Meridian Magazine : : Money Wise : : 401k

The 401(k): A Type and Shadow of Our Mortal Experience?
by Richard P. Halverson

Could the popular 401(k) retirement savings program be a type and shadow of our entire mortal experience? Well, there are some interesting points to compare.

In the last installment I tried to illustrate that the 401(k) retirement program is the most effective means of saving money for retirement ever devised in this country. You do not need to be covered. You can make a conscious decision to work for an employer who does not offer a program. Once you are covered by a 401(k) program, it is still up to you to use your own financial agency to save in a manner consistent with long term financial happiness. If you do, you will get a lot of help from outside sources. First, you will get help from your company in the form of communication, professional management and administration. And most important - many companies will match a portion of what you save. Then the government helps out in its own way. They will allow you to save this money without paying tax on it first. And the money can grow and earn interest without being subject to tax. Between your company and the government, they contribute substantially to your own best efforts. One of the interesting things about this outside help is that you are hardly aware of it being given. If you are paying attention, you simply notice your financial account growing. All of this requires what some feel is sacrifice in the short run to achieve a good goal in the future.

Mortality is a little like a 401(k) program. I make this comparison because most of us know the plan of salvation better than the plan of retirement, and I want to help you understand the latter.

The plan of salvation is the best plan for eternal progression ever devised. You did not need to be covered. You only needed to make a conscious decision to accept it in the pre-existence. Those who did not are no longer in the program. Once you are in mortality, it is still up to you to use your own moral agency to live in a manner consistent with long term spiritual happiness. If you do, you will get a lot of help from outside sources. That outside help comes directly from deity in the form of blessings, salvation and exaltation. One of the interesting things about this outside help is that you are hardly aware of it being given. If you are paying attention, you simply notice your spiritual account growing. All of this requires what some feel is sacrifice in the short run to achieve a good goal in the long future.

Both programs, however, are controversial with some people. They are controversial because both involve risk. Both require the individual to do something in order to receive the full advantage of the program. If the individual is slothful and does not do it well, that person will have a bad long term result. In the pre-existence Lucifer made such a point of that risk that 1/3 followed him. Here there are about 1/3 do not participate in the 401(k) programs available to them. I don't want to suggest that it is Satan who is talking them out of it. But there are those who argue that some how it's not fair and the program should be changed so everyone must participate.

Before I torture this analogy further I want to state clearly that the Lord's Plan of Salvation, of which mortality is a key element, is a perfect plan. Nothing ever conceived by man begins to compare - certainly not the 401(k).

So where are the problems associated with the 401(k)?

PARTICIPATION

Participation is voluntary. Unfortunately, the statistics show less than a majority of workers take full advantage of their 401(k)'s and over one-third do not participate at all. These under participants tend to be the lower paid employees who will need this benefit the most in the future. There are many reasons for poor participation.

• Some people feel they can not afford to save. I know this sounds short sighted. But when you are living from paycheck to paycheck and using your credit card to bridge the long weekends your financial horizon is pretty short.

• Some never get around to it. Retirement seems far away, and it is hard to see any urgency to do anything now.

• Some are intimidated by all the decisions they personally have to make. They have to decide how much to have withheld from their pay. Then they have to decide what investments to make. It can feel very confusing.

• Some simply believe the amount they can put it in is so small it won't add up to anything anyway, so why bother?

The problem is that all these people will eventually grow old and retire, whether they have saved or not. If they have not saved anything, they will be financially destitute. Many politicians worry about that. They see this as a big problem in the 401(k) program. This is a generous nation. People aren't likely to look at a group of destitute retirees and coldly say, "It is their own fault." Instead, politicians will likely make up the difference by raising taxes on those who were wise enough to save.

INVESTMENT DECISIONS

The 401(k) requires the employee to make his/her own investment decisions. Most companies try to help by offering communication about the investment choices. But the company will not make the choice for them. There is no guarantee the employee will do it wisely. Consequently, there is a risk that the employee will lose money. Consider a case where an employee basically left his 401(k) parked in money market funds for several years earning only a modest rate of interest. Then, last year, envious of fellow employees who had been piling up big gains in the growth stock option of the 401(k), he switched his entire $87,000 in January. The growth stock option has done poorly this year and his $87,000 is now worth $67,800 and sinking. Of course, he is trying to decide if he should switch back to something safe. Enough decisions like this, and he'll retire with nothing.

Related to this has been the stock market in general. 401(k)'s began being very popular about 15 - 18 years ago. Since that time the stock market has turned in spectacular returns. Some analysts believe 401(k)'s have helped fuel that great performance. But stock market cycles have not been outlawed. Many analysts wonder what will happen when we get into a long bear market and 401(k) participants see their values decline for several years. Thus far the 401(k) investors have in general been more disciplined than many so called professional investors during the brief setbacks we have experienced. It will be interesting to see what will happen in the future.

THE ONLY RETIREMENT PLAN AT MANY COMPANIES

A 401(k) is the only retirement plan offered by many companies. This is particularly true of younger companies. Some companies have eliminated other retirement plans in favor of 401(k)'s. More established blue chip companies often provide more traditional fixed benefit pension plans and profit sharing plans in addition to a 401(k). Which plans are best for the individual is a very complex issue and I'll spare you the details. There is no easy answer. But the advantage of the pension and profit sharing plans is that the employee doesn't have to do anything. If the employee works long enough, he/she receives a retirement benefit. The company does it all. This substantially eliminates the fears expressed above that people will fail to participate or invest badly and arrive at retirement with nothing. Sound familiar? See some people like these?

Related to the topic of employer discretion is the fact that each employer can tailor the program as it likes. Differing matches, differing vesting, differing investments, differing communications and on can make programs hard to understand. Certainly some 401(k) programs are better than others are.

PORTABILITY AND EARLY WITHDRAWAL

This should be one of the great benefits of a 401(k). But as in all things there is an opposite side. Employees tend to move around in our mobile society. With traditional retirement plans there is often a huge loss of benefits associated with leaving the company. Usually you can not take much of a defined benefit pension plan with you from one company to another. With the 401(k) you can usually take all of it with you. The law allows you to roll your money into another 401(k) plan or into an IRA. In this way you preserve all the tax advantages associated with the plan.

Unfortunately, perhaps, the law also allows you to simply take the money and spend it. This is almost always a terrible decision. Regrettably, a large number of people do it. Few financial decisions could be more short sighted. If the money is withdrawn early, the employee is required to pay tax on the full amount plus a 10% penalty! And remember the full tax means the 401(k) will be taxed at the employee's highest marginal tax rate. Assume the employee fails to roll over $50,000 of 401(k) money when he/she changes jobs. Assume this employee is in a 35% marginal tax bracket. The employee will be required to pay $17,500 in taxes. Then the government will impose an additional 10% penalty bringing the total bite to $22,500. Suddenly the employee is left with only $27,500 out of the original $50,000. And to make matters much worse, the employee will almost certainly spend the $27,500. Often it gets spent for a car, furniture, or even a vacation. So, instead of being left in a plan to grow to say $100,000 by retirement, this employee will have $0 and an old sofa at retirement. Even if your balance is only a fraction of $50,000 the math works the same way. Resist the temptation to take the money and spend it.

Incidentally, I am sure none of the readers of Meridian would ever think of simply taking the money and then choosing not to report it hoping the IRS will never notice. Don't. Their computers are set up to scan for this. They probably will catch you, and then you will have even more penalties and interest to pay.

LOANS

One of the interesting and unusual features of the 401(k) law is that it allows the participant to borrow his/her money from the account. Whether borrowing your own money is a good idea or not depends on a lot of variables. First, whether your program offers the feature or not is up to your employer. Many companies do not want to bother with all the hassles and regulations imposed on them if you borrow money from a retirement plan they are sponsoring. If your company does allow the feature in your plan, you are likely to find it is very restrictive. The amount, the purposes, the interest rate and other terms will all be very limited. After all, your human resources department is not a bank.

Even if you are able to borrow your money it still may not be a good idea.

• First, you will need to pay it back. It is not like taking money out of your savings account. It is a real loan and a loan made from a government qualified employee retirement program. The company will certainly require that your payments be made through payroll deduction. That may be good or bad for you.

• Second, you probably will have no ability to prepay the loan if you want. The company's computer systems probably can not handle that flexibility.

• Third, if you leave the company for any reason before your loan is repaid, the entire amount is due and payable immediately. This may hit you at a very awkward time financially.

• Fourth, if you can not repay the loan when you leave the company or at any other time, the IRS will consider the unpaid balance a premature withdrawal. As discussed above you really do not want to trigger a premature withdrawal.

• Fifth, the rate of interest you pay on the loan may be attractive to you from a borrower's point of view, but it may be lousy from an investor's point of view. In this case you are both. Your loan is now an investment in your 401(k). That may feel good in the short run, but if you forego the possibility of higher returning investments in your account to invest in your own loan, you may pay the price in retirement and with compounding. (Incidentally, this last argument makes a lot of sense to financial planners, but I've never seen it make any sense to anyone who felt they had an immediate need for a loan.)

• Finally, the money is yours. True, the government does have some restrictions on when you can start taking it, and when you finally must withdraw it all. However, owning the money means you have a lot more flexibility on all these issues than say a defined benefit pension plan. And you can leave it to your kids or some favorite cause if you are fortunate enough to have more money than you need in retirement. Now there shouldn't be any problems at all with the ability to leave it in your estate. And there won't be if you have also taken care of your will and other related issues properly. If not, your 401(k) could become a contentious issue to your heirs.

There actually are politicians and policy makers who believe programs like the 401(k) are a bad idea. They think there is too much individual agency, which means too much individual risk. They think, correctly, some people will not do well. They think it costs the government too much in uncollected taxes and believe it would be better if the government took the money and then decided how best to use it for everyone. If you think I am exaggerating at all, I invite you to listen carefully to the debate in this presidential campaign about the future of social security. It is the same issue.

I do not mean to take any political sides in this column but I will say again, I believe the 401(k) is the best retirement program available. I observe that it does involve risk. I also observe that mortality involves risk and I know that is part of a perfect plan. It has been said, you are going to spend eternity somewhere. How happy you will be in eternity depends a lot on the decisions you make in mortality. Perhaps it can also be said, you are going to spend retirement somewhere (hopefully). How happy you will be in retirement depends a lot on how you handle your 401(k) decisions.

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