401(k) Programs: Methadone for the Middle Class
I can’t believe its not butter.
Methadone is a legal drug that is taken by former heroin addicts. It eliminates the “rush” that heroin offers, but it also eliminates withdrawal symptoms. It lets heroin addicts escape the need to buy the expensive illegal drug.
Methadone is for heroin addicts who just cannot bring themselves to go cold turkey from an addictive drug that distorts their perception.
That is what a 401(k) retirement plan is for middle-class workers.
Most workers have no retirement program other than Social Security. About 55% of American workers are eligible for a 401(k) plan, but only about 38% participate. This, according to a 2014 CNBC article perceptively titled, “The right ways to get workers hooked on a 401(k).”
Plans offer as little as 3% of salary from the worker, which is matched by the employer: 3/3. The maximum is 6/6.
The first question that someone being offered a 401(k) program is this: “What has been the rate of return for the program since March 2000?” Why March 2000? Because that was the month in which the heroin rush ended. It began on the weekend of August 13, 1982. The bottom was on Thursday, August 12, when the Dow Jones Industrial Average was 777, and the S&P 500 was 102. The S&P 500 peaked on March 24, 2000, when it closed at 1527.
Why do I say it peaked? It is over 2000 today. We must discount for price inflation. The best way to do this is to go to the inflation calculator of the Bureau of Labor Statistics. It is here. Insert 1527 into the box. Click “Calculate.” As of 2014, you get 2099. That is the break-even point for an investment in the S&P 500. Depending on dividends minus fees, that is a losing investment or close to it, compared with buying Treasury bills.
When you find out what the performance of a 401(k) program has been since March 2000, discount by 15%. That is what price inflation has done to the dollar’s purchasing power.
But what if the fund’s managers won’t tell you what the rate of return has been? Then they are embarrassed by the performance of the program. Why stay in it?
Is the program keeping pace with price inflation? Then ask this: to be relevant for retirement purposes, what rate of return do you need to retire at age 65?
To do this, you need a nest egg that will fund your retirement in comfort. If you reduce this nest egg by the traditional 4% per annum, will it sustain you through retirement? That depends on your life expectancy. To calculate this, you need a life expectancy calculator. Actually, you need two or three. Take the average. Set it for age 65. Then calculate, given your present weight and lifestyle.
What will Social Security provide if you wait until age 67 to retire? (Age 70 is better.) Find out. The younger you are, the lower the likelihood that Social Security and Medicare will outlast you. Both systems are statistically bankrupt. The unfunded liabilities are over $200 trillion. The trust funds are empty: IOU’s from the Treasury.
Then there is your equity in your home. This will do you no good unless you move into low-cost housing and rent your existing home for income, or unless you take out a reverse mortgage. Will you have a mortgage at retirement?
Prof. Alicia Munnell recently wrote an article for MarketWatch on home equity for people in their 60’s. It reveals that the median equity — half have more, half have less — for Americans immediately before retirement is $110,000.
In 2013, 77% of households in their early 60s owned a house. The median house price was $185,000. But 63% of households in their early 60s continued to have a mortgage. Subtracting outstanding mortgage balances from the gross house price yields median home equity of $110,000, which accounts for more than 40% of the homeowners’ total wealth as conventionally measured. The fraction is lower if Social Security wealth and that from defined benefit plans are included in the wealth measure.
That is home equity. So, what is the median value of a 401(k) program for the typical American, age 55-65? A pathetic $104,000.
Combined, the home equity and the 401(k) total about $215,000. But the home equity is being used for consumption: a place to live.
Now, here is my favorite figure. Retirement experts for decades said that the typical family must withdraw 4% per year from capital in order to live comfortably. Today, everyone knows this is fake. I did a Google search. Take a look at the articles. But it was fake back then, too. You can’t take 4% out of your 401(k) nest egg without getting taxed. It’s not your money. It’s the federal government’s money and the state government’s money. They hit you at ordinary income tax rates on withdrawals.
So, you get maybe 3%, not the 4% you pull out. Let’s see: 3% of $104,000 in year one. Then 3% of $100,000 in year two. Then 3% of $96,000 in year three. You think this is the road to comfortable retirement? At the top (beginning), that’s $3,000 a year. How far will that get you? Nowhere. Your goose is cooked. The “experts” who talked about 4% annual withdrawals were trying to sell the suckers investment schemes at high commissions.
Next, you need to estimate your expenses in retirement. This requires a calculator. There are lots of them on the Web. For an introduction on which ones do what, Read this Wall Street Journal article. Click here. For a comprehensive one, click here. If you don’t have Java installed, use this. Your future is on the line. You need to devote some serious thought to this issue.
Do not assume that Medicare will cover your medical expenses. A good article on what Medicare will not cover is here. Its conclusion:
HealthView’s calculations assume that the higher-earning member of the example couple receives the Social Security average of $1,294 a month in today’s dollars, while the spouse earns $817. Based on actual claims data, the couple will incur projected lifetime medical costs of $366,599 in today’s dollars if retiring next year, and costs of $421,083 if retiring in another 10 years.
Then there is the cost of entering an assisted care home.
Excluded from the calculation is the cost of long-term care. An estimated 70% of adults turning 65 will eventually need help with bathing, dressing and other activities of daily living. This type of care can be costly, whether provided in the home or in a facility.According to the Genworth 2014 Cost of Care Survey, the median annual cost of a private nursing-home room is $87,600 nationally, while the median annual cost of a home health aide is $45,188. These expenses vary greatly from region to region–in Alaska, for example, a home health aide costs $56,125 and a private room in a nursing home costs a whopping $240,900.
Grim, isn’t it?
This is why 401(k) programs are methadone. People do not go through the exercise I have just summarized. They prefer not to. They get into the 401(k) program on this assumption: “I am doing all that I can. This will sustain me.” No, it won’t.
You must work much longer than you are planning. You must save far more than a 401(k) plan allows. You must get a much higher rate of after-tax, after-price inflation rate of return. You must actively manage your retirement program. That is a huge defect of a 401(k) program: you do not actively manage it. If your response is this — “But I don’t know how” — then you had better find out how. Better to skip the 401(k) strategy and either start a business or buy income-producing real estate. (Start with books by John Schaub.)
When you retire, you will leave the 401(k) program. The methadone will be removed. You will go cold turkey. If you assume that the 401(k) program is anything more than methadone, you will suffer withdrawal pains to a degree that you can barely imagine today. It doesn’t hurt today. It will hurt greatly when you retire.
If your 401(k) program has not returned at least 10% per year after price inflation since 2000, get out of it. It is methadone. It is numbing your judgment. Skip the income tax benefit and put the money to better uses.
If the program is not generating consistent 10% returns, what good is it? The money that you put in isn’t yours alone. It’s the government’s. The government will tax it as ordinary income when you retire. The only thing that isn’t taxed is the rate of return. That’s the only reason to bother with a 401(k): compounding capital with deferred taxes. If there are not substantial returns, then the 401(k) is simply a form of deferred income. The government says, “Pay us now or pay us later.” Pay them now. After that, they can’t tell you how to invest the money. They won’t monitor what you do with it. They won’t force you to report to them. They do require fund managers to report to them. With a 401(k), you lose privacy. If you are not getting 10% per annum, tax-free, don’t consider it.
It is far better to have nothing saved and therefore conclude, “I must work until I am 80,” than to fool yourself into believing that your 401(k) will provide any meaningful support.
Bottom line: if you regard your 401(k) as anything more than chump change, you are making a mistake. Forget about it. It is distorting your judgment. It is not worth bothering about, one way or the other. So, pull it out, pay the taxes, pay the penalties, and buy something that will appreciate enough to make a difference when you retire.
The stock market’s heroin fix ended on Match 24, 2000, yet it still afflicts millions of addicts. There is no more rush, but the horror of withdrawal pain keeps them in the stock market. It has been 15 years, yet they still cannot break the habit. “I can quit at any time,” they tell themselves. But they don’t.
Now it’s time to end the methadone fix. If you are on methadone, go cold turkey.