Saturday, 11 May 2019

The Truth About 401k - Risk And Benefit

The Truth About 401k - Risk And Benefit

If somebody asked you what's the best way to plan for your future? What would you say? Easy, get a good job and then invest in a 401k. You've probably heard money management advice like max out your 401k contribution if you want to live a healthy retirement.

Have you ever ask yourself is the 401k right for you, and well, it's not a very simple answer it depends on what your financial goals are and the only way you can know if the 401k is a good investment for you or not is if you understand the truth about your 401k

In this article, I want to go over 5 things you need to understand what a 401k

1. How 401k Exist

Back in our grandparents' generation people were handed retirement throughs company-paid pensions if you worked hard at your job for long enough your company would reward you by paying you to retire and then they would pay you every single month while you're in retirement until you died.

  • This was great for employees because you were guaranteed to get paid assuming your company didn't go bankrupt, but this was bad news for your boss, your employer was on the hook for your employment and that cost was a huge question mark on their financial books. 

Your company couldn't predict what the economy was going to look like when it was time for you to retire, your company didn't know what their expenses were going to be like or what their company was going to look like in 10 or 20 year, and they don't know how long you were going to live

They don't know how long they have to keep paying for you to retire with a pension, so there was a lot of uncertainty and nobody likes uncertainty especially when it comes to your money

Corporations naturally wanted an alternative so the employer met with the government and wall street to come up with a solution to help you retire. And they decided the best thing to do was to teach people how to fish and become self-reliant by teaching people money management and investing so you can create your own retirement. Just Kidding, out came your 401k.

2. The Real Benefits Of 401k

The best thing about your 401k is, you get a company match, if you invested $500 into your 401k, your boss might give you another $250 or another $500 to invest. Investing in your 401k is easy, your money is automatically deducted from your paycheck and you have experts managing your money, plus your 401k is risk-free and you get huge tax breaks, you'll see what I mean just keep reading.

3. Cost Of 401k

  • NerdWallet did a study and they found that 92% of Americans don't have a clue of what their 401k fees are. 
But wait a minute, does your 401k cost you money?

Let me put it this way, in 2015 Wall Street money managers made 17 billion dollars in 401k hidden fees, 17 billion dollars figure, it doesn't include the open fees.

To put it in perspective the average American earning a median salary, not a high-income salary, but a median salary can expect to pay around a $138,336 in 401k fees over the lifetime.

The way it works with most funds is every single year your money managers will take a percentage of your total assets every single year as their fee whether or not you make money. they can afford to charge these high fees every single year because they know that when you invest your money in your 401k is going to be invested for a long time

  • If you realize this and you were like what, I don't want to keep paying these fees, and you try to pull your money out of your 401k, that's when the government will come in and they will slap you with a huge penalty.

4. Risk Of Investing In 401k

For many Americans, the 401k is their only investment and their only retirement hope, and that's very risky because you have no real diversification. If you think you have money invested in different funds, thinking you're good, let me go over what real diversification is

Investing your money in a Growth Fund, Dividend stocks and a blue-chip pond isn't real diversification because all of your money is in paper assets, it's only one asset class, so if you ended up retiring when the stock market is down because nothing can go forever, then you might be in trouble, I mean, people that tried to retire during the 2008 crash found that their life investments were worth a fraction of what they invested.

Real diversification is where you invest your money in different asset classes. like one might be paper assets that I've been talking about, one might be physical real estate, and one might be physical gold

This way if the stock market comes down you can go and use your money in a different asset during that time.

5. The Tax Benefits

I've spent a lot of time studying that tax code and one thing that is very obvious is that you get huge breaks for being an investor, but most of those investment tax breaks don't carry over to your 401k.

You're told that when you make a contribution into your 401k you don't have to pay taxes on that money that you contribute, that's your tax break

If you make $50,000 from a job and you contribute $1,000 to your 401k, you don't have to pay taxes under $1,000 and you only have to pay taxes on $49,000. even though that's only partially true because you still have to pay FICA taxes on your $1,000 contribution

But what you need to remember is you don't get to avoid paying taxes on that $1,000, you just defer it until you're old enough to retire

Let me get it clear

When you're old enough to retire and you pull your money out from the 401k account, that's where you get taxed. That is very bad financial planning because why in the world would you plan to have no income when you're old enough to retire.

  • Every investor's goal is to create more income the next year, so this way by the time you're old you should be planning to have a whole bunch of income when it's time for you to retire, 

But for the sake of this article, let keep going along with your example.

If I had $10,000 and I learn how to invest and I took this money and I invested it in the stock market, I didn't use a 401k I did this invest with myself and after 10 years these $10,000 investments grew to a million-dollar and I wanted to pull this million dollars out, I'm going to have to pay taxes on the million dollars

But because I invested this money myself I get investment tax breaks and I would be paying somewhere between 0% and 20% of that money in taxes. And by the way, this example is using today's tax rates.

Tax Rates Affect 401k

With the 401k it's kind of different if we had the same scenario where I took $10,000 and I invested it in my 401k and after 10 years I was old enough to retire and my 401k was worth a million dollars and I pull a million dollars out of my 401k

I don't get that same tax rate, I don't get to pay 0 to 20 percent of that money in taxes, I would have to pay way more than that in taxes because this is classified as ordinary income and I would be paying a lot more in taxes on my profits. Again that's using today's tax rate.

As you can see there's a lot more to the 401k, but that's why I'm writing this article, this way you can be aware and take charges of your finances and do what's best for you financially.

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