Obama’s 401k Plan Is A Double-Edged Sword
By Pinyo • Nov 12th, 2008Now that we know Obama is the next president, we can evaluate his proposal regarding 401k plan more closely. If you recall from my last article, I didn’t like his proposal that would allow people to early withdraw from their retirement funds — i.e., 401k and IRA — without penalty (McCain’s plan was even worse). I quoted The New York Times as follow:
Temporarily suspend mandatory annual withdrawals from Individual Retirement Accounts and 401(k)s. Current rules require investors to start selling stocks at age 70½. Exempt withdrawals made up to the required minimum amount from taxation. Allow savers to withdraw 15 percent, up to a maximum of $10,000, without paying a penalty as the law currently requires for withdrawals before age 59½. These withdrawals are subject to normal taxes.
However, I do like the idea of not forcing people to withdraw their money if they don’t need to. This will allow poor performing portfolio more time to recover and keep more money in the stock market.
Why I Don’t Like The Early Withdrawal Plan
There are many reasons why I don’t like the plan. First, the high opportunity cost that many people may not realize. Let’s say you are 30 years away from your retirement and you withdraw $10,000. At a 7% average annual growth, that $10,000 could grow to over $70,000. Sure, it’s nice to have the money now, but at what price?
Second, what does this really accomplish besides depleting our savings and future retirement fund? Is it (A) to help spur the economy, (B) to help homeowners pay their mortgages, (C) to help middle class face financial hardship? May be there are other reasons, please feel free to add yours below.
To Spur The Economy
If the hope is to spur the economy, then I don’t think it will work well. Let’s see, you withdraw $10,000 and spend the money. As a result, businesses do better due to influx of cash and the stock market may perform a little better. However, the huge outflow of money from retirement accounts will have the opposite effect. In this case, I think it’s a wash and doesn’t really do anything except making everyone poorer in the long run.
To Help Homeowners Pay Their Mortgages
If you are one of the homeowners who can’t afford your mortgage because you recently lost your job this may help you stay afloat for a few months. Hopefully, you’ll get a new job before the $10,000 runs out, but job is extremely hard to find in this economy. So it may or may not work out.
If you are one of the homeowners who can’t afford your mortgage because the teaser rate on your variable rate mortgage ended, then I don’t think $10,000 will help you for very long. Eventually, you’ll run out of money unless you can make up the difference in a few short months — i.e., by spending less or earning more money.
Here’s another article I wrote about saving your home from foreclosure. Some of these suggestions are quite drastic, but at least you are not trading your future for your home.
To Help Middle Class Face Financial Hardship
This is similar to the situation above. If you don’t have enough money to deal with living expenses, raiding your retirement funds is just a short-term solution that will hurt you in the long run. Again, spending less or earning more money is the proper solution.
Now that we are talking about saving money, here’s a huge list of money saving ideas that you can peruse.
Conclusion
I understand that this proposal is just one of many ways to help shore up the financial crisis and economic hardship faced by millions of Americans. Hopefully this will provide some financial relief, but this is the last thing you should consider. Don’t forget the long-term implications when you are raiding your retirement funds, and make sure that the money you take out really does help.
Here are a few tips on how to handle the slow economy:
- Handling My Finances in a Slow Economy at Single Guy Money
- Tips to Survive a Struggling Economy at Being Frugal
- Living In A Down Economy - Determining Your Bare Bones Budget at I’ve Paid For This Twice Already…
- 5 Strategies to Survive An Economic Slowdown at Moolanomy
- Smart Moves and Hedges in a Bad Economy at The Wisdom Journal
All posts by Pinyo
While the plan to suspend required minimum distributions would be great for my parents since they don’t need the money, it really is a stupid idea because …
1) It only helps those that don’t need the money. These folks then don’t have to pay taxes on the RMDs this year, while the folks who are using the distributions to fund their retirement still have to pay taxes on the withdrawals.
But, I’m all for lowering taxes, so here’s the real reason it’s stupid..
2) Because the main argument people make for it - that folks wont have to sell their stocks at a low point - is pathetically lame.
News flash folks: just because you take money out of your 401k doesn’t mean you automatically have to spend it!!!
How about, you know, immediately reinvesting the money back into the stock market in a taxable account.
Yeah, it’s great to delay paying taxes, but you will have to pay them anyway eventually.
This argument that RMD’s are “forcing” people to sell their stock low is incredibly stupid and needs to go away pronto!
@J - Thank you for sharing your thought.
1. In a way it does help those who need the money as well. If there’s less RMD withdrawals, there’s less downward pressure on the overall stock market.
2. Good point about not having to spend the money, but after taxes you have less to reinvest into the stock market. So it’s not an even exchange.
I don’t believe Obama is thinking about the individuals when he proposed this. I believe he’s thinking about the overall impact on the stock market (which many people think is a barometer for our economic health). It may seems like a small deal when you consider it on an individual basis, but multiply that by a couple of millions and that’s a huge amount of money flowing out of the stock market.
This comment is mainly concerned with the proposal that people be allowed to withdraw 15% up to $10k w/o the 10% penalty.
What about personal responsibility? Should we “force” people to be financially responsible?
I understand that the 10% penalty exists to encourage people not to raid their retirement. I understand that practically speaking, if the penalty doesn’t exist, more people will cash out. However, I’ve still always resented that penalty because i think people ought to be able to make their own decisions about their own money. Even if they are bad decisions.
I agree there is a high opportunity cost, and people will pay for it in the long run. I just don’t agree that it is the government’s responsibility to protect people from themselves. And Obama’s proposal is still protecting 85% of retirement balances, (or more, if they have more than $100k saved). The proposal gives people some choice, while still also protecting most of the assets.
And i think he might actually be thinking about the individuals - how about the individuals that ARE ALREADY dipping into their retirement and having to pay the penalty? Those individuals will be helped by this change.
Thanks for the mention Pinyo!
What I wonder is how many withdrawals that happen today would be tax penalty free under Obama’s plan. What is the tax impact? Because with our government spending, we’re going to need to replace it somewhere. Or is the theory that enough additional people would withdraw to make up for the lost tax penalty revenue?
Hey, I thought Obama was going to buy my gas and pay my mortgage and provide me with healthcare and a social security check???? What’s going on???
Interesting stuff.
Regarding the forced withdrawals - we have the exact same debate going on in Canada because a senior’s group is complaining about the mandatory withdrawals from their rrif accounts. It’s a bit ridiculous - they are complaining that they don’t need the money so why should they have to withdraw it?
Regarding early penalties - I prefer the Canadian plan where there is no penalties at all. I think it’s good to have the freedom to do what you want with your money. If you get laid off now and can’t find a new job then I think you are better off spending retirement money than starving to death!
My question is what does a person do who has stock but has heard Obama wants to tax Capital Gain at 39.6%!!! Do we sell all our stock now, before he does that????
I hope this includes or is extended to include ESOP funds …
I agree with you that allowing penalty-free early withdrawals is a bad idea and will ultimately hurt investors who take advantage of it; however, I am still in favor of the RMD rules. They make it much more difficult for people to shelter income from taxes indefinitely. If you get rid of those rules, you’ll have people dodging the estate tax left and right at which point congress will have to raise taxes on everybody.
@Kyle - Good point about the RMD. I can definitely see the rich folks abusing it.
Both my and my wife’s 401k only offer hardship withdrawals and in my plan I’d have to take a qualifying loan first. Obama’s plan, as near as I can tell, won’t supersede that so we can only take a withdrawal if we can provide some documentation supporting a defined need for the withdrawal like medical expenses, unforeseen home damages (like a storm or fire) or tuition. Then Obama says he won’t penalize us 10% for having to make the hardship withdrawal. Seems fair enough on the face of it.
Frankly, I wish we could take it for just about any reason. That 15% could pay off debt that would make a significant positive impact on our cash flow.
My money, my choice. Taking out 10k to pay off a 20% credit card is a good move. Worthless move if you go out and max out a credit card again, but in general taking a small percentage out of your retirement (especially if it is 30 years away) to pay off high interest debt now will reduce debt and free up cash flow to the economy. You know on those frilly expenditures like milk and eggs.