The following is an old article I published back in 2011. However, it’s still relevant today. Thus, I republish it here for your rogueish eyes:
Your financial adviser never told you that your 401(k) was a trust account.
Does the free market work? Does it provide a way for individuals to save money for their future…whatever that future might be? Government-created tax favors are in place, allegedly, to help individuals save money for their future. Without these plans, the onerous taxing of savings would decimate one’s ability to save money.
Why make long-term plans? Well, we are told, we will retire at some point. We won’t be able to work or we won’t want to (or shouldn’t want to). In the classical sense, retirement is a concept which gained traction in Bismark’s Germany in the late 1800s. His Social Insurance program was the model for future socialized government retirement plans.
Eventually, this concept of “retirement” bled its way into the culture. With those ideas dominating, I think it was inevitable that an entitlement mentality would grip the country and allow disastrous programs like Social Security to take root.
However, these ideas also led to the idea of tax favors and “qualified” retirement plans. How so? Think about this for a moment. How does a country support a Social Security system, and increasing government spending? It raises taxes or borrows more money. This has the effect of decreasing both the amount and the value of savings (and money itself) in each and every person’s bank account.
When a politician asks if you want some of that money back, you might scream “yes!” When the politicians answer, they say “OK, there is a program I want to give you called a 401(k)”. When the country agrees to that kind of deal, no one questions whether a 401k plan is right or good, they just argue over tweaks to the system, whether a Roth vs 401k plans are better, how many tax deductions they’re allowed during the year, and whether they get tax credits for investing in certain investments.
The Proposed Incentive
401k) plans are supposed to encourage saving money. They do make it easy. The process, as described in my textbook “Practicing Financial Planning for Professionals” by Sid Mittra, Anandi P. Sahu and Robert A Crane, is outlined as thus:
The employee agrees to take a salary reduction equal to the contribution and is not taxed on the contribution except for F.I.C.A. (Social Security) taxes.
Such “contributions” are, in actuality, a deferral of compensation which accounts for the fact that contributions are not taxed. According to the Employee Retirement Income Security Act:
(a) Benefit plan assets to be held in trust; authority of trustees Except as provided in subsection (b) of this section, all assets of an employee benefit plan shall be held in trust by one or more trustees.
A trust is an arrangement where you transfer assets to an entity which holds and manages the assets. You technically do not own the assets, the trust does. Furthermore, the trustee has the final say about what happens to the money. This doesn’t happen with your 401(k) you say? Yes, it does. Really:
the trustee or trustees shall have exclusive authority and discretion to manage and control the assets of the plan.
Normally, this isn’t a problem and you’re allowed to select investments within the account. I think this is awfully generous, considering. Mind you, I don’t have anything against trust accounts. They can be, however, a double edged sword.
The Real Incentive
I think the real incentive of 401(k) plans is to get you to defer money into an investment account through government-created tax loopholes so that you’re more dependent on government favors. Why would they do this? Well, for whatever reason they want. If the government is short on cash, or they need to find a buyer for Treasuries (or other government debt), they have trust accounts galore to draw upon. Why is this bad? Because it encourages dependence rather than independence. It promotes the idea that the government has the right to tell you where you can save money, how much you can save and how much you will keep after taxes according to where you put that savings.
If the government really wanted to incentivize savings, they would just leave individuals alone. They would let you put the money wherever you wanted. They wouldn’t tax savings at all–regardless of what investment account you used.
What is the solution to the problem? Simple. End all qualified retirement plans. Reduce and eliminate taxes on savings and leave people alone to make decisions about where they save money, how much they save and where they invest. In the end, I don’t think it’s about a Roth vs. 401k. Why do I say that?
Well, there was a time when there were no 401(k) plans or Roth accounts for that matter. Most individuals who wanted to save money for long-term goals invested in private insurance and investment policies, real estate and some stocks. There were no real problems with any of these financial products. The problems arose during the 1970s when tax rates increased dramatically. The government responded by crushing the life insurance industry in the early 1980s (which had traditionally served so-called “middle America”) with a new IRS code section 7702.
The government also decided to modify the way people invested for their future by making other tax code changes including the addition of section 401. Contrary to the claims of deregulation at this time, regulation was actually increasing and shifting towards stronger controls despite the simplification of some laws.
The problems created then persist to this day. The problem is government laws which deny you of the right to keep your savings–money you have earned and have a moral right to–free of any tax. The solution is to strip away all laws which deny you the right to keep the product of your own efforts. The solution is to stop taxing income and, as a result, savings.