Is It Time to Starve Your 401(k)?

Photo: 401K

In the early 1990s, I worked for a benefits consulting firm that managed retirement plans for employees of various companies. Though barred from providing direct investment or tax advice, my coworkers and I gave the standard 401(k) spiel that outlined the benefits of pre-tax contributions. It was a song-and-dance that was pretty much true at the time — “contribute funds pre-tax during your working years; the investments grow tax-free (based upon market performance, of course), and when you withdraw upon retirement, your tax rate is likely to be lower.”

While the logic still makes sense, I’m not so sure the root of that statement applies any longer, or that I could parrot it without some serious reservations now. Newly enrolled 401(k) participants probably still hear it, and I know it echoes in the minds of long-term investors who haven’t looked up from their 9-5 (or 9-9) jobs long enough to consider the game may be changing. But as the U.S. faces staggering debt with two parties that seem intent only upon one-upping the other, and as the ripples of economic instability continue to wash over Europe, the only sure bet seems to be that taxes will go up eventually. (See also: Deciding What You Want Out of Retirement)

The 401(k) Problem

Focusing solely on 401(k) plans may create a trifecta of financial trouble for future retirees:

  1. A generation or two of savers who may not be considering the possibility that their tax bracket in retirement may be equal to (or potentially higher) than during their working years.
  2. Investors who have bought hook, line, and sinker the idea that 401(k) plans are a sure bet for retirement security.
  3. Employees who have maxed out their 401(k) contributions to the point that other potentially more valuable savings vehicles can’t be properly funded.

What’s more, the convenience and hands-off approach that make 401(k) plans so popular tend to lull investors into auto-pilot mode where critical thinking and active investment strategies are replaced by automatic paycheck deductions and only reevaluating investment funds once every blue moon. Are we setting ourselves up for a hard-fall later in life when the bill on all that pre-tax money finally comes due and our tax rate is less-than-optimal?

Another Retirement Savings Option

Though it may sound blasphemous, I think it’s time to put our 401(k) plans on a diet — if not begin to starve them outright. But I make this assertion with two critical caveats. First, if your 401(k) plan offers a company match, don’t walk away from free money. Contribute just enough to get those matching dollars. Second, don’t starve one investment plan without fattening up another. Depending on your current tax situation and age, strongly consider a Roth IRA. The money you put in a Roth goes in after-tax, but your investments grow tax-free and any withdrawals after age 59.5 are not taxed. You can learn more specifics about Roth IRAs by visiting

Regardless of what side of the political fence you’re on, the reality is that taxes must (and will) go up. The only real questions are how soon will it happen and how hard will it hit? If you want to be a defensive investor, it’s time to shake off the old notion that a fat 401(k) balance alone will keep you in dancing in Florsheims and dining on steak in your golden years. More likely, a healthy 401(k) plan will become a smaller and smaller part of a broader strategy that’s centered on one important truth — the tax man is coming.

Do you have a plan B (or C) in place for retirement savings? What do you think will happen with income tax rates over the next 10 or 15 years?

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Guest's picture

Do you trust the government to play by the rules and not tax Roth IRA interest upon withdrawal in the future? Everyone seems to be going Roth IRA. That's going to be a big pot of money just waiting to be taxed. Do you trust the government to keep their hands off Roth IRA interest when it is withdrawn? I don't.

Guest's picture
mark g

The Roth is post-tax money. What would be the point of having a Roth if they change it to a worse-than-traditional-IRA?

Kentin Waits's picture

K.C: I'd be interested to find out if the government has ever changed the rules like that in the past. While I share your concern about what the government may be capable of the in the future, the alternatives seem equal at best.

Guest's picture

They have changed the rules in the past. Look at Social Security. Originally, Social Security benefits were not taxable income thanks to administrative rulings issued by the Treasury Department. That changed in 1983 when Congress authorizing the taxation of Social Security benefits. This is why Roth IRAs or Roth 401Ks seem like pretty scary things. Take a hit now, take a potential hit later.