The 401(k) plan has many benefits and restrictions. Currently, due to the crisis from the coronavirus, Congress has waived some of the penalties, and increased the loan amount— along with altering other provisions.
“For 2020, pension investment losses could be nearing $1 trillion, according to Moody’s analyst Thomas Aaron. He said this year’s losses will significantly compound the underfunded liabilities currently measured by most public pension funds.
Meanwhile, the economic fallout from the coronavirus is weighing on revenue and threatening to keep government agencies from affording their soaring pension costs. He said the credit impact of the 2020 pension investment losses will depend on a variety of factors. Some of those factors include the severity of the asset declines, each government’s funding and cash flow position, and each agency’s ability to absorb cost increases in their budgets.
If the markets do not bounce back dramatically in 2020, he expects pension investment losses to soar so high that many state and local governments will see damage to their credit quality. Such damage may be due to already heightened pension liabilities and having less capacity to defer costs.“
After one graduates from college, on average, the new graduate has accumulated approximately $30,000 in debt…upon completion of undergrad. At this point, he begins to pay down his student loans. A thought experiment: What would happen if the student could pay towards his investments with those funds used to deal with the student loan debt? Read more here:
This video takes an interesting take on some of the risks associated with the 401(k) plan. Although the video is over 10 years old, and it was filmed during the last major market correction(circa 2009), the risk factors surrounding the 401(k) plan have not changed.
Some contextual things to consider while watching the video: The 401(k) plan transfers the retirement risk to the employee. In the past, pension plans were the norm, and the employer would manage the retirement risk for the employee. The year of change: 1974. This is the year ERISA(Employee Retirement Income Security Act). The act itself covers many items, but one major outcome from the passing of this legislation is that the retirement risk transferred from employer to employee. Consequently, the rise in the use of defined contribution qualified retirement plans increased. Some examples of Defined contribution plans are, viz: 401(k), IRA, Roth IRA, and many more. Along this same time, the rise in popularity of mutual funds correlated with the increasing use of 401(k) plans and other defined contribution plans. All of these factors push the risk to the employee, but the employee lacks the control over his funds.
An excerpt: “As money loses its purchasing power, income and wealth are stealthily redistributed. Some individuals and groups of people are enriched at the expense of others. Savers and workers are swindled out of their deserved income and retirement benefits, while those who own goods that rise in value or who borrow money typically reap a windfall profit. Clearly, the banking industry is a major beneficiary of monetary debasement.”
Here is a way to translate this: If you are saving your way to retirement, it’s a highly risky project employing the commonly used strategies to save for retirement. As the units of fiat currency are devalued, with loose monetary policy, it requires more units of currency to purchase goods and services—the prices of those goods seem higher, thanks to the devaluation of the monetary base. In the article, Dr. Polleit breaks down the illusion that the stock market can “beat inflation”. This is false, as rising stock prices are an indicator of inflation, and the true prices of stock are not as high as it seems.
On top of all of this, many Americans are saving for retirement using qualified plan vehicles, such as 401(k) plans. The investments used inside of these plans used to “save” for retirement are typically as follows: Mutual funds, stocks, and the like. The appeal of these vehicles are obvious: All contributions, for the current tax year into the 401(k) type plan, are tax deductible or done Pre tax from payroll deduction. Upon retirement, after 59 1/2, the owner of this plan begins to withdraw the funds, and will be taxed earned income tax on ALL funds. Yes, the original principle AND the gains are taxed. In short, the upward pressure on stock prices, thanks to inflation, benefit the IRS since the funds will be taxed at retirement.
The financial institutions also benefit from the inflation, as equity prices are pushed upwards; this yields higher commissions, higher valuations for assets under management, and higher profits. Consider this: With these investments, all the risk is transferred to the investor, who has little or no control on the investments inside his qualified retirement account, but has the tax burden.
Good luck living off that money during retirement..
Yes, you read that correctly. Well, let’s be more precise: Per the survey done by GObanking Rates, 69% of Americans have less than $1,000 in savings. Erratum: My title has 70%, so I’m sure that 1% makes a huge statistical difference for some. This survey has been done each by this organization since 2014, and for the 2019 survey, it contains 846 respondents.
An argument can be made that they only polled 846 individuals. Fair point. But, I would not be surprised if more respondents were polled, the percentage would not change. There is a myriad of reasons why, but I will mention some here.
50 Percent of Americans Earn $33,000 per year or Less
I recently reported that 50% of Americans earn $33,000 per year or less. This analysis was provided by the United States Social Security Administration. Yep, that is correct: $2,750 per month. This amount is before taxes. Consider housing, food, transportation, child care, and etc, as the expenditures eat into the gross/net income. Since this is the case, it makes it difficult to save money due to the next point…
Rising Cost of Living aka Inflation
The issue of the rising cost of living, specifically for those earning less than $33,000 per year, makes it increasingly difficult to develop any sort of savings. The core issue of the increased cost of living is due to inflationary measures. If you have read the articles on this page, the issues surrounding inflation are constantly addressed. Inflation is not the rise in prices, although the economic actor will see prices rise. When The Federal Reserve continues with loose monetary policy, the winners are the large financial institutions, the cost of inflation is paid by those who earn less than $33,000 per year.
As the dollar is devalued based upon the implementation of loose monetary policy by The Fed, it takes more dollars to buy the goods these people want and need— giving the illusion that prices are actually rising. Due to this economic phenomenon, people in this economic income segment have almost no savings to cover for emergencies. When those emergencies come, these individuals must lean on credit to cover these unforeseen expenses. Once the crisis has ended, the user is stuck with a credit card balance, as this adds to their monthly expenses—these expenditures are currently very close to their income. At this point, many can not continue to pay the regular expenses, and the mounting credit card debt. What happens next? The credit card is defaulted.
Credit Card Default Rates Rising
Due to the lack of income, coupled with the lack of savings, it is no shocker that credit card default rates are on the rise. To be specific, the credit card default rates are on the rise for sub prime borrowers. This trend isn’t exclusive to just credit cards, it is also expanded to other sub prime lending sources such as pay day loans, auto loans, and the like. As previously mentioned, these types of credit are used to help cover the income gap in expenses or cover emergencies. Another source will be for medical expenses as well, due to the rising prices of health care.
At the time of this writing, political pundits will remark how fine the economic metrics look, namely how unemployment is so low. Kudos. Yet, there signs of things that could lead to a market correction, namely in the capital markets. Some of the prime reasons, in my opinion, is based upon Americans not having enough in savings, and the central banks pumping more currency into the banking system. However, since we are living in a consumption based economy(meaning consumption now versus later), there is very little incentive to save..thanks to inflation.
In this “booming” economy, we are told that jobs are being created, and unemployment is at its lowest levels in decades. Prime facie, this seems true. Consider this: Most Americans earn less than equal to $33,000 per year. This statistic comes directly from the Social Security Administration. Excerpt from the report:
“The “raw” average wage, computed as net compensation divided by the number of wage earners, is $8,383,540,628,515.51 divided by 167,669,326, or $50,000.44. Based on data in the table below, about 67.4 percent of wage earners had net compensation less than or equal to the $50,000.44 raw average wage. By definition, 50 percent of wage earners had net compensation less than or equal to the medianwage, which is estimated to be $32,838.05 for 2018. “raw” average wage, computed as net compensation divided by the number of wage earners, is $8,383,540,628,515.51 divided by 167,669,326, or $50,000.44. Based on data in the table below, about 67.4 percent of wage earners had net compensation less than or equal to the $50,000.44 raw average wage. By definition, 50 percent of wage earners had net compensation less than or equal to the median wage, which is estimated to be $32,838.05 for 2018.”
All that means is this: 50 % of United States citizens earn up $634.62 per week, or less, before taxes. It makes sense why people are extending themselves on credit; the subprime auto lending is expanding, while loan defaults are on the rise. With all the macroeconomic issues, e.g. The Fed printing more money and The Government spending spiraling up to new heights, I wish you good luck saving for retirement.
An interesting take on retirement planning for “poor” people. In my view, people should not be “pushed” to save for retirement. When the concept of “pushed” is used here, by me, it refers to by some sort of Government mandate. Should retirement planning be encouraged. Yes, indeed…even for the poor. The key, especially in this economic environment, is not really trying to “save” for retirement, yet increase your cash flow. Saving in this environment is highly risky, since current monetary and fiscal policies are deleterious to savers.
Here is the excerpt from the article:
“It’s a fact: low-wage workers don’t save much for retirement. States are aiming to fix that. But here’s a question: is it really a problem that needs to be fixed? How hard should we push the poor to save for retirement?
Bureau of Labor Statistics data show that 75% of workers in the upper half of the salary distribution — those who earn at least $36,000 on a full-time basis — participate in a retirement plan. Among workers in the bottom quarter of the wage distribution, with average salaries of about $24,000 per year, only 25% participate. That’s a big difference.”
A random thought entered my mind…well not so random. The IRS recently published the marginal income tax rates for 2020.( Yes, I posted them..go here: http://taxfoundation.org/2020-tax-brackets/) Which is good news….for now. With all the other macroeconomic issues, (e.g. growing US deficit, the exponentially expanding US Government Debt, and extremely low interest rates), Financial experts are advising their clients to plow more money into tax deferred retirement vehicles: Most know these cast of characters, 401(k), IRA, and etc. While there is nothing wrong with this advice, per se, but consider the fact that with all those aforementioned macroeconomic issues, is it safe to assume that marginal income tax rates will be higher in the future? Even they are the same, the future retiree will have fewer deductions to offset the tax liability once they begin to draw down the funds from their retirement plans.
If rates are higher, then the accumulated funds will be taxed at a higher rate, as the funds are withdrawn at retirement. Does this mean one should not contribute to their current tax deferred plan? No, not really. It really depends on the person. However, it would be prudent to have some sort of program that provides an income that is tax free or very close to being tax free income. I’m betting tax rates will increase at retirement age, and many people will live longer. If my bet is correct, having a tax free income stream, at retirement, should be a top priority. A thought to consider.