Obama’s 401k Plan Is A Double-Edged Sword

By Pinyo, on November 12, 2008

Now 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

This article was featured in the Carnival of Economics hosted by Kavmerica.com.

Pinyo is the owner of Moolanomy Personal Finance and an entrepreneur with over 20 years of business experience. He is interested in business management, investing and wealth management. He has written for many online publications, including American Express Currency and U.S. News Money. You can follow him on Facebook and Twitter.

Add Your Question or Comment (28 Comments)

1. J:

   November 12, 2008 at 4:38 pm

   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!
2. Pinyo:

   November 13, 2008 at 8:54 am

   @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.
3. Audrey:

   November 19, 2008 at 12:38 pm

   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.
4. SingleGuyMoney:

   November 19, 2008 at 3:55 pm

   Thanks for the mention Pinyo!
5. Lisa:

   November 19, 2008 at 11:32 pm

   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?
6. Kathy:

   November 19, 2008 at 11:34 pm

   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???
7. ABCs of Investing:

   November 21, 2008 at 12:20 am

   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!
8. Confused:

   November 23, 2008 at 1:29 am

   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????
9. d sprague:

   December 1, 2008 at 8:03 pm

   I hope this includes or is extended to include ESOP funds …
10. Kyle:

    December 5, 2008 at 3:53 pm

    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.
11. Pinyo:

    December 10, 2008 at 12:20 am

    @Kyle – Good point about the RMD. I can definitely see the rich folks abusing it.
12. MyMoney:

    January 6, 2009 at 2:38 pm

    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.
13. Curtis:

    January 7, 2009 at 3:49 pm

    You are obviously a well kept and financially sound person. Why would anyone make an early withdrawal from their retirement account? No one has too, but I would like that opportunity. If I can use my retirement money to pay off debt on 21% signature loans as opposed to keeping it in the stock market and earning a negative 10%, why would I NOT do that? Simple, because I am not allowed to by law. Once my debt is paid off, that extra $4,000 a year, that usually goes to interest at some financial institution that can’t manage their money without help from the government, will now be able to go into “My” retirement account. The laws governing retirement accounts were put their as a forced savings tool. We all know there is no reason to save for the future if you can not live in the present. All I am asking is help from the government to allow me to use my own money. What is the harm in that?
14. Cary:

    January 19, 2009 at 6:54 pm

    I agree with Curtis. We all know that we would like to maximize long term savings in a 401k or IRA. But if short term expenses are killing a person (and 20% and above APRs are common penalty rates on credit cards these days), that small withdrawal could make a dramatic positive change in their immediate cash flow.

    What if that $10K goes to helping a person make a move to start a new job? or keep a mortgage or other debts paid? or simply keep their lights on?

    With a short term fix, that person can then go on to make up that $10K over the near future. Again, we are in a debt crunch, when even those who should be able to borrow for short term needs are getting a no back in answer. I absolutely agree that this should be part of the final bill. We all can soberly discuss maximal savings with the electricity turned on!
15. Texrat:

    January 28, 2009 at 11:30 am

    Some of us will have no choice at all. Things are bad, getting worse, and the ivory tower advice of some doesn’t put food on the table or keep a house of the auction block for those of us losing our jobs.

    http://tabulacrypticum.wordpre.....-the-401k/
16. Pinyo:

    January 28, 2009 at 11:45 am

    @Texrat – Yes, I am arguing from the best case scenario. However, I do recognize that the economy is bad and unemployment number is looking even worse. Unfortunately, some people may not have any option and taking money out will be the best financial option.
17. Texrat:

    January 28, 2009 at 1:01 pm

    It’s good that you are able to acknowledge the unfortunate reality.

    In 2002 I cashed out half my 401K and rolled the rest into a new IRA, taking the eventual penalty hit with the hope I would soon find employment equal to what I had just lost. I wound up out of fulltime work nine months (240 job applications, 3 interviews) but it didn’t take that long for me to realize I had never seen a situation like that before (most jobless periods for me had been 2 months maximum).

    The good news was I doubled that IRA money in 2 years thanks to sharp investments (especially Corning, GLW). The bad news is that even though I moved much of it to low-risk stocks and funds in early 2008 it still lost half its value starting late last year. The worse news is I just lost another job after taking a loan against my 401K for emergency house repair (credit was too tight for any other loan). I can’t pay that loan back in 90 days as required… that’s one reason I’m hoping for some sort of break.

    BTW, up to around 50 applications already after around two months. 6 interviews (2 with recruiters) but no real prospects. I want to WORK.
18. Pinyo:

    January 28, 2009 at 1:15 pm

    @Texrat — Wow, that’s really tough situation you’re facing, and I want to wish you the best. I admit that I am not always aware what other people are going through. I guess you can never really appreciate it until you’re facing it.

    As for repaying your 401k loan, have you considered social lending network? I have an introduction to social lending and borrowing article that may be helpful. If you qualify, you may be able to avoid the taxes and early withdrawal penalty.
19. Texrat:

    January 28, 2009 at 1:43 pm

    Thanks for the reference @Pinyo. I’m glad I checked out your blog!
20. joy griffin-alsheimer:

    February 17, 2009 at 1:40 pm

    I’m personally for taking money out of my 401k now and paying off high interest credit cards and making some needed home improvements rather than losing it on the stock market!
21. joy griffin-alsheimer:

    February 17, 2009 at 1:44 pm

    Is removing my money from my 401k still an option? Is it part of the stimulus or not?
22. Bazz:

    February 23, 2009 at 12:13 pm

    I’m with Joy, still waiting to hear if early penalty free 401K withdrawls were included in the recovery plan as Obama said over and over .
23. Pinyo:

    February 23, 2009 at 10:38 pm

    @Joy and Bazz — I haven’t keep up with the news lately, but I’ll post something if I hear about it. The last thing I heard was aid for homeowners that are at risk of foreclosure, new home buyer credit, and possibly car buyers sales tax deduction.
24. Jen:

    February 26, 2009 at 5:04 pm

    What are the chances the government will some day say “There is so much money in peoples’ personal 401K, IRAs etc, we feel it is in the best interests of the country to take that money for the better good of the nation.” Then they will take that money and use it for whatever they see fit.
25. Pinyo:

    February 26, 2009 at 5:07 pm

    @Jen – I doubt that will happen. Worse case scenario, they will just print more money making our savings worth less.
26. Jen:

    February 27, 2009 at 9:45 am

    I sure hope you are right.
27. mike:

    May 10, 2009 at 3:07 am

    i like not haveing the penalty.
    my wife lost her job i got layed of and had to find another job
    but found one that pays half.
    i had a lone that i used to buy my home.
    and when i left my old job they converted my load to a cash withdrawl
    and i had to pay the penalty.
    i have never had to pay anything to the irs because i have always claimed married but hold out a higher rate.
    not this yr i had to set up a pament plan with them to pay off the tax debt (that was all penalties)

    i could use some help like a no penaly i have always payed my taxes and tried to save for my future and my family. but i had no other options in this matter.
28. Chris:

    August 3, 2009 at 8:58 am

    So in a nutshell, does anyone think that Obama and Congress and the rest want to take our 401ks, IRA, retirement accounts and dump those billions into Government based (3%) retirement accounts for the masses?

    Anyone have any ideas?