Yes, 401(k) Plans Still Make Sense

David Dierking

There was a "hot take" article on Bloomberg earlier this week talking about 401(k)s. To be fair, I really like Bloomberg and use it often in my own personal research. But I vehemently disagree on its take on the subject.

Here's the header for the article in question:

Screen Shot 2020-07-22 at 8.24.35 AM

The crux of the article centered around the differences in the tax environments back in 1980 and today (there are other more structural arguments made that I won't discuss here, but the link to the original article is above). The author's main point was that the 401(k) is no longer as tax-advantageous today as it was then.

He uses the following numbers:

Screen Shot 2020-07-22 at 8.42.42 AM

I believe this part of the argument is true. Tax rates are much lower today than they were back then and the tax deferral savings from contributing to a 401(k) plan are lower.

But saying that "401(k) Plans No Longer Make Much Sense" is a bit disingenuous to the argument since that statement casts such a wide net. If the article's title had been "401(k) Plans No Longer Generate The Tax Benefit They Once Did", I don't think we'd be having this discussion.

But we are, so I think it's important to point out why 401(k) plans still make a lot of sense for investors despite the fact that they generate fewer tax benefits today than they did four decades ago.

Note: Bob Powell over at Retirement Daily does a nice job of providing his thoughts on this article as well as curating a list of others' opinions on the subject as well.

Employer Matching Contributions

This is perhaps the greatest benefit of all. The majority of employers will add a matching contribution to your 401(k). All you have to do is save enough to receive the match and the money is yours. As about as close to free money as you'll find.

Roth 401(k) Option

The Roth option for both the 401(k) and the IRA give you the option of paying taxes upfront on contributions, but taking withdrawals tax-free in retirement. However, not every 401(k) plan offers the Roth option. If yours does, it's a great way to avoid some of the tax liability you could ordinarily be exposed to in retirement.

Automatic Investing

The odds are very good that if you have to manually do it yourself, you're not going to do it. Automatic investing where you don't have to think about a thing is they best way to accumulate savings over time. You can still set up an automatic investment plan through a taxable or IRA account as well, but taking it right out of your paycheck before you even see the money is the better way to go.

Many Retire With A Lower Tax Rate

The argument that tax rates today are lower is valid, but many people find themselves in a lower tax bracket in retirement. Avoiding taxes at a higher rate when you're contributing and paying them in retirement at a lower rate still generates additional tax savings regardless of what those rates actually are.

Conclusion

Some of the points I mention above were discussed, albeit briefly, so I don't want to give the impression that they were ignored altogether, but the difference in tax rates was the main point of that article.

I think a different title would have been more appropriate and worry that many retirement savers might get the wrong impression by seeing it. I think that's unfortunate because the 401(k) plan should still be fully taken advantage of by American workers.

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