We’ve heard of the young and the restless, but the young and the…retired?
When you live in San Francisco and you work in tech, you’re constantly surrounded by twenty- or thirty-somethings flush with money from their recently-acquired/IPOed startups. If they’re smart with their money, they’ll be set for life. And in the meantime, they’ll be able to enjoy their wealth.
Recently I came across the term, pretirement, which is a relatively new term that loosely describes a period of life after you’ve begun your career but before retirement age. But that’s a lot of gray area—roungly 3 to 4 decades to be exact.
So I got to thinking, what can young people do to maximize their future wealth without compromising their current lifestyle? And it involved doing the unthinkable: throwing the 401k plan under the bus.
In theory, retirement plans like 401k are a great idea and it can work well for many with limited lifetime upward mobility (e.g., blue-collar or public sector jobs) for whom there may be less ability for outside savings or investment. Many companies offer 401k plans such that you contribute right from your paycheck and you never even noticed it. If the company matches the donation, even better, because then you’re basically getting free money.
And there’s an incentive for companies to offer a 401k, too: by contributing to a 401k, employers avoid several taxes that they would otherwise have had to pay if they directly gave you the money while still including the full amount in your benefits package.
But I’m just going to say it: for many young people, 401ks are a bad idea. Here’s why:
- Opportunity cost for 30-40 years. Essentially this refers to what else you could be doing with the money you’re putting away. If you saved tens of thousands of dollars in a savings account versus a 401k, you might have enough money for a down payment on a house, or to start your own business, for example.
- Inflation. The dollar loses its value. During recessions, like the one in the 1970s, the dollar lost a majority of its value. The dollar you put away now won’t have the same value as the one you receive later.
- Taxes. Death and taxes are unavoidable. And while your 401k contributions are nice because they’re not taxed now, they are likely to be higher when you go to withdraw your money.
- Fees. If you come across hard times and you want to withdraw your money, you’ll get hit with gigantic fees—just to get at your own money. There’s a flat 10% fee, plus additional taxes.
- Loss of control. The dirty little secret with 401k plans is that you don’t actually get to control where your money goes. You put your money into a plan that is provided to you, with little actual control over the individual stocks or bonds you’re buying. What you’re purchasing is a fund, which is a bank-chosen set of stocks with an estimated return. Once you put money into a fund, your money is given to a faceless trader somewhere in the world to play with your money.
- Risk. Last but not least, there’s risk. Between 2008 and now, millions of Americans have seen their portfolios shrink by half. If you’re young, it generally won’t matter too much in the long-term because there’s decades to make it up. But if you’re old, you’re screwed. The instability of our financial systems and the almost certain promise of a broken Social Security system raises the question of whether we should be handing the reins of our financial future to other people.
- Debt. If you’re young and just graduated from college, you probably have student loans or other debt. Often times, student loan debt is 5% or greater and credit card debt or private loans are 10-15% or even higher. Your best bet is to pay off your debt before you do any type of saving. There is not a single savings account out there that will give you a return of greater than 5%, so if you have any type of debt, you’re better off paying off your high-interest debt BEFORE saving for retirement. That said, it’s always good to have a small amount of money in your savings in case of emergency or unexpected financial hardship like a job loss. As you begin to pay off your debt remember to pay off high-interest revolving credit FIRST (i.e., credit cards, charge cards, etc.) before paying off lower-interest loans (i.e., student loans, car loans, mortgage, etc.)
- One life to live. This is a personal, irresponsible mantra of mine. As Alanis Morissette said in Ironic, “An old man, turned 98; He won the lottery, and died the next day…” Life is unpredictable. You could live to be 120 or you could die tomorrow. Money that sits in your bank account or in a retirement plan won’t do you much good when you’re dead, but it could do a lot of good right now.
If you’re a smart, educated, driven member of the workforce, it’s likely that you’ll make enough money over the course of your lifetime to invest your own money, rather than depending on the government or large banks to do it for you. Let’s put it this way: if you believe strongly that there is NO guarantee that you’ll ever see your Social Security or 401k money and you make other provisions (like an IRA), you’ll be fine. If, by a miracle, those of us born in the 1980s start receiving our Social Security and 401k checks (sometime in the 2060s), it’s just a cherry on top of the cake.