E128: How to Know if Investing in a 401K is Best For You

In this episode, we discuss is a 401k worth it? Learn how you can determine whether or not it makes sense for you to invest in a 401k. This speaks to the more common question people have of, “What should I be doing with my money?”

Not everyone is the same or in the same place. It can make sense for some people to put money in it, whereas other people should really steer clear from it. So, today, we provide simple ways to make the best investment decision for you and your family.

Topics Discussed:

  • How to tell if a 401k is right for you
  • When should you stop contributing to a 401k
  • Considering future taxation and the probability of rates going up
  • What to know and think about when it comes to matching
  • The fees to be aware of and watch out for
  • How to factor age into your decision matrix
  • Is a 401k worth it

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Transcript: How to Know if Investing in a 401K is – Is a 401k worth it?

Nate: In this episode, we discuss how you can determine whether or not it makes sense for you to invest in a 401k. Is a 401k worth it? She’s Holly, and she helps people find financial freedom.

Holly: He’s Nate. He makes sense out of money. This is Dollars and Nonsense. If you follow the herd, you will be slaughtered.

Nate: All right, well, today we’re going to dive in and answer a question that is probably one of the most common questions we get when people are meeting with us and figuring out what should I be doing with money? What should I be doing with it? And if you are an employee or even an employer of a small business, many times a 401k will come up in the conversation. And a lot of times we get asked, “Nate, should I be putting money in a 401k? How do I tell if a 401k is right for me? How do I tell if I should stop making contributions to it, and instead do something else, whether that’s infinite banking, whether that’s investing in X, Y, Z?”

So we really wanted to shoot this podcast and just have a discussion, questions you could ask yourself that would help you determine whether or not it’s right for you. Because not everyone is the same, Holly. Not everyone is in the same place. So it can make sense for some people to put money in it, whereas other people should really steer clear from it.

Holly: And I think it’s important that you be willing to ask the questions before you just jump in and do something. Nate and I have always said you should do your research in why you want to do it and why you’re doing this. So just because everybody is, remember, stop and ask yourself these questions. And if you are contributing to a 401k, it’s so important to ask these questions, to ask if you should still be contributing to that 401k.

Nate: Yeah, I think a lot of people may think that we are just very much against 401ks. And I would say, that’s not just because we want to be against 401ks, we’ve asked ourselves these same types of questions and made decisions based on that. And I think if you’ve met with us, you know that we don’t offer the same advice to everybody. Not everyone gets the same exact advice. Every person is unique. Every person’s financial situation is unique and what they want their money to do is unique. Not everyone has the same goal. I think we’ve talked about that many times on this podcast that not everybody’s goal is the same with money. And so when goals are not the same, the pathway to achieve a goal has to be different if the goal is different. So 401ks may be actually a good fit for certain individuals, but I guess you would say, Holly, we both probably agree you that for the vast majority of people, there’s better alternatives, but that doesn’t mean that that’s the case across the board. So I guess we could dive in.

Holly: Yes.

Nate: The first question I feel like most people will need to ask when they’re dealing with a 401k or when they’re dealing with any sort of tax-deferred program, a program where I make contributions and I don’t pay taxes on my contributions the year I make the contribution, but sometime in the nebulous future when I take money out of that program, I have to pay taxes on any distributions I make. So a 401k fits that bill. So the first question we should all be asking with those types of programs is what do I think is going to happen to tax rates in the future? Will I be in a lower tax bracket in the future or will I be in a higher tax bracket in the future? And depending on your answer, what you believe is going to happen, that should really push your decision, make a big part of the decision to participate in a program like this.

Holly: And you can make it even simpler, Nate, not even do you believe that you’re going to be in the lower tax bracket but I think we have to ask ourselves over time do we think taxes in the same way? Not only are you going to be in the lower tax bracket, but are taxes going to rise. Because you have to remember, it’s a deferred tax. You’re just not paying it today. You’re paying it in the future. And you’re paying also on that growth. So you have to ask what is going to happen in the future. And some of you might truly believe you will be in a lower tax bracket, so it makes sense to go into and do a 401k. Some of you will probably say, “No, I don’t think I’m going to be in a lower tax bracket or taxes are going to rise or increase. So maybe I should make a change.”

Nate: And that’s exactly right. And just because one person answers one way, it does not mean everyone has to answer that way. The only way for you to be in a lower tax bracket in the future, to pay less in taxes in the future is typically you vote people into the government and they decide to lower taxes. Which, I think a lot of people are probably assuming that’s a low probability, especially as the government debt gets larger and larger, as more and more benefits are being added and certain ones are running out of money like Medicare and Social Security, very few people think that true taxes are going to go down. The other way to be in a lower tax bracket is just to be earning less money. But even with that, the older you get, typically a lot of the deductions that you’ve been taking also start to disappear. So what you find is the combination of both.

A lot of people had thought, well in retirement, I won’t be needing as much income so I’ll be in a lower tax bracket, that just doesn’t always pan out. In fact, it’s panning out less and less and it definitely will be panning out less if it’s true that tax rates will go up in the future. You could easily have contributed a lot of money to a 401k in this deferred tax program just to wind up paying a lot more in taxes on the back end than you ever saved during the process of putting it in. So it’s a very important question to ask. Do you think you’ll be in a lower tax bracket, paying less taxes, 30 years down the road, 20 years down the road, whenever you’re coming to distribute money from the 401k? Do you think it’ll be lower taxes then or higher? And your decision will have a huge impact. If you think taxes are going up, you might want to steer clear of the 401k. If you think taxes are going to stay the same or go down, then you’d be more likely to benefit from 401k contribution.

Holly: And then that leads to the next question of if you’re going to do the 401k, what type of match is there? What is taking place in the match? Is there even a match taking place?

Nate: Exactly right. So the only benefit that exists in a 401k, the only real pro that I can find, will be the employer match. If you are working for an employer and they’re offering a match of… Let’s say, you contribute 3% of your salary and the employer will match 3%, then what we found here is that’s a real benefit being offered, this match that is being offered. And so that’s a question you should ask, what kind of match exists? And we’re going to get into a few more questions that clarifies a few things, but I guess what I would tell you right now is there is absolutely no reason, in my opinion, to contribute any money to a 401k above and beyond an amount that’s being matched. And on top of that, the match has got to be pretty good. It can’t be 25 cents on the dollar or something like that, some tiny little match.

It’s got to be a dollar for dollar match, something like that. And if they’re offering a match and you want to contribute, now there’s going to be some qualifying questions you have to ask, just because they’re offering a match, believe it or not, does not mean you should take advantage of it. And that’s what we’re going to get into. But I will say, if the employer’s not offering a match, run away from the 401k. The fees are too high. The risk is too high. The tax deferral risk is too high. There’s just no reason to. But if the employer’s offering a match, now we have a real potential reason to do it, though that is not the end results. We’re going to ask a few more questions, but just note that, hey, yeah, if they’re offering a match then you have a real reason to potentially do it if the match is good enough, but even on top of that, there’s just really no reason to be putting more money in then whatever the employer’s signed to match. That’s my opinion.

Holly: I would say you honestly only want to do it if there is a match and you only want to put in the money, and Nate said this, but you only want to put in whatever they’re matching. You don’t want to put in more than what the match is. There’s so much you could lose and there’s fees, all these things hidden in there that you don’t even realize because most of the time you don’t see that money, it’s just automatically it comes out of your paycheck. So you don’t really see or know that it exists. But in reality, you want to make sure that if you’re going to do this 401k, what is the match and is it beneficial to you as a match?

Nate: Exactly. So if you’re getting a match, it’s possible, makes sense, but anything above a match or if there’s not a match being offered. So that would be for all of you small business owners, whether you’re doing a 401k or a SEP IRA or something like that, there’s no match being offered, it’s just you so I couldn’t imagine putting money into one of those and locking it up where I’m penalized and taking a lot of risk on the money for really no additional benefit. But if you are an employee and you’re getting a match, it might make sense, I don’t think a lot of people understand, within the 401k, it’s typically the highest amount of fees of any sort of stock market investment. So in other words, if you’re going to invest in the stock market and you’re not getting a match on that money, don’t put it in the 401k, put it in the same place you wanted to put it.

In other words, invest in the S&P 500 or wherever your willing to put the money, but just don’t do it through the 401k because the 401ks are notorious for having the highest amount of fees of any sort of investment vehicle, because not only do you have a mutual fund, a management fee, but you also have a 401k plan management fee and it’s hard to figure out what those are. So there’s just no reason to be paying these excess fees by using the 401k instrument when you don’t need to. Because all we’re really after is the match to begin with, and just because offering they’re offering match that doesn’t mean you should do it. And we’re going to talk about a couple more questions that’ll help you narrow it down even further.

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Nate: So I guess the next question that you have to ask, once again, is do you want to participate in the stock market at this time? If you’ve answered the first question about taxes and you’re like, “Okay, yeah, I don’t think taxes are going to go up too crazy. I’ll probably be paying around the same amount of taxes.” Okay. So you went through that thing then you say, “Okay, I’m getting a match,” so now you might be leaning towards doing the 401k, but the next question, you also have to answer a yes to. There’s no reason to throw money into a stock market investment which is almost all of what’s offered in a 401k practically. Everyone is in some sort of mutual fund that mimics some sort of stock market portfolio when they invest in their 401k. And it’s very typical, probably 90% of the people.

So you have to ask the question, do you want to participate in the stock market at this time? Especially in the year 2021 at record highs, on the heels of a pandemic with the Federal Reserve printing money left and right. Are we in the red zone of a bubble? And if you think yeah, we are, then why would you throw a whole bunch of money? Even if you’re getting a match, why would you throw a whole bunch of money into a 401k just to see half of it or more disappear? Now, no one has a crystal ball in this, but I do believe that you should always be doing with money what you believe in. So if you don’t really believe the stock market’s going to do well, or you believe we’re in a bubble, then you should follow that. You shouldn’t just throw it in because everyone else is doing it so I might as well do it.

Holly: You have to ask yourself do you believe also the stock market is risky? Are you willing to lose money as well as gain money? It’s not just the I’m putting the money in and I’m doing really well when the stock market goes up, there’s times when it goes down as well. And so you have to be aware whatever dollar you put in and it’s matched, you could gain money as well as you could lose that money.

Nate: As we’ve said before, the 401k itself, especially in the stock market, the older you get, the more nervous you should be about the risk you’re taking because you don’t have time on your side anymore. So the problem with the 401k, and we’ve talked about this before, is due to it being mainly invested in the stock market, you never really know how much money you’re going to have in the future. You never have any clue because it’s only based on the stock market evaluation. Some people would rather build their life having a lot more control of what’s happening in the money. And if that’s you, if you’re just tired of the ups and downs, feel like you’re never getting anywhere, feel like it’s too much risk to be stomaching because you have no idea what the value’s going to be in the future, I would probably say you’re leaning towards trying to figure out a different way to build wealth that does not participate in the 401k.

Even if there’s a match, it might not make sense. If you’re worried the taxes are going to go up and you’re worried like me that the stock market’s going to come crumbling down at some point, it can’t go up for forever, then suddenly the 401k, even though there might be a match involved, you might be leaning against it.

Holly: And I will say, Nate, on the same hand with the stock market question, I think you have to do your due diligence and research as well. But according to most financial experts and individuals, we’ve already achieved the golden years or golden ages per se of the stock market. And if that’s true, then it’s never going to be as good as it was in the past. So we’re investing in something knowing or what most people of view as it’s already achieved the highest it’s ever going to go or the best performance it’s ever done so do we really want to continue taking that risk in the future knowing that as history has predicted in the past it’s already gotten to where it would be and eventually the bubble pops. It’s got to go down as well as go up.

Nate: And we can talk more about that too, with the baby boomers retiring and having to sell of their assets to live on, it’s starting right now and you can just keep going on and on about some headwinds that every economist is seeing for future growth in the stock market. But then again, you might be listening to this podcast and be like, “I love my stocks. I love the performance that I’ve had and so forth.” And that’s great. That would point you to say, “Yeah, it’s a good tool,” because you’ve made an active decision that it’s doing what you want it to do. That’s actually our last question as well, does the 401k help me achieve my goals? It doesn’t really even matter fully your answers to all the other questions, this is the be all answer that you have to make. Does what the 401k provides for me help me achieve my goals better than another tool?

And a lot of people have just been taught to put money into 401k, they’ve been doing it for a long time and they have never really taken a step back and say, “Okay, what is the 401k providing for me? And what can I do instead if I was to stop contributing there and instead do something different with the money?” And this is really where I believe is the primary focus point for everybody. I’ve talked to a lot of people, they’re wrestling with this question. Should I put money in the 401k? I’m getting this match. Should I do it? And at the end of the day, what they really want is not a typical build up this big giant nest egg in the stock market and at age 65 start liquidating it over time to produce income and just stay at their job.

There’s still some people who are like that and maybe a 401ks good for that but most of the people I speak with are like, “I want to start some moves today in my 20s, my 30s, my 40s, and even in my 50s. I want to start making moves today. I don’t want my money locked up there where I can’t touch it. I want to start using it now. And I want to maybe invest in policies, invest in real estate and do some things that are going to produce passive income and affect my life today, as opposed to just the buy and buy future outlook of a 401k.” Just because there’s a matches it doesn’t mean you should put money in because if it’s not achieving your goals, which could be I want to start a business, I want to be able to buy some rental properties, I want to be able to use this money in policies to get out of debt, all these other goals that you might have, that a 401k will actually hinder your ability to achieve,

Holly: To be able to have access to the money without penalty is important. You have to look at the age that you’re at and say, ‘Do I want to not be able to access this money for X amount of years?” Even in our 40s or 45 or 50, you’re still talking about nine and a half years if I’m 50 years old before I can access this money or use it. And I think the important thing there is that it is your money yet you don’t have access to it to use and is that really what you want in regards to where you’re trying to go and what you’re trying to achieve in your life?

Because in reality, if you answer, “I want to do this, this and this in my life,” and I asked this of a client the other day, what do you want to live on and retire on? And how much are you putting away to achieve that, really? And he was like, “Yes, I’m not doing nearly enough,” but it was never I should go, and I’m going to say throw, but throw the money in the 401k because I’m in my 30s and I want to wait 29 years.

Nate: If the goal in retirement is to produce enough passive income to where you don’t actually have to work anymore, and I don’t like the word retirement, most of our listeners know that.

Holly: I don’t either.

Nate: I don’t think it’s the highest and best goal for building wealth. As far as the end game’ concerned. I don’t think it should be the end all be all of financial planning. And in fact, I think it’s a dangerous idea to have that be such a primary focus in most people’s minds. But I do believe that if that’s part of your goal is retirement income, it just so happens to be that 401ks are just known for not really being that great of income producers. We’ve talked about this before, you can look this up, if you’ve got money in a typical 401k style investment portfolio, the recommended withdrawal rate, in other words, how much money you can withdraw every year or in layman’s terms, how much income you can take out of a 401k, is only around 3% to three and a half percent these days.

In other words, if you build up a million dollars in a 401k, they’re saying that reasonably can only produce 30 to $35,000 of income every year for the rest of your life. That’s how much money you can actually take out. And the reason for that is due to the volatility. They don’t know what’s going to happen. So if you take out too much every year, then a stock market collapse could just totally drain the account and it would not be able to support itself from that point at that withdrawal rate. So all that to say, there’s just things that do so much better at producing higher amounts of income than a 401k. And it happens to be that’s most people’s goal in life. The goal is to be able to produce passive income. So if you do choose to achieve that goal using a 401k you have to at least come into it knowing the end game, with the end game in mind.

If after this podcast you’re still like, “Yeah, I do think it’s a good idea and I do want to continue to contribute at least up to the match,” at least you’ll have made that decision knowing that hey, due to this match I might want a little bit of exposure to the stock market and I’m not totally bought into the taxes are going to go up in the future and so forth, if that’s you, that’s great. You’re welcome to still join us. It’s not like you have to hate 401ks to practice IBC. We got plenty of clients who still contribute. But what I will say is at least we want you to make the decision to contribute to a 401k based on a rational decision that you made looking at the pros and cons and not just because you’ve always has been doing it or because Nate and Holly said don’t do it or whatever it is. Think about it for yourself and make it your own rational, logical decision.

Holly: That’s the key, however you answer these questions, there’s not a right or wrong answer, it’s what you truly believe and what you understand and know. And so if there’s something you don’t honestly know, if you don’t know how to answer do I think taxes are going to go up or down or what’s happened with taxes, do a little research then answer that question. If it’s not about the match but it’s how volatile is the stock market, go and ask those questions or find out for yourself what you know is happening or what they’re telling you is happening, I guess, look at the history of what’s happened and taken place and then answer that question if you don’t know the answer, but there’s not a right or wrong answer with any of the questions Nate and I put out to you, it’s really how you answer it and what you believe. So we’re not against 401ks but we also want you to just ask these questions so you know why you’re doing what you’re doing versus just blindly doing something because you’ve been told it’s a good idea.

Nate: I think that’s right. And a lot of times I get asked, “Well, is it better for me to put money into an infinite banking policy as opposed to putting money in a 401k?” That question’s impossible to answer with any sort of objectivity. That’s why we’re asking all these questions. Because how could I possibly tell the future and know what your 401k performance is going to be, what your policy performance is going to be and then also compare that to all the things you’re able to use the policy to accomplish and do over the next 20 to 30 years that you wouldn’t have been able to do with the 401k. It’s literally impossible to objectively answer that question. I cannot answer if a 401k is better or a policy is better than each other, because everybody’s in their own specific situation but we do all have to answer these questions for ourselves to determine for ourself is the 401k a better option for wealth building than the other things that are available to me.

So just keep that in mind, we’re not against 401ks. We’ve asked these questions and realized we’d rather have control of the money. We’d rather use it and accomplish other things than a 401k might hinder us to be able to accomplish. But we’re not opposed to individuals who do want to contribute to it, as long as they’ve understood and they’re cool with the answers to these questions. But at the end of the day, if your employer is not offering a match or if you’re contributing above the match, I would really encourage you to stop because I think you’re actually hurting yourself in that way. If they are offering a match, go ahead and answer the rest of these questions to determine if it’s really a good fit. But at least if there is a match there is some benefit to a 401k and it might make sense for you to contribute. Especially if you’re just not interested in looking to do anything else. Anything else before we close down, Holly?

Holly: No, I think that…

Nate: Was good.

Holly: Awesome.

Nate: Well, I hope you enjoyed this. I hope everyone got so something from it. I’m sure we could talk more about this and I’m sure we’ve got other podcast episodes that might flesh some of this out better too, but these four questions, what do I think is going to happen to taxes? What kind of match is being offered? And am I contributing more than the match? That would be a big issue. Do I want to participate in the stock market at this time? And is the 401k actually what it offers? Does it help me achieve my goals? And based on the answers to those questions, you can get a good idea whether or not this is something you want to do. With all that being said, this has been Dollars and Nonsense. If you follow the herd, you will get slaughtered.

Holly: For free transcripts and resources, please visit livingwealth.com/e128

Announcer: Dollars and Nonsense podcast listeners, one more thing before you go, ease worry and start your journey towards security today. Visit livingwealth.com/secretbanking. You’ll gain instant free access to the special one hour course Holly and Nate made for you. Again, that’s livingwealth.com/secretbanking.