Bloomberg: 401(k) Plans No Longer Make Much Sense for Savers

[Feivel2000]

https://www.bloomberg.com/opinion/articles/2020-07-21/401-k-plans-no-longer-make-much-sense-for-savers

As someone who wishes, Germany would offer something similar to a 401k, this article seems pretty crazy and badly researched...

[Engineer93]

The article mentions that the marginal tax rate is now 12% but that is only for individuals making less than 40k a year or a family making less than 80k a year.  I would assume that most people who have the option to contribute to a 401k are making more than that which would put them in the 22% tax rate bracket.

[Morning Glory]

The article mentions that the marginal tax rate is now 12% but that is only for individuals making less than 40k a year or a family making less than 80k a year.  I would assume that most people who have the option to contribute to a 401k are making more than that which would put them in the 22% tax rate bracket.

The article used median income for a family of four, which is about 60k.

[friedmmj]

The article makes a good point for lower income workers.  People who are making higher incomes still benefit tremendously from pre-tax 401k investing.

[YttriumNitrate]

The article mentions that the marginal tax rate is now 12% but that is only for individuals making less than 40k a year or a family making less than 80k a year.  I would assume that most people who have the option to contribute to a 401k are making more than that which would put them in the 22% tax rate bracket.

The article used median income for a family of four, which is about 60k.

The median household income (for any family size) is about 60k. The median household income for a family of four is notably higher.
https://www.justice.gov/ust/eo/bapcpa/20190501/bci_data/median_income_table.htm

[DadJokes]

The article makes a good point for lower income workers.  People who are making higher incomes still benefit tremendously from pre-tax 401k investing.

Except that the Roth option provided by many 401(k)s is a great option for low income families, and it isn't even mentioned in the article.


The article's suggestions:
1. Require 401(k)s to allow in-service rollovers to IRAs
2. Make 401(k) distributions tax-free up to the median income (or some other set amount)
3. Make it so that 401(k) contributions also reduce FICA taxes (similar to how HSAs do)

While I think the clickbait title of the article makes it difficult to take the article seriously, I have no complaints to any of those proposals. They all benefit savers.

[wageslave23]

I like the article.  I feel like I am constantly explaining to clients that 401k contributions are only a deferral of taxes.  Their benefits are greatly exaggerated.  They probably give the most benefit to mustachians, who have high earnings and then low income in retirement.  Most people in the general population who are high earners will also have high income in retirement.

[Engineer93]

The article mentions that the marginal tax rate is now 12% but that is only for individuals making less than 40k a year or a family making less than 80k a year.  I would assume that most people who have the option to contribute to a 401k are making more than that which would put them in the 22% tax rate bracket.

The article used median income for a family of four, which is about 60k.

The median household income (for any family size) is about 60k. The median household income for a family of four is notably higher.
https://www.justice.gov/ust/eo/bapcpa/20190501/bci_data/median_income_table.htm

I would also assume that the median household income for families that have access to a 401k (eliminates minimum wage, etc.) is probably a lot higher than 60k.

[mizzourah2006]

The article makes a good point for lower income workers.  People who are making higher incomes still benefit tremendously from pre-tax 401k investing.

Except that the Roth option provided by many 401(k)s is a great option for low income families, and it isn't even mentioned in the article.


The article's suggestions:
1. Require 401(k)s to allow in-service rollovers to IRAs
2. Make 401(k) distributions tax-free up to the median income (or some other set amount)
3. Make it so that 401(k) contributions also reduce FICA taxes (similar to how HSAs do)

While I think the clickbait title of the article makes it difficult to take the article seriously, I have no complaints to any of those proposals. They all benefit savers.

I agree with 1, but I'm having trouble understanding 2 and 3. If we do 2, why not just make income up to the median level tax free? Why specifically 401k distributions? and for 3, one is to pay for health expenses and the other is deferred retirement money. I think FICA taxes should be paid on earned income to be used for normal expenses, now or at some indeterminant time in the future, unless you are suggesting you defer the FICA taxes until distribution, but that seems to go against your second point.

[friedmmj]

I like the article.  I feel like I am constantly explaining to clients that 401k contributions are only a deferral of taxes.  Their benefits are greatly exaggerated.  They probably give the most benefit to mustachians, who have high earnings and then low income in retirement.  Most people in the general population who are high earners will also have high income in retirement.

In general, having high income in retirement is a result of poor planning.  You worked too long and over-saved.

[dogboyslim]

In general, having high income in retirement is a result of poor planning.  You worked too long and over-saved.

Or the result of good planning, since you spend a lot and wanted to continue spending a lot in retirement.  (not the mustachian apprach, but the one most high income retirees are using).  A difference in values is not poor planning.

[friedmmj]

In general, having high income in retirement is a result of poor planning.  You worked too long and over-saved.

Or the result of good planning, since you spend a lot and wanted to continue spending a lot in retirement.  (not the mustachian apprach, but the one most high income retirees are using).  A difference in values is not poor planning.

I'm ok with a high spender having high income.  I was being critical of the large number of retirees that have over-saved and only spend a small fraction of what they can afford to spend.

[DadJokes]

The article makes a good point for lower income workers.  People who are making higher incomes still benefit tremendously from pre-tax 401k investing.

Except that the Roth option provided by many 401(k)s is a great option for low income families, and it isn't even mentioned in the article.


The article's suggestions:
1. Require 401(k)s to allow in-service rollovers to IRAs
2. Make 401(k) distributions tax-free up to the median income (or some other set amount)
3. Make it so that 401(k) contributions also reduce FICA taxes (similar to how HSAs do)

While I think the clickbait title of the article makes it difficult to take the article seriously, I have no complaints to any of those proposals. They all benefit savers.

I agree with 1, but I'm having trouble understanding 2 and 3. If we do 2, why not just make income up to the median level tax free? Why specifically 401k distributions? and for 3, one is to pay for health expenses and the other is deferred retirement money. I think FICA taxes should be paid on earned income to be used for normal expenses, now or at some indeterminant time in the future, unless you are suggesting you defer the FICA taxes until distribution, but that seems to go against your second point.

I'm not saying that 2&3 are necessarily good for the country, just that they are good for many individuals (myself included).

For 2, I also have no problem making all income up to a certain point tax free. Call it increasing the standard deduction or whatever. However, that would reduce tax revenue a lot. Just making 401(k) withdrawals tax-free seems like a compromise (not that I think it would happen).

For 3, I'm already using my HSA as a normal retirement account, rather than for health expenses. I don't have to pay FICA taxes when I eventually withdraw that money. I see no logical reason why it's okay for that but not for normal retirement savings. Naturally, this would hurt the already strained social security & Medicare programs, so it won't happen either unless paired with an increase in the income cutoffs.

[mizzourah2006]

The article makes a good point for lower income workers.  People who are making higher incomes still benefit tremendously from pre-tax 401k investing.

Except that the Roth option provided by many 401(k)s is a great option for low income families, and it isn't even mentioned in the article.


The article's suggestions:
1. Require 401(k)s to allow in-service rollovers to IRAs
2. Make 401(k) distributions tax-free up to the median income (or some other set amount)
3. Make it so that 401(k) contributions also reduce FICA taxes (similar to how HSAs do)

While I think the clickbait title of the article makes it difficult to take the article seriously, I have no complaints to any of those proposals. They all benefit savers.

I agree with 1, but I'm having trouble understanding 2 and 3. If we do 2, why not just make income up to the median level tax free? Why specifically 401k distributions? and for 3, one is to pay for health expenses and the other is deferred retirement money. I think FICA taxes should be paid on earned income to be used for normal expenses, now or at some indeterminant time in the future, unless you are suggesting you defer the FICA taxes until distribution, but that seems to go against your second point.

I'm not saying that 2&3 are necessarily good for the country, just that they are good for many individuals (myself included).

For 2, I also have no problem making all income up to a certain point tax free. Call it increasing the standard deduction or whatever. However, that would reduce tax revenue a lot. Just making 401(k) withdrawals tax-free seems like a compromise (not that I think it would happen).

For 3, I'm already using my HSA as a normal retirement account, rather than for health expenses. I don't have to pay FICA taxes when I eventually withdraw that money. I see no logical reason why it's okay for that but not for normal retirement savings. Naturally, this would hurt the already strained social security & Medicare programs, so it won't happen either unless paired with an increase in the income cutoffs.

Sure, but in 3 you are an extreme minority. The majority of people are putting into their HSA what they plan to use for healthcare expenses. It's a bit of a loophole in the HSA, but if you expanded that to actual retirement savings that would be disastrous.

All of those things would personally benefit me as well, but I still don't see how they'd benefit the majority of people. A very small % of people will be pulling the HH median income from their 401ks at the time of distribution.

[Morning Glory]

They forgot about state income tax, since those are deferred also. One could move to a lower tax state in retirement.
I currently pay more each year in state taxes than federal.

[ender]

The article mentions that the marginal tax rate is now 12% but that is only for individuals making less than 40k a year or a family making less than 80k a year.  I would assume that most people who have the option to contribute to a 401k are making more than that which would put them in the 22% tax rate bracket.

The article used median income for a family of four, which is about 60k.

It used median household income in 2020 and then top 5% household income in 1980 (median income from 1980 put you at a 21% tax bracket, not 43% as the article misleadingly states).

The irs specifically has a doc about their 1980 taxes. I have no clue where this author got their data but it was all blatantly incorrect. That specifically calls out the median income in 1980, and from their charts on the bottom it's blatantly obvious anyone paying 43% marginal rate isn't remotely close to middle class.
 
It's just... wrong.

If you inflation adjust income that they used for their 1980 income to 2020 it's $115k or so. Which means... surprise, capital gains taxes are now not 0%. And surprise, marginal rates are not 12%.

It's just a clickbait article that is full of inaccurate and misleading information. Which really is par for the course for financial articles these days but this one was egregiously bad because it's basically lying.

[chicagomeg]

The article makes a good point for lower income workers.  People who are making higher incomes still benefit tremendously from pre-tax 401k investing.

Except that the Roth option provided by many 401(k)s is a great option for low income families, and it isn't even mentioned in the article.


The article's suggestions:
1. Require 401(k)s to allow in-service rollovers to IRAs
2. Make 401(k) distributions tax-free up to the median income (or some other set amount)
3. Make it so that 401(k) contributions also reduce FICA taxes (similar to how HSAs do)

While I think the clickbait title of the article makes it difficult to take the article seriously, I have no complaints to any of those proposals. They all benefit savers.

I agree with 1, but I'm having trouble understanding 2 and 3. If we do 2, why not just make income up to the median level tax free? Why specifically 401k distributions? and for 3, one is to pay for health expenses and the other is deferred retirement money. I think FICA taxes should be paid on earned income to be used for normal expenses, now or at some indeterminant time in the future, unless you are suggesting you defer the FICA taxes until distribution, but that seems to go against your second point.

I'm not saying that 2&3 are necessarily good for the country, just that they are good for many individuals (myself included).

For 2, I also have no problem making all income up to a certain point tax free. Call it increasing the standard deduction or whatever. However, that would reduce tax revenue a lot. Just making 401(k) withdrawals tax-free seems like a compromise (not that I think it would happen).

For 3, I'm already using my HSA as a normal retirement account, rather than for health expenses. I don't have to pay FICA taxes when I eventually withdraw that money. I see no logical reason why it's okay for that but not for normal retirement savings. Naturally, this would hurt the already strained social security & Medicare programs, so it won't happen either unless paired with an increase in the income cutoffs.

Number 1 sounds great but it's just going to be another tactic for expensive financial advisors to get their claws into people's savings. There are definitely some bad 401k plans out there, but they don't hold a candle to what an advisor at EJones would be excited to sell you.

I think number 2 is just silly. The only people likely to pay meaningful federal taxes on their 401k's in retirement are those with enough money they can afford to pay them.

Number 3 could be useful for some people. There are two major bend points for wages & resulting SS benefits. If you're below the first bend point in wages, you get back 90% of what you pay into SS. From doing taxes at a VITA site for 10 years, I can tell you that many low income earners ARE enrolled in their 401k at low percentages, probably due to automatic contributions. It would be harmful to the lowest income folks to exempt this income from FICA because you're just reducing their final benefits. Since low income people often withdraw their 401k balance before retirement to cover financial emergencies, this will only hurt them in the long run. On the other hand, there's a cap to the SS tax anyway at the high end, so really wealthy people already only pay Medicare taxes on those contributions. A good chunk of people in the middle could benefit from this change, but as someone else mentioned up thread, I can't really see a politically feasible path for taking money away from the SS program when it's already in poor financial shape.

[teen persuasion]

The article makes a good point for lower income workers.  People who are making higher incomes still benefit tremendously from pre-tax 401k investing.

No, a family of four with lower income is likely eligible for EITC, and contributions to a traditional 401k can increase the EITC amount considerably.  The phaseout rate is 21% for 2 children, and my state matches EITC at 30%, an additional 6.3% phaseout rate, for a minimum marginal rate of 27.3% (before any tax reduction at all).  Contributions to a tIRA are not equivalent for EITC, because they reduce only AGI, not w2 wages (as 401k contributions do), and EITC is tested on both.  Lower income families with children should contribute to 401k, and then use the refundable credits from EITC & CTC to fund Roth IRAs for greater retirement savings.

[MissPeach]

I think a lot of this is still about expenses. If I am low income but can easily meet my expenses (which is a common FI strategy) then I can use the 401K to modify my AGI to take advantage of EITC, ACA, lower my taxes, etc. Many lower income people don't think this way but it's possible to do if expenses are low.

I also think they should have mentioned a Roth 401K or Roth IRA as that is possibly a better option for that bracket as an alternative.

[Arbitrage]

Pretax plans are not just tax deferral - you also avoid all capital gains taxes (just as you do for Roth). 

[BTDretire]

As one that recently retired and spent most of my life in lower tax brackets, I think I made a mistake by funding IRAs rather than Roths.
 I'm in the starting process of doing Roth conversions in the 12% tax bracket.

[fattest_foot]

I like the article.  I feel like I am constantly explaining to clients that 401k contributions are only a deferral of taxes.  Their benefits are greatly exaggerated.  They probably give the most benefit to mustachians, who have high earnings and then low income in retirement.  Most people in the general population who are high earners will also have high income in retirement.

Except just by virtue of "saving," you'll have a higher income working than in retirement, provided you keep your standard of living consistent. That money you're saving is money that's currently not going towards your lifestyle spending.

[Buffaloski Boris]

I think it was a poor article although I liked two of the three suggestions.

First, why it’s a poor article in a nutshell: it assumes the tax situation that we have right now stays static, which to me is the most wishful of thinking. Also, it ignores the impact of state income taxes. I pay 1/3 to 1/2 as much in state income tax as I do federal and it seems that darn near every financial blogger and “celebrity” out there ignores state income taxes.

Now I happen to agree with items 1 and 3 below:

The article's suggestions:
1. Require 401(k)s to allow in-service rollovers to IRAs
2. Make 401(k) distributions tax-free up to the median income (or some other set amount)
3. Make it so that 401(k) contributions also reduce FICA taxes (similar to how HSAs do)

As for item 2, why should retirement income be treated any differently from W2 income? Or said another way, why do we perpetually screw over workers in favor of investors? I do happen to win in the current arrangement but I don’t think it’s particularly just.

[Much Fishing to Do]

I still think the existence of 401ks is crazy and just don't get why we can't just have a consistent and solid IRA and Roth IRA option available for everyone (without the crazy low maximums, at least in  allowed).  That way everyone can pick stuff with good fees and whatever investments they want.  And it would get us away from the crazy circumstances I always found myself in thorughout my working career, from employers that didn't offer me a 401k (and therefore I could only save like 5k/year in a retirement account) to the years I was self-employed and could plow like $50k+ into it per year.  The years I didnt have a 401k available I just couldn't understand why the IRS would compound the fact that my job sucked with not allowing me to save as much in retirement vehicles as people with good jobs, but the years I had a successful business I got the added benefit of being able to plow so much more in to avoid my really high bracket at that point.

And as has been mentioned, leaving the Roth option out of this discussion and using the average tax brackets is what leads to its conclusion.  Using a Roth 401k/IRA always worked well for me when my bracket was under 20% and the traditional always worked well for me when bracket was over 20%.

[Morning Glory]

I still think the existence of 401ks is crazy and just don't get why we can't just have a consistent and solid IRA and Roth IRA option available for everyone (without the crazy low maximums, at least in  allowed).  That way everyone can pick stuff with good fees and whatever investments they want.  And it would get us away from the crazy circumstances I always found myself in thorughout my working career, from employers that didn't offer me a 401k (and therefore I could only save like 5k/year in a retirement account) to the years I was self-employed and could plow like $50k+ into it per year.  The years I didnt have a 401k available I just couldn't understand why the IRS would compound the fact that my job sucked with not allowing me to save as much in retirement vehicles as people with good jobs, but the years I had a successful business I got the added benefit of being able to plow so much more in to avoid my really high bracket at that point.

And as has been mentioned, leaving the Roth option out of this discussion and using the average tax brackets is what leads to its conclusion.  Using a Roth 401k/IRA always worked well for me when my bracket was under 20% and the traditional always worked well for me when bracket was over 20%.

Yes, it would be nice if companies like fidelity or Vanguard could offer a 401k to the general public, instead of tying it to employment. Would be nice if health insurance worked that way too.

[Buffaloski Boris]

I still think the existence of 401ks is crazy and just don't get why we can't just have a consistent and solid IRA and Roth IRA option available for everyone (without the crazy low maximums, at least in  allowed).  That way everyone can pick stuff with good fees and whatever investments they want.  And it would get us away from the crazy circumstances I always found myself in thorughout my working career, from employers that didn't offer me a 401k (and therefore I could only save like 5k/year in a retirement account) to the years I was self-employed and could plow like $50k+ into it per year.  The years I didnt have a 401k available I just couldn't understand why the IRS would compound the fact that my job sucked with not allowing me to save as much in retirement vehicles as people with good jobs, but the years I had a successful business I got the added benefit of being able to plow so much more in to avoid my really high bracket at that point.

And as has been mentioned, leaving the Roth option out of this discussion and using the average tax brackets is what leads to its conclusion.  Using a Roth 401k/IRA always worked well for me when my bracket was under 20% and the traditional always worked well for me when bracket was over 20%.

Yes, it would be nice if companies like fidelity or Vanguard could offer a 401k to the general public, instead of tying it to employment. Would be nice if health insurance worked that way too.

It would be even better if pensions were still a thing. 401(k)s were a convenient way for employers to ditch pensions and go to a defined contributions plan instead.  For current company that was arguably a good thing.  We're the minority.  Although we often disagree the vast bulk of the people here are financially literate and in some cases would be very good financial advisors in their own right. For most folks who are more or less financially illiterate, the move to defined contribution plans has been a train wreck.   

[bmjohnson35]

One of the major advantages of a 401k plan is the "automatic" nature of the program. In an ideal world, everyone is disciplined and invests regularly. Of course, we don't live in that world.  Putting aside the matching dollars by the employer and the inherent tax advantages, the importance of this aspect of a 401k shouldn't be underestimated for the general public.

The vast bulk of my career was with one employer.  Our fees were never what is listed in this article.  I don't know if the article exaggerates the average fees or maybe our 401k administrators were better than average.

[Feivel2000]

It would be even better if pensions were still a thing. 401(k)s were a convenient way for employers to ditch pensions and go to a defined contributions plan instead. 

The problem of a pension is, you have to guarantee something. If you need a guaranteed return from a financial institution, it will suck.
That's why all private options in Germany suck.

[DadJokes]

It would be even better if pensions were still a thing. 401(k)s were a convenient way for employers to ditch pensions and go to a defined contributions plan instead. 

The problem of a pension is, you have to guarantee something. If you need a guaranteed return from a financial institution, it will suck.
That's why all private options in Germany suck.

I don't get why people view pensions so favorably.

1. They require that people work for the same company for their whole career. Very few people do that anymore. In many cases, the only way to get a raise is to change jobs. That'll be even more likely when the current employer can hold a pension over people's heads.

2. Why would people want to put their future in the hands of their employer instead of controlling it themselves? Look at all of these companies and state governments whose pensions are wildly underfunded. A lot of companies have had to freeze payments or even reduce them.

[rantk81]

(USA-centric comment) I think the majority of companies have eliminated, or are in the process of phasing out defined benefit pension programs.
Public sector/government jobs are almost the only place where there are any significant number of jobs that have any kind of pension program remaining anymore.
Even some of those are starting to be phased out. Public sector/govt pensions can sometimes be perceived to have a stronger "guarantee" due to the government's ability to just keep increasing taxes to fund it, when necessary.

Even back in 2004 when I first entered the "professional" work-force, pensions from private companies were few-and-far-between.  I do prefer the 401k/defined-contribution model for myself personally.  I've never worked for an employer that offered any kind of pension plan.  I'd probably only consider it, if it were a government-job.  But that ship has already sailed, since I'm so close to FIRE'ing. :)

[Buffaloski Boris]

It would be even better if pensions were still a thing. 401(k)s were a convenient way for employers to ditch pensions and go to a defined contributions plan instead. 

The problem of a pension is, you have to guarantee something. If you need a guaranteed return from a financial institution, it will suck.
That's why all private options in Germany suck.

The problem we have in the US is that the state pension, such as it is, is essentially a poverty benefit.  For most it means that they cannot retire and maintain something close to their existing lifestyle if they don't have a significant pension or private retirement benefit and unfortunately most people don't.  Again, financial literacy in the US is the exception not the rule. So those without a private pension, suboptimal as those may be, are in a world of hurt. 

Speaking to Germany, I don't know how the taxation works there on investments.  Are capital gains treated as ordinary income?  If not, why not put together your own investment portfolio of investments and treat it as your own privately developed pension?       

[Feivel2000]

The problem we have in the US is that the state pension, such as it is, is essentially a poverty benefit.  For most it means that they cannot retire and maintain something close to their existing lifestyle if they don't have a significant pension or private retirement benefit and unfortunately most people don't.  Again, financial literacy in the US is the exception not the rule. So those without a private pension, suboptimal as those may be, are in a world of hurt. 

This is not really differently in Germany. In 2030 it is expected, that your pension is roughly 60% of your last salary (after taxes and healthcare). And only if you are 67 years and have paid into the pension for (?, not sure here, roughly) 40 years.

Speaking to Germany, I don't know how the taxation works there on investments.  Are capital gains treated as ordinary income?  If not, why not put together your own investment portfolio of investments and treat it as your own privately developed pension?

It's complicated. Of course this is possible and probably the best choice for most saving. But it's from your taxed income.
Thanks to the Betriebsrentenstärkungsgesetz, you can save un-taxed income. But it is crazy complicated, it has to be a pension, taxation and health insurance in the future are unclear and, of course, the costs are so high that you have to become VERY old before it makes sense...

[rantk81]

This is not really differently in Germany. In 2030 it is expected, that your pension is roughly 60% of your last salary (after taxes and healthcare). And only if you are 67 years and have paid into the pension for (?, not sure here, roughly) 40 years.

I'm pretty sure that Social Security retirement benefits for individuals are far less than 60% of your final salary (BEFORE taxes and healthcare costs), even after a 35+ year career of paying into the system.  Maybe if you include the additional 50% benefit for a non-working spouse, you might get close to 60%?

[Feivel2000]

I am not criticising our main pension system (even though it doesn't come for free: both, the employer and the employee, pay each 9.3% of the brutto salary each month).

I am criticising our auxiliary options. Practically everything that's tax deductable is only beneficially to the insurance industry.

[park10]

I like the article.  I feel like I am constantly explaining to clients that 401k contributions are only a deferral of taxes.  Their benefits are greatly exaggerated.  They probably give the most benefit to mustachians, who have high earnings and then low income in retirement.  Most people in the general population who are high earners will also have high income in retirement.

In general, having high income in retirement is a result of poor planning.  You worked too long and over-saved.

By that weird logic (!) all the CEO's, Directors, Doctors, Surgeons, Chief Scientists, Entrepreneurs, High Skilled Engineers etc etc all are horrible planners and just dumb as a rock. Next time a doctor treats or operates on your kids /parents, yourself tell them how pathetic they are....... Its absolutely unreal that this posters' mindset still exists.

[Buffaloski Boris]

It would be even better if pensions were still a thing. 401(k)s were a convenient way for employers to ditch pensions and go to a defined contributions plan instead. 

The problem of a pension is, you have to guarantee something. If you need a guaranteed return from a financial institution, it will suck.
That's why all private options in Germany suck.

I don't get why people view pensions so favorably.

1. They require that people work for the same company for their whole career. Very few people do that anymore. In many cases, the only way to get a raise is to change jobs. That'll be even more likely when the current employer can hold a pension over people's heads.

2. Why would people want to put their future in the hands of their employer instead of controlling it themselves? Look at all of these companies and state governments whose pensions are wildly underfunded. A lot of companies have had to freeze payments or even reduce them.

For people posting on the MMM forums, pensions are suboptimal.  We are a small subset of the population. "Normal" in the US is up to your butt in debt, and with negligible retirement savings.  Pensions aren't a great alternative but they are better than relying solely on social security which is what most people have.

[DadJokes]

It would be even better if pensions were still a thing. 401(k)s were a convenient way for employers to ditch pensions and go to a defined contributions plan instead. 

The problem of a pension is, you have to guarantee something. If you need a guaranteed return from a financial institution, it will suck.
That's why all private options in Germany suck.

I don't get why people view pensions so favorably.

1. They require that people work for the same company for their whole career. Very few people do that anymore. In many cases, the only way to get a raise is to change jobs. That'll be even more likely when the current employer can hold a pension over people's heads.

2. Why would people want to put their future in the hands of their employer instead of controlling it themselves? Look at all of these companies and state governments whose pensions are wildly underfunded. A lot of companies have had to freeze payments or even reduce them.

For people posting on the MMM forums, pensions are suboptimal.  We are a small subset of the population. "Normal" in the US is up to your butt in debt, and with negligible retirement savings.  Pensions aren't a great alternative but they are better than relying solely on social security which is what most people have.

That still doesn't address either of the issues with pensions that I noted. Even if some people aren't willing to save for themselves, that doesn't make pensions ideal. Automatically opting new employees into putting 5-10% of their paycheck in the 401(k) is a much better option to address that issue.

[rab-bit]

It would be even better if pensions were still a thing. 401(k)s were a convenient way for employers to ditch pensions and go to a defined contributions plan instead. 

The problem of a pension is, you have to guarantee something. If you need a guaranteed return from a financial institution, it will suck.
That's why all private options in Germany suck.

I don't get why people view pensions so favorably.

1. They require that people work for the same company for their whole career. Very few people do that anymore. In many cases, the only way to get a raise is to change jobs. That'll be even more likely when the current employer can hold a pension over people's heads.

2. Why would people want to put their future in the hands of their employer instead of controlling it themselves? Look at all of these companies and state governments whose pensions are wildly underfunded. A lot of companies have had to freeze payments or even reduce them.

3. Pensions can often (at least partially) be left to spouses after the death of the pensioner but are then gone,  while any unused 401k and IRA balances can be left to children, charities, etc.

[friedmmj]

The article makes a good point for lower income workers.  People who are making higher incomes still benefit tremendously from pre-tax 401k investing.

No, a family of four with lower income is likely eligible for EITC, and contributions to a traditional 401k can increase the EITC amount considerably.  The phaseout rate is 21% for 2 children, and my state matches EITC at 30%, an additional 6.3% phaseout rate, for a minimum marginal rate of 27.3% (before any tax reduction at all).  Contributions to a tIRA are not equivalent for EITC, because they reduce only AGI, not w2 wages (as 401k contributions do), and EITC is tested on both.  Lower income families with children should contribute to 401k, and then use the refundable credits from EITC & CTC to fund Roth IRAs for greater retirement savings.

Great point.  I was thinking of folks in the middle or slighly above who are making maybe 50-100k.  For them, the article is more valid.  But you raise a really great point about folks who are EITC eligible due to their lower incomes.  For them, it makes sense as long as they have their basic necessities covered with remaining take home pay.

[friedmmj]

I like the article.  I feel like I am constantly explaining to clients that 401k contributions are only a deferral of taxes.  Their benefits are greatly exaggerated.  They probably give the most benefit to mustachians, who have high earnings and then low income in retirement.  Most people in the general population who are high earners will also have high income in retirement.

In general, having high income in retirement is a result of poor planning.  You worked too long and over-saved.

By that weird logic (!) all the CEO's, Directors, Doctors, Surgeons, Chief Scientists, Entrepreneurs, High Skilled Engineers etc etc all are horrible planners and just dumb as a rock. Next time a doctor treats or operates on your kids /parents, yourself tell them how pathetic they are....... Its absolutely unreal that this posters' mindset still exists.

OK, I was making the point that if you are only going to spend modesly amount in retirement then you don't need to accumulate such a huge retirement savings stash that would put you into a high income tax bracket in retirement.  On the other hand, if you're going to live large in retirement then you shouldn't care about paying taxes because you can easily afford it. It's amazing how much energy these high rollers spend on avoiding taxes or worrying about taxes.

[LetItGrow]

I like the article.  I feel like I am constantly explaining to clients that 401k contributions are only a deferral of taxes.  Their benefits are greatly exaggerated.  They probably give the most benefit to mustachians, who have high earnings and then low income in retirement.  Most people in the general population who are high earners will also have high income in retirement.

In general, having high income in retirement is a result of poor planning.  You worked too long and over-saved.

By that weird logic (!) all the CEO's, Directors, Doctors, Surgeons, Chief Scientists, Entrepreneurs, High Skilled Engineers etc etc all are horrible planners and just dumb as a rock. Next time a doctor treats or operates on your kids /parents, yourself tell them how pathetic they are....... Its absolutely unreal that this posters' mindset still exists.

OK, I was making the point that if you are only going to spend modesly amount in retirement then you don't need to accumulate such a huge retirement savings stash that would put you into a high income tax bracket in retirement.  On the other hand, if you're going to live large in retirement then you shouldn't care about paying taxes because you can easily afford it. It's amazing how much energy these high rollers spend on avoiding taxes or worrying about taxes.

I struggle a bit sometimes because I feel I could be doing more to lower taxes later. Then I think, it’s just some taxes, been paying them all along, should be fine. And I know there is some low hanging fruit.

[ender]

I struggle a bit sometimes because I feel I could be doing more to lower taxes later. Then I think, it’s just some taxes, been paying them all along, should be fine. And I know there is some low hanging fruit.

I've always considered that if I end up paying a ton of taxes later, by prioritizing pretax retirement now, it means one of these happened:

• I considerably oversaved
• Tax code changed enough to completely screw over lowish income earners (since my retirement income will likely need to at most be median household income)
• The government added a wealth tax on low wealth individuals with most of it in retirement
• Rules regarding IRA/401ks change dramatically

Honestly, #2-4 really only seem concerning if #1 happens too. But they are possibilities still.

[moof]

Last dollar principle applies.  So every 401k dollar saved would have been taxed at your full current tax bracket (or more if you would have been just above the line).  Most of your withdrawals will be at a low tax bracket, and perhaps if investments allow you to live large some of the withdrawals will edge into the higher brackets, a problem I would love to have.

For those of us who also have high state income tax it holds open the option to shop around for a better deal.  I currently have a 22% federal and 9% state rate, so I would need to be expecting to pay a higher tax bracket than 31% for a modest lifestyle for it to make sense to funnel any my 401k to Roth dollars.  That would be a huge shift from an expected 12% bracket with an effective rate down around 5-15% depending on if we change states.

[teen persuasion]

The article makes a good point for lower income workers.  People who are making higher incomes still benefit tremendously from pre-tax 401k investing.

No, a family of four with lower income is likely eligible for EITC, and contributions to a traditional 401k can increase the EITC amount considerably.  The phaseout rate is 21% for 2 children, and my state matches EITC at 30%, an additional 6.3% phaseout rate, for a minimum marginal rate of 27.3% (before any tax reduction at all).  Contributions to a tIRA are not equivalent for EITC, because they reduce only AGI, not w2 wages (as 401k contributions do), and EITC is tested on both.  Lower income families with children should contribute to 401k, and then use the refundable credits from EITC & CTC to fund Roth IRAs for greater retirement savings.

Great point.  I was thinking of folks in the middle or slighly above who are making maybe 50-100k.  For them, the article is more valid.  But you raise a really great point about folks who are EITC eligible due to their lower incomes.  For them, it makes sense as long as they have their basic necessities covered with remaining take home pay.

Contributing to traditional 401k or SIMPLE IRA and HSA gets us down from $75k combined  to well into EITC refund territory.  We can make ourselves *look* lower income for both taxes and FAFSA for financial aid.

That EITC has a 21% phaseout rate.  Our state matches EITC at 30%, essentially another 6.3% phaseout rate.  Add on our state and federal tax brackets, and the marginal rate on 401k, etc, contributions is easily 45+% in the 12% bracket where most would say to go all Roth.  Those refundable credits are valuable, and often ride along with related nonrefundable credits (have kids to be eligible for larger EITC, also have CTC under 17 with $600 nonrefundable or CTC over 17 with $500 nonrefundable; AOTC, 60% nonrefundable; Retirement Saver's credit up to $2k, due to reduced AGI).  We waste thousands in nonrefundable credits we can't use, annually.  Drives me crazy - if I tried to use them for Roth conversions, they either dry up (RSC as AGI increases, same for EITC) or hurt in other ways (FAFSA increased EFC cuts financial aid). 

It's definitely more beneficial for us to get refundable credits as large as possible, and use those for more retirement savings (Roth IRAs - no further tax advantage to be gleaned).  We won't begin serious Roth conversions until EITC eligibility goes away with dependents, the cost is too great.

[The_Big_H]

It would be even better if pensions were still a thing. 401(k)s were a convenient way for employers to ditch pensions and go to a defined contributions plan instead. 

The problem of a pension is, you have to guarantee something. If you need a guaranteed return from a financial institution, it will suck.
That's why all private options in Germany suck.

I don't get why people view pensions so favorably.

1. They require that people work for the same company for their whole career. Very few people do that anymore. In many cases, the only way to get a raise is to change jobs. That'll be even more likely when the current employer can hold a pension over people's heads.

2. Why would people want to put their future in the hands of their employer instead of controlling it themselves? Look at all of these companies and state governments whose pensions are wildly underfunded. A lot of companies have had to freeze payments or even reduce them.

For people posting on the MMM forums, pensions are suboptimal.  We are a small subset of the population. "Normal" in the US is up to your butt in debt, and with negligible retirement savings.  Pensions aren't a great alternative but they are better than relying solely on social security which is what most people have.

Social security also SUCKS for FIREers.  I know good and well I could make a whole lot more with another 12.4% into index funds than what it will pay out.
That being said, "I'm okay with it" since it prevents a whole lot of very financially illiterate people from starving in old age.



One other great benefit to 401k.... Protected from bankruptcy and hidden from many calculations of your ability to pay (FAFSA)
 (if we ever had a wealth tax, tax advantaged accounts would likely be excluded)

[dresden]

The article should have done more to educate on Roth 401k, Roth IRA, post-tax 401k contributions along future with rollover options to a Roth IRA with those post-tax contributions, rolling over regular 401k contributions to a Roth IRA, etc.

At least from my volunteer tax return work it seems there is a much bigger problem with seniors not having enough savings vs. getting burned by saving too much in a 401k.

A real simple fix would be to exclude the first 10-15k or so of 401k withdrawels from the social security taxability formula (but still fully included in taxable income).  The tax isn't the problem so much as the near double taxation you get because it makes your social security taxable.

The article should have mentioned the importance of lowering your expense load in retirement so you can withdraw less.  For example, a paid-for house reduces the need to withdraw significantly.