Myth: Retirement Accounts Are Designed To Help You Retire Early
There’s a factory near where I once lived that was built about 40 years ago and no one has ever retired from it.
Is it because the job is so great no one ever wants to quit? Hardly.
It’s because workers use their 401K plans exclusively to fund their retirement. Unfortunately, the money contributed to these plans must stay there until they reach 59.5 years old and the back-breaking work and ruthless company policies claim these workers long before they can use this money penalty-free.
They either die, or get fired before they reach retirement age.
Retirement accounts that allow you to compound money tax-free are designed to keep you in the work force until you’re too old to use the money. It’s actually a boon for organizations and corporations to maintain a hungry, available pool of labor. The system also benefits the financial industry, which can maintain trillion-dollar accounts (filled with your money) over long time periods.
If the government and your company really wanted you to retire, they would allow you to maintain any investment account tax-free. They could let you compound the money, increasing the balance exponentially, and then tax it when you withdraw it as income. If that was the case, more and more people would leave their jobs once their accounts were large enough to spin off an acceptable level of income.
And then what would your boss do?
This is not meant as advice to abandon your retirement plans. In fact, you should keep contributing and even maxing them out. You should never deny yourself free money, even when the terms are not exactly satisfactory.
But, if you want to retire early, you need to add tools that lie outside of the typical retirement plans. You need to create a trading or investment account that you control now and one that can produce consistent and exponentially-increasing returns. It may sound like an impossible order, but as technology becomes more advanced, investors and traders will have more opportunities to create just such an account.
This is the first post in a series about financial myths that make you poor. For more information, you might want to read the previous article in this series. It’s called Financial Myths That Make You Poor.
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is one of my favorite financial books of all time. It's an allegory about a guy who has a terrible job, and how he overcomes challenges to achieve his dreams.
“It’s actually a boon for organizations and corporations to maintain a hungry, available pool of labor.”
Wow…I never really thought about this, but it’s actually a very valid point! No wonder they match a certain percentage…because they are actually making money off of it. Very enlightening.
-http://www.switchtoriches.com
Thanks for the stopping by, Jim.
Yeah. My friend mentioned this to me once.
He also said that no one ever gets paid what they’re worth in the wage-earning world. Or they’d go bankrupt.
When a person makes a contribution to a 401(k) or other salary deferral retirement account their money is theirs to keep. If they quit or are fired, they can rollover their account balance into an IRA and take it with them, investing it independently of any corporate 401(k) program. The money can then be withdrawn AT ANY TIME, but withdrawals before 59 1/2 do face a 10% “early withdrawal penalty”.
There are several hardship exemptions to making early withdrawals exempt from the early withdrawal penalty, but the one that interests most people is a 72(t) rule which allows people to begin withdrawals penalty-free AT ANY AGE provided they make substantially the same withdrawals each year.
There’s actually a complicated set of rules to define the exact amount that meets the penalty exemption. The IRS has a FAQ:
http://www.irs.gov/retirement/article/0,,id=103045,00.html
More readable descriptions abound if you just Google “72(t)”. Financial software programs or speaking with most any financial advisor or IRS representative will also get you further information and a fast calculation of the amount that can be withdrawn penalty-free annually.
People can and do use 401(k) monies to fund retirements before age 59 1/2. I don’t have any idea why the workers at the factory you mentioned never do so. Having investments outside of a 401(k) account does give more options, but sacrifices employer matches and total tax deferral before actual withdrawal.
Thanks for the great information, Jane.
I agree that workers should take full advantage of these retirement plans: “This is not meant as advice to abandon your retirement plans. In fact, you should keep contributing and even maxing them out. You should never deny yourself free money, even when the terms are not exactly satisfactory.”
I think the complexity of the IRS rules, as well as the 10 percent penalty, hinder using the plans before retirement age for most workers. Which is the intention of the penalty, I’m sure.
Ok, I’ll buy it for 401ks, but you don’t talk about Roth IRAs. If this is the government’s intention, then why would they allow Roth IRAs, where you could start drawing down your contributed money at any time without penalty?
1) prior to 59.5, draw down on a mix of Roth IRA contributions and taxable account
2) after 59.5, draw down 401k + Roth IRA earnings
Sounds like the Roth IRA ruins the conspiracy theory, in my view. If they wanted what you are saying they want, they would change Roth IRAs to penalize early withdrawal of contributions.
Hi Matt
Thanks for your comment. I think the Roth is a better choice. And your plan for an early retirement is a good one.
Here’s something to consider: Isn’t there a limit on how much you can contribute to a Roth? If you contribute $5,000 a year for 20 years, that would be $100,000, not including interest. Hardly enough to retire.
And I believe there are restrictions on how you can invest the money. So compounding this money in a Roth is difficult.