(The following is an edited excerpt from my new book, The Smartest 401(k) Book You'll Ever Read, used by permission, Perigee Books/Penguin Group [USA] Inc.).
With 401(k) assets plunging as the markets continue their downward spiral, employees are looking at their 401(k) statements with a sense of dread. Few, however, challenge the conventional wisdom that investing in these plans is a "no brainer" because of the employer match.
I agree with most advisors who believe the corporate match of a 401(k) and 403(b) plan is too good to pass up. Investors probably should contribute to these plans - at least the minimum amount necessary to obtain the maximum employer match. However, I'm more concerned than most about future developments that could make any investment in retirement plans a bad choice.
I don't know about you, but I find the government to be pretty scary. Recent events have demonstrated that it has very broad power to have a serious impact on our rights.
The possibility of retroactive legislation that could sharply reduce, or even eliminate, the benefits of current retirement planning cannot be discounted. The ability of the government to pass retroactive tax legislation going back as much as ten years has been sanctioned by the Supreme Court, which has referred to this disturbing conduct as "customary practice."
Don't take my word for it. In its brief to the Supreme Court supporting the power of the government to take away your money retroactively, the Justice Department had this chilling observation: "The taxpayer must be prepared for such possibilities."
Are you prepared for the possibility that the government could retroactively impose a new tax on distributions from your retirement accounts? It could happen. If it does, it could seriously erode the benefits of participating in these plans.
In addition, looming darkly over your retirement planning horizon is the uncertainty of the ordinary income tax rate at your retirement. It cannot be predicted or quantified. What we do know is that by investing in a tax-deferred plan you have surrendered your right to be taxed at the historically more favorable long term capital gains rate.
Even if tax rates stay the same, it's by no means a foregone conclusion that your post-retirement tax rate will be lower than your pre-retirement rate. Here are some variables that could adversely affect your tax rate:
You are likely to be single at some point in retirement. If so, your status as a single filer could put you in a higher bracket.
You may decide to work in retirement, to supplement your income or just because you may find it satisfying to do so.
You may not have the same tax breaks in retirement that you presently have -- like your deduction for mortgage payments.
When you add to these potential problems the lack of liquidity of retirement plans, the limited and often poor choice of investment options available to plan participants, and the high fees buried in these plans, you begin to question the unbridled enthusiasm of financial planners and the financial media for investing in these plans.
I fully understand the hype. These plans are great for employers, for the mutual fund and insurance industries, for brokers and for annuity salesmen.
There are ways to maximize your retirement savings within these plans. I discuss them in my book. If Congress served the needs of its constituents, instead of the powerful lobbyists for the securities and insurance industries, it could easily legislate the changes that would provide much needed disclosure and protection to plan participants. Nothing would make me happier than to make books like mine unnecessary.
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