Friday, September 14, 2007

Reasons For Not Participating in a 401(k) Plan

Occasionally the topic of retirement savings comes up at work. I'm amazed at some of the thinking.

One colleague made the comment that if he had $50,000 he could retire. Being an immigrant, I thought perhaps he was planning to return to his home country and live in a mud hut. But I didn't pursue the topic. Then a couple of years later, he was looking at needing to retire and told me that all he had was Social Security. When I asked about his 401(k) he said that he wasn't participating. When I asked why he said "It might go down". Well, with a 50% employer match and 100% match after 5 years, it has to go down a lot to lose money. And if afraid that "it might go down" the plan offers a money market fund. So he lost out on the employer match for 6 years at this employer. And with the relatively small amount he could have saved, he would pay very little if any taxes on his distributions if he spread it out over a number of years.

Another fellow employee told me that he wouldn't participate because he didn't want his money in our employer's stock. Yes, it's a good idea to diversify. But beginning last year, those who were vested had the option to sell their company stock and chose other investments. After the conversation, I got to thinking that maybe he thought his contribution had to be invested in company stock. Which was never the case, although that has always been an option.

Another colleague who is participating thought that the only way to get funds of the employer match out of the company stock was to pursue our unique option of being able to have up to a certain limit distributed each year -- he wasn't aware of the plan change last year allowing diversification.

Before making decisions about participating in your employer's 401(k) plan, get a copy of the Summary Plan Description and read up on the rules. And if it's been awhile since you've read yours, get a fresh copy because they can be amended periodically, and review the information there.

Any other excuses for not participating?


Anonymous said...


1) You have enough savings outside of your 401k that you don't need it for retirement

2) You're in a lower tax bracket than your heirs

3) You don't want to be completely screwed by the government when you die and the government takes half of your estate, and then charges your heirs regular income tax on the remaining half, *far* surpassing any tax benefit you may have gotten.

Engineering My Finances (EMF) said...

Interesting perspective from the last commenter.

With regard to 1): While as I've discussed elsewhere there are possible tax disadvantages to having too much in your 401(k), the employer match has to be considered before deciding that there's a net disadvantage. And once you've money in a 401(k), you may have options to convert to Roth.

As to 2) and 3): I'm doing retirement savings for me, not for my heirs. Call it selfish if you want, but to me the best thing you can do for your heirs is minimize the chance that you'll become a burden to them. As far as being screwed by the government after I die, I figure I'll be beyond being screwed by anyone, or at least I won't care if they do.

One of the coworkers I mentioned has inherited a 401(k) but hasn't been participating in his. I encouraged him to start participating in the 401(k) to offset the distributions he will have to begin taking.

Anonymous said...

I agree that if your employer provides a match, it would have to be an unusual circumstance to justify not participating.

I don't know how many employers offer a match -- mine doesn't; my employer contributes ~8% of one's salary to a profit sharing plan regardless of his 401k contribution.

In general, though, tax deferred vehicles are not always a slam dunk. If you're in a low- or no-tax state, for example, and plan on retiring to a high-tax state, you may very well be deferring less tax than you'll wind up paying at retirement.

If you're lower income, the tax savings is less substantial on a percentage basis than if you're high income.

I agree that one should plan for his own retirement rather than for his heirs. However, having just gone through this process as an heir, I can tell you that it is heart-wrenching to see money painstakingly saved by a loved one wrested away by the government.

Another thought; if someone is planning on retiring early, at some point he should have substantial non-401k savings. My wife and I, at age 30, have each been contributing the maximum to our 401ks for 10 years. Between those accounts and our profit sharing, we each have well beyond $200K saved. We've talked about retiring at 40 or 45, and are considering decreasing our 401k contributions and increasing our after tax savings.

Engineering My Finances (EMF) said...

To the 2nd anonymous commenter:

I think in most cases the rule of thumb to participate in the 401(k) to get the employer match and then fund your Roth IRA fully generally applies. Particularly if you think you'll be in a higher tax bracket, which could be as you mention moving to a state with a higher income tax. Could also result from taxation of Social Security benefits as I've mentioned elsewhere in this blog.

With respect to your comment about early retirees not contributing to the 401(k) -- I expect you have in mind the penalty for withdrawals before age 59 1/2. However, there's a way around it, which is commonly referred to as rule 72t. This allows you to take distributions without penalties before the age of 59 1/2, but rule 72t has its own restrictions. Google "rule 72t" and read up on it.

I recommend also checking out the FIRE forum linked on the main page of my blog if you haven't yet done so. The FIRE forum is for early retirees and wannabes. Also for wishtobes.

For those who "inherit" tax-deferred funds, you have to be careful how they are handled because if you take a distribution all at once it is taxed at a high marginal rate. By handling it properly, you can spread the distribution over a number of years and reduce the tax hit.

azphx1972 said...

Great post. I found your blog while searching for information to discourage someone from ceasing participation in his 401k plan:

I will be checking out your other blog entries for more valuable information. Thanks!

SavingDiva said...

I currently contribute enough to get the maximum employer contribution to my 401k...and I contribute to my RothIRA...I wasn't able to max it out last year, but I will try to this year.

Anonymous said...
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Engineering My Finances (EMF) said...

Using a 72t for college savings makes sense only if your kids are college age while you're in your 50s. IIRC, once started a 72t withdrawal has to continue until the age of 59 1/2.

And as far as rolling over to an IRA, it has to be a Roth IRA and then you have to wait 5 years only being able to withdraw the principal without penalty.

Recommend seeking competent professional help if you are thinking about such a tactic.

Anonymous said...
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