relatively short time. They let me go in order to downsize. If I had invested my money in a 401K with an employer match I would have lost all of my match because I wasn’t fully vested in the company.
As an example my last job was an ESOP in which I automatically earned stock in the company. I had worked there over two years and was laid off, a few months later they cashed out my stock for me. I had no choice in the matter and what little they gave me was heavily taxed with penalties.
Maybe your job is very stable and you will be at the same company for a long time, but I wouldn’t count on it.