401k alternatives

401k Alternatives

401k plans have become as common as carrying a cell phone. It seems like everyone has one, or a form of it anyway.

For those that aren’t familiar with exactly what they have, here is what a 401k actually does for you:

1. Defers taxes – Instead of paying taxes today, you can postpone those taxes to a later date.

2. Defers tax calculation – as the money grows, so does the tax along with it. When money is withdrawn, you are taxed on the future value, not the current value.

Back in the early 1980’s, when 401k plans began (more about this in our first Money Time Podcast here), they were designed to reduce taxes in retirement. Since the highest marginal tax bracket was around 90%, and retirement was based on pensions, it was easy to assume a lower tax bracket in the golden years.

So the logic behind the 401k plan is to postpone high income tax today to a lower tax bracket later.

Reality in Retirement

To assist in this discussion, we interviewed multiple CPAs to better understand tax brackets in retirement.

“Most folks expect a lower bracket, and that doesn’t develop the way they anticipate” – Rick Sager CPA

Rick was right in line with the other 5 CPAs we interviewed. It is becoming a rare situation that you actually retire at a lower tax brackets.

If, indeed, you do retire at a higher tax bracket, then technically you have “lost” as far as the game goes. You’ve essentially postponed lower taxes to higher ones. Sounds fun right?

If that’s the case, then we can rule out IRAs, SEPs, and other tax deferred sponsored plans as alternatives, since they essentially do the same thing… postpone taxes. That boils down my alternatives to 2 specific things, but first…

The Other Big Issue

Apart from the tax structure itself, 401k plans do the one thing that really gets under my skin. It takes away your control. The vast majority of 401k plans tie up your money with that 401k provider. You can’t touch, and you can’t use it.

This has essentially left 401k plans subject to high levels of risk by offering mainly stocks and mutual funds as investment options. While that may be appropriate at times, the vast majority of 401k owners are 100% at risk, and I can assure that in the last decade, those risks have not paid off.

Alternatives to Your 401k

So what 401k alternatives or alternatives investments are out there?

Let me name a few:

1. Roth IRA – A Roth IRA provides you the 2 things the 401k does not. It lets you pay the taxes now (in a lower tax bracket), and grow your money tax free. In addition to a better tax situation, it provide you the ability control in deciding where the money is invested. A great alternative to 401k plans that have little investment options outside of the stock market.

2. Permanent Life Insurance – When structured properly, a high cash value life insurance policy can be a great 401k alternative. Here are a few advantages:

Tax Structure – Similar to the Roth IRA, a permanent life insurance policy is funded with after tax dollars, and grows tax free.

Liquid – Unlike government qualified plans (including the Roth IRA), permanent life insurance is 100% liquid and accessible.

Guarantees – Permanent life insurance has no where to go but up. It provides solid guarantees that ensure growth, and no losses.

Safety – In addition to the other advantages above, these type of policies have been around for centuries. Time has tested and proven their ability to safe, predictable vehicles to grow your money.

All in all, I recommend looking at 401k alternatives above and beyond any company match (free money right?). Having more control over your tax situation and your investment options may prove to be a great financial decision.

3 thoughts on “401k Alternatives

  1. I’m one of the thousands that have probably come here looking for alternatives to my 401k and IRA….you hit the nail on the head, I did because my parents did it and I thought it’s what everybody did.

    1. It’s hard not to do what we everyone else does. At some point though, you’ve got to decide that if what the crowd is looking for is the same thing you are.

  2. Jake,

    I find this article fascinating. Sry if this has been said, but out of curiosity, what is your profession?

    Let’s say your company provides 401k matching. What are some investment alternatives you would reccomend beyond that?

    I feel like stock, 401k, real estate etc. all heavily rely on the US economy. Even your job is an investment in the US economy in my opinion. Looking for a new unusual ways to diversify.

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