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🎥  The 401k is a SCAM? The truth about 401ks...

Is the 401k a scam?

🌲 Evergreen 🎥 Video 👔 Business 💰 Money 🧧 Investing

🎥  The 401k is a SCAM? The truth about 401ks...

VIDEO INFORMATION

Title: The 401k is a SCAM? | The truth about 401ks...
Channel: The Dividend Dream
Duration: Approximately 17 minutes


HOOK

When a simple Twitter poll revealed that nearly half of respondents believe 401ks are scams, it exposed a fundamental divide in retirement planning philosophy that challenges conventional financial wisdom.


ONE-SENTENCE TAKEAWAY

The 401k’s value depends on individual circumstances, and for many people (especially high earners or those seeking early retirement) after-tax options like Roth accounts and taxable brokerages may provide superior returns and flexibility.


SUMMARY

This video from The Dividend Dream tackles the controversial question of whether 401ks are scams, sparked by a Twitter poll where the creator asked his 18,000 followers for their opinions. To his surprise, about half of the respondents considered 401ks to be scams, with many expressing frustration about limited access to funds until age 59.5 and concerns about tax implications. This mixed response prompted the creator to conduct a thorough analysis of 401ks, comparing them to alternative investment strategies.

The video begins by examining the fundamental differences between pre-tax 401ks and Roth 401ks. The creator explains that pre-tax 401ks offer an upfront tax break, with funds growing tax-deferred and taxed upon withdrawal, while Roth 401ks use after-tax contributions but allow tax-free growth and withdrawals. He notes that approximately 88% of 401k plans now offer Roth options, nearly double the percentage from 2011.


A significant portion of the video is dedicated to analyzing the tax implications of both approaches. The creator presents detailed scenarios showing how tax rates during working years versus retirement years dramatically impact the final outcomes. If tax rates are lower in retirement, pre-tax 401ks may be advantageous, but if tax rates are higher in retirement (which many anticipate given current "tax sale" conditions), Roth and after-tax options become more favorable.

The video introduces a third option that many overlook: after-tax 401k contributions, which are different from Roth 401ks despite both using after-tax dollars. The key distinction is that after-tax 401ks have much higher contribution limits ($69,000 in 2024 compared to $23,000 for pre-tax and Roth options), and while contributions can be rolled into a Roth IRA, earnings are taxed as ordinary income upon withdrawal.


The creator utilizes a Schwab calculator to demonstrate various scenarios, adjusting factors like years to retirement, annual salary, savings rate, and tax rates. In almost every scenario except when tax rates in retirement are significantly lower than during working years, after-tax options provide better returns.


For the "scam" question, the creator concludes that while 401ks aren't technically scams, they have significant limitations that make them less than ideal for certain individuals. It is crucial 401ks are problematic for those seeking early retirement due to the 59.5 withdrawal restriction and 10% penalty for early access.

The video concludes with practical recommendations: always take advantage of company matches since they represent "free money," check if employers offer after-tax 401k options, and consider taxable brokerage accounts for those planning early retirement. The creator shares his personal experience, noting that his million-dollar taxable brokerage was essential for his early retirement.


Throughout the video, the creator maintains a balanced perspective, acknowledging that 401ks can be appropriate for some people (particularly low earners) while highlighting why alternatives might be better for others (especially high earners and early retirees). Viewers should consult with certified financial planners to determine the best approach for their specific situations.


INSIGHTS

  1. The Retirement Account Divide: The Twitter poll revealing that nearly half of respondents view 401ks as scams exposes a fundamental disagreement in financial planning philosophy between traditional and alternative approaches.
  2. Tax Rate Assumption is Critical: The decision between pre-tax and after-tax retirement accounts hinges almost entirely on whether you expect your tax rate to be higher or lower in retirement—a prediction that shapes which strategy will yield better returns.
  3. The "Tax Sale" Concept: Current tax rates may be relatively low compared to future rates, making Roth and after-tax contributions more attractive for long-term planning as they lock in today's tax rates.
  4. Company Match as "Free Money": Regardless of other considerations, the employer match in 401ks represents an immediate return that should be maximized before considering alternative investment strategies.
  5. The After-Tax 401k Opportunity: Many investors are unaware of after-tax 401k options, which offer significantly higher contribution limits ($69,000 in 2024) than traditional or Roth 401ks.
  6. Early Retirement Incompatibility: Traditional 401ks are poorly suited for early retirement due to the 59.5 age restriction and 10% penalty, making taxable brokerage accounts more appropriate for those planning to retire early.
  7. The High Earner Dilemma: Those with high incomes during their working years may face higher tax rates in retirement due to required minimum distributions (RMDs) from large nest eggs, making Roth and after-tax options more favorable.
  8. The Flexibility Premium: Beyond pure numbers, the flexibility of taxable accounts and Roth IRAs provides significant value that isn't captured in simple tax calculations, especially for those with non-traditional retirement plans.


FRAMEWORKS & MODELS

The 401k Decision Framework

  • Components: Pre-tax 401k, Roth 401k, After-tax 401k, Taxable Brokerage
  • How it works: Evaluates retirement options based on current vs. future tax rates, income level, early retirement plans, and employer match
  • Evidence: Detailed scenario analysis showing how different tax assumptions dramatically impact final outcomes
  • Significance: Provides a systematic approach to retirement account selection based on individual circumstances rather than generic advice
  • Application: Use the framework by first securing employer match, then evaluating tax rate expectations, and finally selecting the optimal account type based on personal retirement timeline

The Tax Rate Prediction Model

  • Components: Current tax bracket, expected future tax bracket, political and economic factors affecting tax policy
  • How it works: Projects whether tax rates will be higher or lower in retirement to determine whether pre-tax or after-tax contributions are more advantageous
  • Evidence: Historical tax rate trends and current fiscal conditions suggesting taxes may increase in the future
  • Significance: This prediction is the single most important factor in determining whether traditional or Roth accounts will provide better returns
  • Application: Consider both personal income trajectory and broader tax policy trends when making retirement account decisions

The Early Retirement Compatibility Assessment

  • Components: Access to funds before 59.5, penalty avoidance, income needs, withdrawal strategy
  • How it works: Evaluates retirement account options based on their suitability for early retirement, with emphasis on flexibility and accessibility
  • Evidence: The creator's personal experience using a taxable brokerage account for early retirement
  • Significance: Traditional retirement planning often assumes retirement at 65+, but this framework addresses the growing trend of early retirement
  • Application: For those planning early retirement, prioritize taxable brokerage accounts and Roth IRAs over traditional 401ks beyond the employer match

The Three-Tier Retirement Strategy

  • Components: Tier 1 (Employer match), Tier 2 (Tax-advantaged accounts), Tier 3 (Taxable investments)
  • How it works: Prioritizes retirement contributions by first securing employer match, then maximizing tax-advantaged accounts, and finally using taxable investments
  • Evidence: The creator's recommendation to always take the employer match first, then evaluate other options
  • Significance: Provides a structured approach to retirement planning that ensures no "free money" is left on the table while optimizing for individual circumstances
  • Application: Implement this strategy by first contributing to receive the full employer match, then evaluating whether traditional or Roth accounts are better based on tax expectations, and finally using taxable accounts for additional savings


QUOTES

  1. "I used to think this was just sarcasm but do you really think 401ks are a scam?"
    • Context: The creator's initial Twitter question that sparked the investigation
    • Significance: Reveals the surprising level of skepticism about 401ks even among financially engaged people
  2. "They are not a scam no especially if there's any type of employer match but then I started seeing other responses like no they aren't scams but maybe they aren't for everyone."
    • Context: Early responses to the Twitter poll showing the division of opinion
    • Significance: Highlights the nuanced middle ground between "complete scam" and "perfect for everyone"
  3. "One thing I heard over and over was that you can't take your money out until 59.5 and that really rubs people the wrong way."
    • Context: Explanation of why many people view 401ks negatively
    • Significance: Identifies lack of flexibility as a primary concern with traditional 401ks
  4. "Taxes are on sale right now and that inevitably taxes are likely to go up in terms of percentage as the years and decades go on."
    • Context: Discussion about current vs. future tax rates
    • Significance: Captures the argument for Roth and after-tax contributions based on tax rate expectations
  5. "In almost every single scenario the after tax contribution is going to give you a better return."
    • Context: Conclusion from analyzing different scenarios with the Schwab calculator
    • Significance: Summarizes the video's key finding about the superiority of after-tax options in most situations
  6. "I would definitely think about matching your corporate match because that's free money."
    • Context: Recommendation about prioritizing employer contributions
    • Significance: Emphasizes that regardless of other considerations, employer matches should always be maximized
  7. "I have about a million dollar in taxable brokerages which has essentially been key for my early retirement."
    • Context: Personal example of the creator's retirement strategy
    • Significance: Provides real-world evidence of how taxable accounts can facilitate early retirement


HABITS

  1. Maximize Employer Match First: Always contribute enough to your 401k to receive the full employer match before considering other investment options, as this represents an immediate, guaranteed return.
  2. Evaluate Tax Rate Expectations: Regularly assess your current tax bracket and research trends in tax policy to make informed decisions about whether pre-tax or after-tax retirement accounts will be more beneficial.
  3. Research Employer Plan Options: Check if your employer offers after-tax 401k options, which many employees don't know about but which provide significantly higher contribution limits.
  4. Consider Early Retirement Needs: If early retirement is a goal, prioritize building taxable brokerage accounts alongside retirement accounts to ensure access to funds before age 59.5 without penalties.
  5. Use Retirement Calculators: Utilize tools like the Schwab calculator mentioned in the video to model different scenarios based on your specific financial situation and retirement goals.
  6. Diversify Account Types: Rather than putting all retirement savings in one type of account, consider maintaining a mix of pre-tax 401k, Roth IRA, after-tax 401k, and taxable brokerage accounts for maximum flexibility.
  7. Regularly Reassess Strategy: Review your retirement strategy annually or when major life changes occur, as factors like income, tax laws, and retirement timeline may shift the optimal approach.
  8. Consult Professionals: While doing your own research is important, consider consulting with certified financial planners who can provide personalized advice based on your complete financial picture.


REFERENCES

  1. Twitter Poll: The creator's informal survey of his 18,000 followers that revealed nearly half believe 401ks are scams, sparking the investigation in the video.
  2. TIAA Article: Referenced source comparing after-tax Roth versus pre-tax plan contributions, including contribution limits and tax implications for 2024.
  3. Yahoo Finance Article: "How do my investment benefits compare pre-tax versus after tax," cited for its explanation of how pre-tax investments don't completely evade taxation but merely defer it.
  4. Schwab Calculator: Online tool used in the video to model different retirement scenarios, allowing users to adjust variables like years to retirement, annual salary, savings rate, and tax rates to compare outcomes.
  5. 2024 Contribution Limits: $23,000 for pre-tax and Roth 401ks ($30,500 for those 50+), and $69,000 for after-tax 401k contributions, as mentioned in the video.
  6. Required Minimum Distributions (RMDs): The concept that retirees must begin taking minimum withdrawals from traditional retirement accounts at age 73, which can push them into higher tax brackets.
  7. The "Little Known Secret" Video: Creator's previous video referenced as providing information on how to avoid the 10% penalty for early withdrawals from retirement accounts before age 59.5.
  8. Seeking Alpha: Financial research platform mentioned by the creator as a resource for those doing their own investment research.



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