Posted on: November 6, 2017

Tackling 401(k) Plans

Tackling 401(k) Plans
 Dr. Taemin Cha & Dr. Osman Masahudu

In an effort to create more cash flow for the federal government is discussing reducing the pre-tax contribution limit for 401(k) plans. Our finance professors Dr. Masahudu and Dr. Cha tackle 401(k) plans. Check out their thoughts below!

Are 401(k) plans really helping people save money?

Dr. Masahudu: 401ks have different terminology depending on the sector you work. They are called 401ks for private sector employees and Thrift Savings Plan (TSP) for federal employees. Both are qualified retirement plans that allow eligible employees to save and invest for their own retirement on a tax deferred basis. However, both the federal government and private sector employers match employee contributions. Contributions are capped at $18,000 as of 2017. Without these plans, it will be tough for people to save for retirement. What makes it easier for people to increase their retirement savings is the ability to enroll participants automatically. Everyone’s retirement savings will be hurt if left to save consciously. For example, GoBankingRates did a survey recently to ascertain the average amount in people’s saving account. The survey indicated that more than half of Americans (57 percent) have less than $1,000 in their savings account. This could be detrimental if people are consciously left to save for retirement. The government will by no means discourage retirement savings if the cap is lowered from $18,000 to $2,400. There will be a lot of disincentive for both employees and employers.

Dr. Cha: Yes. 401(K) plan, one of the defined contribution (DC) pension plans, is a very powerful saving tools for middle income American workers. First, it is an inexpensive way to create a professionally managed, diversified portfolio. Unless you are a full time fund manager, making money in the market is tough and almost impossible. The advantage a 401(K) plan offers is that highly experienced fund managers work full time to manage the money you invest in and another advantage of 401(K) is the tax benefit. Under current law, approximately 132 million workers contribute to a 401(K) or similar plan on a pre-tax basis. These wages are not subject to federal tax withholding at the time of deferral but distributions are taxed as ordinary income.

Do you think the potential change to the pre-tax 401(k) will help individuals save money or do you anticipate a decline in people utilizing 401(k)?

Dr. Masahudu: There will be a significant decline in retirement savings because both employers and employees will have no incentive to participate or manage the retirement program. We all know what the government is trying to do; the government is trying to increase the government cash flows perhaps in the short-term. The effort to increase the government revenue base in the short-term will have permanent negative effect on most people’s retirement savings. The government’s primary responsibility is to serve the public or maximize the well-being of the people. The government should take politics out of this important issue and work in a bi-partisan manner to determine what will be in the best interest of the people. The future of the people should be the priority and not political interests.

Dr. Cha: There is no firm evidence that the timing of when saving accounts are taxed affects how much American workers save in pension plan. However, it is very likely that a significant number of workers would put their money into other types of investment such as mutual funds, Index Funds or ETFs. These investment packages do not provide any benefit from tax break and contribution.

What types of retirement things can individuals consider using in place of a 401(k)?

Dr. Masahudu: It is difficult in the absence of 401k or TSP to save for retirement. However, people still have a number of options to invest for their retirement or post-work years. It is highly recommended for people to work with reputable financial advisors when 401ks or TSPs are not available; because of the various risks and cost involved in investing outside the traditional retirement accounts. In addition, everyone’s financial goas are different and it’s difficult to recommend one particular investment portfolio.

Dr. Cha: Another type of retirement plans is the defined benefit pension plan. It is a retirement account for which employers pony up all the money and promises employees a set payout when they retire. Usually, the final benefits are calculated based on a formula that takes into account how long an employee was on the job and his/her average salary during last few years of employment. Of course, this plan is not linked to market movement and the amount that employees receive would not be sufficient enough for them to live comfortably in retirement.

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