Written by Kyle J Christensen, CFP, Sept. 27, 2019

When I asked clients why they are contributing to their company 401(k) they give me two answers usually, 1) they get a match, and 2) they save on taxes. Interestingly I’ve never heard anyone say that they are contributing to their 401(k) because they love the stock market, or because they have a lot of confidence in their ability to choose great investments within their plans. Those answers have never been verbalized to me. In fact, one of the questions I like to ask my clients is, “If you were to rate yourself on a scale of 1 to 10, 10 being you are an expert, and 1 being that you have no idea what you are doing, where would you rate yourself?” The most common answers are “1” or “negative” something.

Let me first address the number two reason people say they are contributing to their 401(k) plan first, which is the supposed tax benefit. If I were to ask you what you think taxes are going to do over time, increase, decrease, or stay the same, what would you say? If you said, increase, you are giving the same response I hear from clients every day. It also happens to be what I believe too. My question then is, if you accomplish your objective to pay off your house, and have your kids move out and live successfully on their own, how are you possibly going to be in a lower tax bracket? The only way that can be possible is if you make less money in the future AND taxes either stay the same or decrease in the future. Why would anyone want to work with a financial planner whose goal is that you receive less income when you retire? I wouldn’t. So, by putting money in a 401(k) do you really save taxes? You almost certainly do not. You simply kick the can down the road to a time when paying taxes is going to hurt even more than they would today.

Answer number one, “I’m contributing to the 401(k) because I get a match”. Most often the match is thought of as “free money”. If I get 100% match, isn’t that free money that I would just lose if I didn’t contribute? Yes and no. Yes, if you don’t contribute to the 401(k) you will not receive the match. But, no it isn’t free. In fact, nothing is truly free in my opinion, least of all money. There is always a cost to “free”. So, what is the cost to the “free” match?

The goal of every financial institution is to somehow convince us to put our money in their coffers. They do this through various means, by promoting products and by strategies that help them accomplish their goal. Once our money goes into their coffers they want us to leave it there. Makes sense, as we would want the same thing if we owned the financial institution. The longer we leave our money there, the longer they have to use it for their benefit, which also makes sense. We can see that with regards to bank accounts. If you use a checking account you usually get very little to no interest on the account. If you are willing to give up a little more ready-access and put the money in a savings account, you will get a higher interest rate from the bank. And if you are willing to leave the money in there for years, you can move the money into CD’s and make even more interest. What is the cost to you? Access and control. The more access and control you are willing to give up, the higher interest they are willing to give you. If somehow they could convince you to leave your money with them forever, they would, and they do.

From the employer standpoint a matching contribution is simply a hiring and employee retention tool. They don’t really care if the plan really works for the employee. That’s not the purpose of it. In fact, many employers don’t even offer a match anymore. They simply provide employees a plan that they can contribute to so that they can say to new hires “we have a retirement plan as one of our benefits”.

Let’s get back to the cost of the employer match. If I contribute money to my 401(k) plan in order to get the match, what do I give up? First, I give up time. Sometimes huge periods of time. In other words, when can I get that money back? Answer: After age 59.5 or longer if I am still employed with the employer offering the plan. I have access to my money when I am separated from employment. Even if I could access the money prior to separation from employment, I would be taxed (ordinary income tax) and penalized 10% on any withdrawal, outside of a few rare exceptions. Yes, a person can usually also borrow up to $50,000 from their 401(k), but that ends up being a pretty raw deal with double taxation (another topic for another day). Point is, a person has little or no access to their funds and absolutely no cash flow that can come from the 401(k) until the person is separated from employment and older than 59.5. This means a person starting a 401(k) at age 30 today would be giving up access to their own money for almost three decades.

How much control does a client have over the performance of their mutual fund investments within their 401(k)? In fact, how much control does the client have over the choices of mutual funds within the 401(k) that they are offered? The answer is the same for both questions. None.

Let me ask you this, would any financial institution invest their own money into something that 1) didn’t provide any current cash flow, 2) was something they gave up all control of, 3) had no expertise in, and 4) couldn’t get their money back for very long periods of time, possibly even decades? The answer to that is obviously no. They would never do that! So, why are they suggesting that it’s a great thing for us to do? Remember, if they could convince us to put our money into something that gives them control and use of our money for long periods of time, wouldn’t they try to promote that? Wouldn’t that be the thing they marketed most? Yes, and yes.

The match is the opposite of free. It has a tremendously high cost. Giving up control, giving up access, giving up cash flow, and giving up expertise. Since when is a good investment one that you give up all of those things? The match is not free money and a 401(k) doesn’t give you a tax break long term. This is a strategy born from and promoted by financial institutions who have one objective in mind. Think about this the next time someone tells you that they contributing to a 401(k) to get a free match.