401(k) Nightmares: What They Don’t Tell You

Summary

In this video, Grant Cardone delves into the complexities of 401ks, offering insights on their tax structure, associated fees, control limitations, and alternatives. He explains the differences between Roth and Traditional 401ks, emphasizing how taxes are deferred or paid upfront. Cardone highlights the hidden fees that can drastically reduce long-term gains and urges viewers to examine their expense ratios. He also discusses the control limitations imposed by employers and Wall Street on 401k investments and suggests alternatives like IRAs, stocks, real estate, and businesses. Ultimately, he advises viewers to diversify their investments beyond just 401ks for better financial growth.

Takeaways

• 😀 A 401k does not let you avoid taxes; it only defers them until you withdraw the funds. With a Roth 401k, taxes are paid upfront, but withdrawals are tax-free.
• 😀 Traditional 401ks allow you to invest pre-tax money, but you will pay taxes on the amount you withdraw later, which depends on your tax bracket at that time.
• 😀 Roth 401ks require you to pay taxes before contributing, but withdrawals during retirement are tax-free, which could be beneficial for those expecting higher income in retirement.
• 😀 Taxes could increase in the future due to rising national debt, potentially impacting your 401k withdrawals if you have a traditional 401k.
• 😀 401k fees, such as expense ratios, can significantly erode your returns over time. Be sure to check the fee structure of your 401k investments.
• 😀 Even small differences in expense ratios can have a big impact on long-term savings. A 0.85% fee can cost you hundreds of thousands or even millions over several decades.
• 😀 You may have limited control over your 401k investments, as you can only invest in a set of funds chosen by your employer or plan manager, not individual stocks or assets.
• 😀 Some employers offer 401k matching, but be aware of vesting schedules that may require you to stay with the company for several years to fully claim the employer’s contributions.
• 😀 While 401ks are great for starting investments, they should not be the sole investment vehicle. Consider using IRAs, individual stocks, and other asset classes for broader diversification.
• 😀 Alternatives to 401ks include investing in real estate, businesses, and stocks through brokerage accounts or IRAs, offering greater flexibility and potential for higher returns.

Q & A

What is the main difference between a Roth 401k and a Traditional 401k?

The main difference lies in when taxes are paid. With a Traditional 401k, you defer taxes until you withdraw the money in retirement. In contrast, with a Roth 401k, you pay taxes upfront before contributing, but your withdrawals in retirement are tax-free.

What happens to the money you put in a Traditional 401k?

When you contribute to a Traditional 401k, the money grows tax-deferred, meaning you don’t pay taxes on it until you withdraw it. The contributions reduce your taxable income for the year you make them, but you pay taxes when you take the money out.

How does a Roth 401k work differently from a Traditional 401k?

In a Roth 401k, you contribute after-tax income, meaning you pay taxes on the money before it goes in. However, when you withdraw the money in retirement, you won’t owe any taxes, even on the growth.

What should someone consider when deciding between a Traditional and Roth 401k?

The key factor is predicting your future tax rate. If you anticipate a lower tax rate in retirement, a Traditional 401k may be beneficial. If you expect a higher tax rate, or want tax-free withdrawals in retirement, a Roth 401k could be the better choice.

What is an expense ratio in the context of a 401k?

An expense ratio is a fee that is charged by the money manager of your 401k’s investment funds. This fee is a percentage of your investment each year and can impact your returns over time.

Why is it important to understand the expense ratio of your 401k?

The expense ratio is important because it directly affects your investment returns. Even small fees can compound over time, potentially costing you tens of thousands or even millions of dollars in the long term.

What is the impact of a high expense ratio on your 401k?

A high expense ratio means more of your investment returns are going to the money managers as fees. For example, a 0.85% expense ratio could cost you over a million dollars in potential returns over several decades compared to a lower fee.

How can you reduce the impact of fees on your 401k?

To reduce the impact of fees, it's important to review the expense ratios of your 401k’s funds. Look for lower-fee options or funds that provide a good return relative to the fees charged.

What are the limitations of investing in a 401k?

The main limitations of a 401k include a limited selection of investment options, which typically consist of mutual funds or index funds, and a lack of diversification outside of the stock market. This makes 401ks less flexible for certain types of investments like real estate or individual stocks.

What alternatives are there to investing solely in a 401k?

Alternatives to investing solely in a 401k include opening an IRA, investing in individual stocks through a brokerage, buying real estate to rent out, or investing in private businesses or startups, all of which provide more diversification and control over investments.