WEBVTT 00:00:00.000 --> 00:00:02.000 Welcome back to the Deep Dive, where we extract 00:00:02.000 --> 00:00:04.200 the most vital insights from the stack of sources 00:00:04.200 --> 00:00:07.740 you need to master. Today, we are wrestling with 00:00:07.740 --> 00:00:11.439 a giant, the retirement savings vehicle that 00:00:11.439 --> 00:00:15.240 really defines modern American finance, the 401k. 00:00:15.380 --> 00:00:17.859 It really is. It's absolutely central to the 00:00:17.859 --> 00:00:21.280 financial lives of millions. And yet, for something 00:00:21.280 --> 00:00:24.280 holding, what, around $6 .4 trillion in assets? 00:00:24.399 --> 00:00:26.640 A staggering number. Yeah, the complexity and 00:00:26.640 --> 00:00:29.559 the jargon are just... They're staggering. Our 00:00:29.559 --> 00:00:31.640 goal today is to take you beyond that acronym. 00:00:31.699 --> 00:00:34.039 We want to give you not just the rules and the 00:00:34.039 --> 00:00:37.100 limits, but the strategy and really the philosophy 00:00:37.100 --> 00:00:39.159 behind them. Exactly. And we've pulled together 00:00:39.159 --> 00:00:40.780 everything we could find. We've got the historical 00:00:40.780 --> 00:00:44.659 records, the detailed IRS rules, and some surprisingly 00:00:44.659 --> 00:00:47.020 sharp criticism. Including one from the man who 00:00:47.020 --> 00:00:49.060 basically created the modern version of the plan. 00:00:49.299 --> 00:00:51.079 Right. So our mission for you, the listener, 00:00:51.259 --> 00:00:54.439 is pretty simple. We want to demystify the structure, 00:00:54.659 --> 00:00:56.539 help you understand the mechanics, and really 00:00:56.539 --> 00:00:59.799 evaluate the tradeoffs of this powerful, but 00:00:59.799 --> 00:01:02.460 let's be honest, very complicated savings vehicle. 00:01:02.679 --> 00:01:05.239 And the deeper you look, the more striking the 00:01:05.239 --> 00:01:07.780 history becomes. I mean, this cornerstone of 00:01:07.780 --> 00:01:09.959 national retirement savings. It was never designed 00:01:09.959 --> 00:01:12.579 to be a national system. No, not at all. And 00:01:12.579 --> 00:01:14.409 this is where it gets really interesting. The 00:01:14.409 --> 00:01:17.049 401k was an unexpected legislative accident. 00:01:17.230 --> 00:01:20.049 It came out of the Revenue Act of 1978, and it 00:01:20.049 --> 00:01:22.549 started as a loophole. A niche tax strategy. 00:01:22.750 --> 00:01:25.909 Exactly. A niche strategy to help highly compensated 00:01:25.909 --> 00:01:29.489 executives minimize their tax exposure. And this 00:01:29.489 --> 00:01:32.090 is the key part. This was during a period when 00:01:32.090 --> 00:01:35.650 the top marginal income tax rate was a jaw -dropping 00:01:35.650 --> 00:01:38.769 70%. We will definitely come back to how that 00:01:38.769 --> 00:01:41.409 context shaped the system we have today. Hashtag 00:01:41.409 --> 00:01:43.450 I, the unexpected history and core definition. 00:01:44.120 --> 00:01:45.939 OK, let's unpack this from the very beginning. 00:01:46.079 --> 00:01:48.920 We hear the term 401k all the time. But what 00:01:48.920 --> 00:01:51.400 exactly I mean, what does that specific subsection 00:01:51.400 --> 00:01:54.019 of the U .S. Internal Revenue Code officially 00:01:54.019 --> 00:01:56.700 define it as? Well, at its heart, it's an employer 00:01:56.700 --> 00:01:59.180 sponsored defined contribution plan. OK, defined 00:01:59.180 --> 00:02:02.019 contribution. Break that down. That phrase is 00:02:02.019 --> 00:02:04.500 absolutely key. It means the benefit you get 00:02:04.500 --> 00:02:06.920 in retirement is defined only by how much is 00:02:06.920 --> 00:02:10.289 put in by you and your employer. And how well 00:02:10.289 --> 00:02:12.270 those investments do over time. So it's not a 00:02:12.270 --> 00:02:14.210 guarantee? No, not at all. It's a personal retirement 00:02:14.210 --> 00:02:16.669 savings account that is tethered to your job. 00:02:16.849 --> 00:02:20.090 And the main mechanism is that employees make 00:02:20.090 --> 00:02:22.710 these periodic contributions, either pre -tax 00:02:22.710 --> 00:02:25.090 or post -tax, straight from their paychecks, 00:02:25.090 --> 00:02:27.150 right? Straight from the paycheck, often supplemented 00:02:27.150 --> 00:02:29.789 by an employer match. And from the employer's 00:02:29.789 --> 00:02:32.590 side, from a bookkeeping perspective, which you 00:02:32.590 --> 00:02:36.110 as the employee never see, those funds are handled 00:02:36.110 --> 00:02:39.270 in a very specific way. Oh, so? The second that 00:02:39.270 --> 00:02:41.669 money is withheld, the employer's obligation 00:02:41.669 --> 00:02:44.710 to send it to the plan administrator is immediately 00:02:44.710 --> 00:02:47.490 classified on their books, on the general ledger, 00:02:47.590 --> 00:02:50.229 as a payroll liability account. So it's money 00:02:50.229 --> 00:02:53.169 they legally owe. Instantly. And they have to 00:02:53.169 --> 00:02:54.969 transfer it, usually within a few business days. 00:02:55.189 --> 00:02:58.169 It's a highly regulated, very current liability. 00:02:58.650 --> 00:03:00.909 Now let's get back to that unexpected history. 00:03:01.189 --> 00:03:03.050 You mentioned this kind of plan was actually 00:03:03.050 --> 00:03:05.349 banned for a while. What was going on in the 00:03:05.349 --> 00:03:09.379 70s? Yeah. So before 1974, some employers offered 00:03:09.379 --> 00:03:11.960 this choice, a cash or deferred option. You could 00:03:11.960 --> 00:03:15.099 take the money as taxable cash now or you could 00:03:15.099 --> 00:03:16.960 have the employer put it into a retirement plan 00:03:16.960 --> 00:03:20.099 for you. OK. But Congress got worried. They saw 00:03:20.099 --> 00:03:22.039 that these were being used maybe a little too 00:03:22.039 --> 00:03:25.439 aggressively by. High -paid people, mostly for 00:03:25.439 --> 00:03:27.159 tax sheltering, so they just put a stop to it. 00:03:27.199 --> 00:03:29.620 They put a moratorium on any new plans while 00:03:29.620 --> 00:03:31.860 they studied how to regulate them. And that study 00:03:31.860 --> 00:03:34.639 led to the Revenue Act of 1978. Exactly. The 00:03:34.639 --> 00:03:36.979 new legislation got wrapped into that massive 00:03:36.979 --> 00:03:41.159 act, specifically in Section 401K, which reauthorized 00:03:41.159 --> 00:03:43.719 these cash or deferred plans, but only if they 00:03:43.719 --> 00:03:46.680 met these new... much stricter non -discrimination 00:03:46.680 --> 00:03:49.319 tests. And companies jumped on it pretty fast. 00:03:49.659 --> 00:03:52.080 Incredibly fast. I mean, that reauthorization 00:03:52.080 --> 00:03:55.060 was enacted in November of 78. And the records 00:03:55.060 --> 00:03:57.259 we have show that a company like Hughes Aircraft 00:03:57.259 --> 00:03:59.560 was among the very first to implement a plan 00:03:59.560 --> 00:04:02.620 just weeks later. Wow. It shows they were already 00:04:02.620 --> 00:04:04.419 thinking about how to transition their existing 00:04:04.419 --> 00:04:07.919 savings plans into this new, you know, tax -advantaged 00:04:07.919 --> 00:04:10.110 framework. But the real name to know here is 00:04:10.110 --> 00:04:13.189 Ted Benna. He's the one who gets credit for creating 00:04:13.189 --> 00:04:16.610 the first truly functioning 401k plan at his 00:04:16.610 --> 00:04:18.990 employer, the Johnson Companies. And his goal 00:04:18.990 --> 00:04:21.610 wasn't to, you know, save America's retirement. 00:04:21.670 --> 00:04:24.230 No, his motivation was purely tactical. It was 00:04:24.230 --> 00:04:26.910 all about cutting the current tax bill for executives. 00:04:27.129 --> 00:04:29.810 Right. Benna was working with these bank executives 00:04:29.810 --> 00:04:32.149 who were getting deferred compensation bonuses 00:04:32.149 --> 00:04:34.810 and they were just desperate for a way to shelter 00:04:34.810 --> 00:04:37.160 that income. And you have to put yourself in 00:04:37.160 --> 00:04:39.819 their shoes, a high earner in the late 70s, early 00:04:39.819 --> 00:04:43.319 80s, looking at a marginal tax rate of 70%. I 00:04:43.319 --> 00:04:45.680 mean, that's a massive financial incentive. You're 00:04:45.680 --> 00:04:48.759 going to find any legal way you can to push that 00:04:48.759 --> 00:04:50.819 income into a structure where it's not taxed 00:04:50.819 --> 00:04:54.300 immediately. 70%. That context just changes everything 00:04:54.300 --> 00:04:56.699 about why this was created. The whole point of 00:04:56.699 --> 00:04:59.160 the original 401k was about minimizing a huge 00:04:59.160 --> 00:05:02.300 current tax bill. It wasn't about, say, long 00:05:02.300 --> 00:05:04.100 -term compound interest for the middle class. 00:05:04.480 --> 00:05:08.370 Precisely. Benner realized the new 401k language 00:05:08.370 --> 00:05:11.470 let employees defer salary on a pre -tax basis 00:05:11.470 --> 00:05:14.470 and that it could apply to current income, not 00:05:14.470 --> 00:05:17.370 just profit sharing. His first plan let people 00:05:17.370 --> 00:05:20.370 contribute up to 25 % of their salary capped 00:05:20.370 --> 00:05:22.790 at $30 ,000 a year. Those are huge numbers for 00:05:22.790 --> 00:05:25.430 back then. They are. And they clearly show the 00:05:25.430 --> 00:05:27.750 initial focus was on high earner tax mitigation. 00:05:27.970 --> 00:05:31.939 That niche idea just... It exploded and it morphed 00:05:31.939 --> 00:05:33.819 into the mass retirement vehicle we have today, 00:05:33.980 --> 00:05:36.319 almost completely by accident. So this accidental 00:05:36.319 --> 00:05:38.399 history brings us right to the most fundamental 00:05:38.399 --> 00:05:41.220 decision you face when you open a new 401k. The 00:05:41.220 --> 00:05:43.899 big one. Traditional or Roth. This choice is 00:05:43.899 --> 00:05:46.420 all about when you pay the tax bill. And, you 00:05:46.420 --> 00:05:48.519 know, tax experts have these models for it. E 00:05:48.519 --> 00:05:50.680 .T. and T. Right. The traditional plan follows 00:05:50.680 --> 00:05:53.699 the exempt, exempt, taxed or E .T. model. And 00:05:53.699 --> 00:05:55.579 the Roth's follows the taxed, exempt, exempt 00:05:55.579 --> 00:05:58.250 or two model. And the critical thing to see here 00:05:58.250 --> 00:06:00.529 is that in both models, that middle E, the middle 00:06:00.529 --> 00:06:02.930 exempt, refers to the growth. The growth of your 00:06:02.930 --> 00:06:05.810 investments is permanently tax -free. You never, 00:06:05.850 --> 00:06:07.889 ever pay tax on the profits your money generates. 00:06:08.250 --> 00:06:10.689 Okay, so let's start with the classic, the traditional 00:06:10.689 --> 00:06:15.470 or pre -tax 401k, the classic deferral. So when 00:06:15.470 --> 00:06:17.910 you contribute to a traditional account, that 00:06:17.910 --> 00:06:20.290 money gets deducted from your taxable income 00:06:20.290 --> 00:06:23.509 for this year. So you get an immediate tax break. 00:06:23.920 --> 00:06:25.839 an immediate and if you're in a high tax bracket 00:06:25.839 --> 00:06:28.420 a powerful break it's a very substantial benefit 00:06:28.420 --> 00:06:32.240 but and this is important the deferral only applies 00:06:32.240 --> 00:06:34.879 to your income tax what about payroll taxes you 00:06:34.879 --> 00:06:37.779 still pay them crucially you still pay the full 00:06:37.779 --> 00:06:40.819 7 .65 percent for social security and medicare 00:06:40.819 --> 00:06:44.339 on that contribution that tax is not deferred 00:06:44.339 --> 00:06:46.000 it doesn't matter if you choose traditional or 00:06:46.000 --> 00:06:49.110 raw and the income tax bill just It comes due 00:06:49.110 --> 00:06:50.930 later. It comes due when you take the money out 00:06:50.930 --> 00:06:52.689 in retirement. So if you're a listener, you're 00:06:52.689 --> 00:06:54.769 essentially making a bet. That's a great way 00:06:54.769 --> 00:06:57.029 to put it. You're betting that your personal 00:06:57.029 --> 00:06:59.589 income tax rate, your marginal rate, is going 00:06:59.589 --> 00:07:01.730 to be lower when you retire than it is right 00:07:01.730 --> 00:07:04.149 now in your prime earning years. That is the 00:07:04.149 --> 00:07:06.230 core calculation. If you contribute while you're 00:07:06.230 --> 00:07:09.209 in a 35 % bracket and you retire into a 15 % 00:07:09.209 --> 00:07:12.430 bracket, you win that bet. Big time. But what 00:07:12.430 --> 00:07:20.079 if you lose? required minimum distributions force 00:07:20.079 --> 00:07:23.100 you to withdraw a lot of money, and that pushes 00:07:23.100 --> 00:07:25.540 your retirement income into a higher tax bracket 00:07:25.540 --> 00:07:28.240 than when you contributed, then the deferral 00:07:28.240 --> 00:07:30.860 actually backfires. It becomes a penalty. Okay, 00:07:30.920 --> 00:07:33.220 now let's flip that for the Roth 401k. With the 00:07:33.220 --> 00:07:36.379 Roth, the pain is all up front. Exactly. Roth 00:07:36.379 --> 00:07:38.279 contributions are made with post -tax money. 00:07:38.620 --> 00:07:41.579 You don't get a tax deduction now, so you feel 00:07:41.579 --> 00:07:44.930 that tax hit immediately. But the monumental 00:07:44.930 --> 00:07:47.769 benefit is on the back end. Tax -free. Qualified 00:07:47.769 --> 00:07:50.410 distributions in retirement are completely 100 00:07:50.410 --> 00:07:53.470 % tax -free. Right. You will never owe the government 00:07:53.470 --> 00:07:55.569 another dime on that money. Not the principal, 00:07:55.750 --> 00:07:57.829 not the growth. So let's be very clear about 00:07:57.829 --> 00:07:59.850 the rules for qualified distributions. They're 00:07:59.850 --> 00:08:02.189 strict. Very strict. We looked into the code 00:08:02.189 --> 00:08:03.990 and two things have to be true at the same time. 00:08:04.509 --> 00:08:06.870 First, the distribution has to happen more than 00:08:06.870 --> 00:08:09.649 five years after your very first Roth contribution 00:08:09.649 --> 00:08:12.310 to that specific plan. The five -year clock. 00:08:12.829 --> 00:08:14.889 Right. And second, the withdrawal can't be made 00:08:14.889 --> 00:08:18.170 before you turn 59 and a half unless a very specific 00:08:18.170 --> 00:08:20.709 exception applies, which are detailed in IRS 00:08:20.709 --> 00:08:23.589 code section 72T. And there's a key administrative 00:08:23.589 --> 00:08:27.189 difference here from an IRA. A Roth 401k contribution, 00:08:27.569 --> 00:08:31.009 once you make it, it's set in stone. It's irrevocable. 00:08:31.230 --> 00:08:34.009 You can't later convert it back to a pre -tax 00:08:34.009 --> 00:08:36.850 traditional contribution. With a Roth IRA, you 00:08:36.850 --> 00:08:40.059 can do that. Not so with a 401k. So this brings 00:08:40.059 --> 00:08:42.240 us to what you said is the profound insight connecting 00:08:42.240 --> 00:08:45.039 both accounts. The permanently tax -free profits 00:08:45.039 --> 00:08:47.720 on your after -tax savings. This is the real 00:08:47.720 --> 00:08:50.399 A -plus advantage. It's not the deferral itself. 00:08:50.720 --> 00:08:52.639 Okay, this is a nuanced point, and I think we 00:08:52.639 --> 00:08:54.379 really need to spend a minute on it because it 00:08:54.379 --> 00:08:55.980 forces you to think about the traditional account 00:08:55.980 --> 00:08:58.159 in a totally different way. It really does. So 00:08:58.159 --> 00:09:00.340 let's use a conceptual model. Think of it as 00:09:00.340 --> 00:09:02.840 the government co -owner. When you contribute 00:09:02.840 --> 00:09:05.419 pre -tax to a traditional account, you get that 00:09:05.419 --> 00:09:08.879 immediate tax reduction. Conceptually, that tax 00:09:08.879 --> 00:09:10.940 reduction is the government investing its share 00:09:10.940 --> 00:09:14.059 right alongside yours. They are essentially lending 00:09:14.059 --> 00:09:17.899 you that money to invest tax -free. So if I contribute 00:09:17.899 --> 00:09:23.399 $1 ,000 and my tax rate is, say, 25%, the government 00:09:23.399 --> 00:09:26.200 basically owns $250 of that amount, but I get 00:09:26.200 --> 00:09:28.379 to invest and manage the whole $1 ,000. Exactly 00:09:28.379 --> 00:09:31.779 right. And that full $1 ,000... grows tax -free 00:09:31.779 --> 00:09:34.379 for decades. When you finally take a distribution 00:09:34.379 --> 00:09:36.779 in retirement, the tax you pay on that withdrawal 00:09:36.779 --> 00:09:39.759 is just the government reclaiming its $250 share 00:09:39.759 --> 00:09:42.419 of the principal. Okay. Plus the profits that 00:09:42.419 --> 00:09:45.559 its $250 share generated, all calculated at whatever 00:09:45.559 --> 00:09:47.919 your tax rate is in retirement. So the withdrawal 00:09:47.919 --> 00:09:50.750 tax isn't a tax on my growth. It's just the government 00:09:50.750 --> 00:09:53.710 taking back its loan plus its share of the profits. 00:09:53.970 --> 00:09:57.409 The money I actually saved, my original $750, 00:09:57.789 --> 00:10:01.110 that part grew tax -free forever. That is the 00:10:01.110 --> 00:10:03.769 crucial synthesis. The only real difference between 00:10:03.769 --> 00:10:06.190 traditional and Roth is who gets to benefit from 00:10:06.190 --> 00:10:08.009 the leverage on the government's portion. Right. 00:10:08.090 --> 00:10:10.509 If you bet correctly on a lower tax rate in retirement, 00:10:10.649 --> 00:10:12.690 you win because the government takes less back. 00:10:13.149 --> 00:10:15.429 But the tax -free growth is the core feature 00:10:15.429 --> 00:10:17.149 of the whole vehicle no matter when you pay the 00:10:17.149 --> 00:10:22.470 tax. To boil that all down, the only true benefit 00:10:22.470 --> 00:10:25.470 in both systems is tax -free growth, and the 00:10:25.470 --> 00:10:28.029 timing of the tax is just a bet on future tax 00:10:28.029 --> 00:10:30.250 rates. Is that the simplest way to say it? That 00:10:30.250 --> 00:10:32.389 is the most accurate assessment. And one last 00:10:32.389 --> 00:10:34.190 point on eligibility that we have to mention. 00:10:34.549 --> 00:10:37.490 The Roth 401k has a really big advantage over 00:10:37.490 --> 00:10:39.289 the Roth IRA for some people. You're talking 00:10:39.289 --> 00:10:42.690 about high earners. Yes. The Roth IRA has a strict 00:10:42.690 --> 00:10:45.549 upper income limit. If you earn too much, you 00:10:45.549 --> 00:10:48.350 just can't contribute, period. The Roth 401k, 00:10:48.409 --> 00:10:50.490 on the other hand, has no income restriction 00:10:50.490 --> 00:10:53.149 at all. This makes it an incredibly valuable 00:10:53.149 --> 00:10:56.230 tool for what the IRS calls highly compensated 00:10:56.230 --> 00:10:59.269 employees, or HCEs, who are locked out of the 00:10:59.269 --> 00:11:01.789 Roth IRA. It gives them a way to get that permanently 00:11:01.789 --> 00:11:03.990 tax -free growth that's otherwise unavailable 00:11:03.990 --> 00:11:06.409 to them. OK, so shifting from that philosophical 00:11:06.409 --> 00:11:09.850 choice to the hard reality of compliance, the 00:11:09.850 --> 00:11:12.009 annual contribution limits. And these are absolutely 00:11:12.009 --> 00:11:13.929 unforgiving. If you get this wrong, the penalties 00:11:13.929 --> 00:11:15.730 can be devastating. So we need to break down 00:11:15.730 --> 00:11:17.570 two separate limits. The first one is the one 00:11:17.570 --> 00:11:19.289 most people know about, and it limits what you, 00:11:19.389 --> 00:11:22.110 the employee, can put in from your salary. That's 00:11:22.110 --> 00:11:24.909 the employee elective deferral limit, or if you 00:11:24.909 --> 00:11:27.509 want the code, the 402G limit. For the latest 00:11:27.509 --> 00:11:30.230 year we have in our sources, that limit was $23 00:11:30.230 --> 00:11:34.509 ,000 for 2024. And that's a combined total, right, 00:11:34.590 --> 00:11:37.830 for both your traditional pre -tax and any Roth 00:11:37.830 --> 00:11:40.590 post -tax contributions you make. It all goes 00:11:40.590 --> 00:11:42.610 in one bucket against that limit. And these limits 00:11:42.610 --> 00:11:45.289 aren't static. No, they're indexed for inflation. 00:11:45.409 --> 00:11:48.750 They usually go up in $500 increments. And Congress 00:11:48.750 --> 00:11:51.809 also created a special provision for older workers, 00:11:52.009 --> 00:11:54.769 the catch -up contribution. This is for employees 00:11:54.769 --> 00:11:57.769 who are age 50 or older at any point during the 00:11:57.769 --> 00:12:01.059 year. For 2024, that catch -up limit was an extra 00:12:01.059 --> 00:12:04.980 $7 ,500. So an older employee could contribute 00:12:04.980 --> 00:12:09.059 up to $30 ,500 in total. And our sources pointed 00:12:09.059 --> 00:12:12.019 out a very specific temporary increase to that 00:12:12.019 --> 00:12:15.659 catch -up limit coming in 2025 and 2026, specifically 00:12:15.659 --> 00:12:18.799 for people aged 60 through 63. So that's a targeted 00:12:18.799 --> 00:12:20.799 effort to let people who are really close to 00:12:20.799 --> 00:12:23.840 retirement save even more right at the end. Exactly. 00:12:23.940 --> 00:12:25.879 It's a government push to facilitate that late 00:12:25.879 --> 00:12:27.970 -stage saving. Okay, so that's just the employees 00:12:27.970 --> 00:12:30.669 part. The second limit is much, much higher. 00:12:30.850 --> 00:12:33.169 It's the total amount that can go into the account 00:12:33.169 --> 00:12:36.169 from all sources, employee and employer. That's 00:12:36.169 --> 00:12:39.090 the Section 415 limit. This is the absolute ceiling. 00:12:39.269 --> 00:12:41.950 It includes your deferrals, your catch -up, any 00:12:41.950 --> 00:12:44.490 employer match, and any profit sharing. And the 00:12:44.490 --> 00:12:47.909 limit is? It's the lesser of 100 % of your compensation 00:12:47.909 --> 00:12:52.929 or a statutory dollar amount. For 2024, that 00:12:52.929 --> 00:12:56.460 was $69 ,000. plus your catch -up if you're eligible. 00:12:56.679 --> 00:12:58.919 We should probably clarify how the employer match 00:12:58.919 --> 00:13:01.320 works with the Roth choice because that can be 00:13:01.320 --> 00:13:03.960 confusing. It can. Employer matching funds are 00:13:03.960 --> 00:13:06.500 great, but they always have to be made on a pre 00:13:06.500 --> 00:13:09.620 -tax traditional basis. Always. Always. So if 00:13:09.620 --> 00:13:12.200 you contribute $10 ,000 to your Roth 401k and 00:13:12.200 --> 00:13:15.340 your employer puts in a $5 ,000 match, that $5 00:13:15.340 --> 00:13:17.679 ,000 from them is traditional money, you'll pay 00:13:17.679 --> 00:13:19.500 tax on it when you withdraw it down the road. 00:13:19.679 --> 00:13:21.799 And some companies also do profit -sharing contributions. 00:13:22.360 --> 00:13:25.409 Yes. And those are separate from your own contributions. 00:13:25.809 --> 00:13:28.669 But just like the match, those profit sharing 00:13:28.669 --> 00:13:31.549 dollars are pre -tax and they count toward that 00:13:31.549 --> 00:13:35.610 big aggregate Section 415 limit. Before we get 00:13:35.610 --> 00:13:38.519 into penalties. There's a specific group of workers 00:13:38.519 --> 00:13:41.000 who are sort of left out here, government employees. 00:13:41.320 --> 00:13:43.340 Right. Federal, state, and local governments 00:13:43.340 --> 00:13:46.240 are generally barred from offering 401K plans 00:13:46.240 --> 00:13:49.519 if the plan was established after May of 1986. 00:13:50.279 --> 00:13:52.120 They usually offer something called a Section 00:13:52.120 --> 00:13:55.899 457B plan. Which is similar but not identical. 00:13:56.299 --> 00:13:58.779 Similar limits but different rules, especially 00:13:58.779 --> 00:14:00.320 around when you can get your money after you 00:14:00.320 --> 00:14:02.440 leave your job. Okay. Let's talk about the danger 00:14:02.440 --> 00:14:05.090 zone. Over -contribution. This happens a lot 00:14:05.090 --> 00:14:06.769 when someone switches jobs mid -year, right? 00:14:06.809 --> 00:14:09.049 Oh, it's a huge risk. The new company's payroll 00:14:09.049 --> 00:14:11.990 system has no idea what you contributed at your 00:14:11.990 --> 00:14:15.350 old job. But the limits apply to you, personally, 00:14:15.549 --> 00:14:17.590 across all the plans you participate in for the 00:14:17.590 --> 00:14:20.769 year. And if you go over that 402G limit... You 00:14:20.769 --> 00:14:23.090 have to fix it. The excess contribution, plus 00:14:23.090 --> 00:14:25.370 any earnings it generated, has to be distributed 00:14:25.370 --> 00:14:27.850 back to you by April 15th of the following year. 00:14:28.110 --> 00:14:30.549 And if you miss that deadline, you fall into 00:14:30.549 --> 00:14:33.389 the double taxation drought. How does the IRS 00:14:33.389 --> 00:14:36.909 manage to tax you twice on the same money? It's 00:14:36.909 --> 00:14:40.190 brutal. The initial excess contribution was never 00:14:40.190 --> 00:14:42.809 a valid deferral, so it's taxable income in the 00:14:42.809 --> 00:14:45.029 year you earned it. That's tax number one. But 00:14:45.029 --> 00:14:48.110 if you make the correction late, the distribution 00:14:48.110 --> 00:14:50.850 of that excess money is also reported as income 00:14:50.850 --> 00:14:52.789 in the year you take it out. That's tax number 00:14:52.789 --> 00:14:55.330 two. You get taxed twice on the principal amount 00:14:55.330 --> 00:14:57.769 you contributed by mistake. that is just a punishing 00:14:57.769 --> 00:15:01.230 outcome for what could be a simple mistake okay 00:15:01.230 --> 00:15:03.690 finally let's quickly hit the contribution deadlines 00:15:03.690 --> 00:15:05.990 they're different depending on the business they 00:15:05.990 --> 00:15:09.409 are for a standard corporation or an llc taxed 00:15:09.409 --> 00:15:12.110 as one contributions generally have to be in 00:15:12.110 --> 00:15:15.169 by the end of the calendar year but for unincorporated 00:15:15.169 --> 00:15:17.779 businesses Sole proprietorships, partnerships, 00:15:18.220 --> 00:15:21.379 the deadline is much better. How so? It's extended 00:15:21.379 --> 00:15:23.659 all the way to your personal tax filing deadline. 00:15:23.720 --> 00:15:26.799 So April 15th or even September 15th, if you 00:15:26.799 --> 00:15:29.700 file an extension. The 401k is designed for long 00:15:29.700 --> 00:15:32.159 term saving and the IRS uses some pretty heavy 00:15:32.159 --> 00:15:34.139 financial incentives to make sure it stays that 00:15:34.139 --> 00:15:36.480 way. Absolutely. So we need to get into the rules 00:15:36.480 --> 00:15:38.700 around early access, starting with the big one, 00:15:38.779 --> 00:15:41.059 the general penalty age. The magic number is 00:15:41.059 --> 00:15:44.159 59 and a half. If you take any money out before 00:15:44.159 --> 00:15:47.309 then. you get hit twice. First, you pay ordinary 00:15:47.309 --> 00:15:49.309 income tax on the amount. And second, you pay 00:15:49.309 --> 00:15:52.769 a separate, very painful 10 % penalty excise 00:15:52.769 --> 00:15:55.429 tax. So it's designed to make you think twice 00:15:55.429 --> 00:15:59.090 or three times. It is. It's there to ensure the 00:15:59.090 --> 00:16:01.149 money stays invested for its intended purpose, 00:16:01.330 --> 00:16:03.809 which is retirement. OK, but there are emergency 00:16:03.809 --> 00:16:06.970 exits. The one people ask about most is the hardship 00:16:06.970 --> 00:16:10.149 withdrawal. The IRS has a very narrow definition 00:16:10.149 --> 00:16:12.990 of a real hardship. Very narrow. The code lays 00:16:12.990 --> 00:16:16.070 out six specific reasons. Things like unreimbursed 00:16:16.070 --> 00:16:18.470 medical expenses, costs for buying your primary 00:16:18.470 --> 00:16:21.110 home, some educational costs for the next 12 00:16:21.110 --> 00:16:23.929 months. Things to prevent foreclosure or eviction. 00:16:24.210 --> 00:16:26.549 Right. Funeral expenses or repairs for damage 00:16:26.549 --> 00:16:29.330 to your main home. It's a specific list. But 00:16:29.330 --> 00:16:31.289 then this is the crucial part for you, the listener. 00:16:32.139 --> 00:16:34.759 IRS says it's okay, your employer can still say 00:16:34.759 --> 00:16:37.419 no. That's the critical footnote. The employer 00:16:37.419 --> 00:16:40.460 is the final gatekeeper. The specific plan document 00:16:40.460 --> 00:16:44.100 determines what's allowed. An employer can, and 00:16:44.100 --> 00:16:48.159 often does, choose to disallow some or even all 00:16:48.159 --> 00:16:50.419 of those hardship reasons. And we should probably 00:16:50.419 --> 00:16:53.120 mention, you know, the CARES Act in 2020 was 00:16:53.120 --> 00:16:55.639 a temporary exception to all this. It was. It 00:16:55.639 --> 00:16:58.080 allowed penalty -free withdrawals. of up to $100 00:16:58.080 --> 00:17:00.860 ,000 for people dealing with pandemic -related 00:17:00.860 --> 00:17:03.779 issues. But that was a very specific, temporary 00:17:03.779 --> 00:17:06.900 measure. So beyond hardship, what are the other 00:17:06.900 --> 00:17:09.579 common ways to get your money early without that 00:17:09.579 --> 00:17:12.160 10 % penalty? Well, the sources list a few key 00:17:12.160 --> 00:17:14.960 exceptions. If you leave your job in or after 00:17:14.960 --> 00:17:17.079 the year you turn 55, that's called the age 55 00:17:17.079 --> 00:17:20.119 rule, you avoid the penalty. You also avoid it 00:17:20.119 --> 00:17:22.740 in cases of death or total and permanent disability, 00:17:23.099 --> 00:17:25.240 distributions that are part of a divorce settlement, 00:17:25.400 --> 00:17:28.440 a QDRO. Also avoid it. And then there's a complex 00:17:28.440 --> 00:17:30.880 one called substantially equal periodic payments 00:17:30.880 --> 00:17:34.279 or 72T payments. Let's talk about 401K loans. 00:17:34.420 --> 00:17:36.680 A lot of people see this as borrowing from yourself. 00:17:36.960 --> 00:17:39.180 You know, no big deal. But there's a hidden tax 00:17:39.180 --> 00:17:42.059 flaw. There is. On the surface, it seems great. 00:17:42.259 --> 00:17:44.960 The interest you pay on the loan goes right back 00:17:44.960 --> 00:17:46.859 into your own 401K account. So you're kind of 00:17:46.859 --> 00:17:48.900 paying yourself interest. Right. The problem, 00:17:49.000 --> 00:17:51.259 the tax complexity, comes from the fact that 00:17:51.259 --> 00:17:53.700 you make those loan repayments, including the 00:17:53.700 --> 00:17:56.430 interest, using after -tax money. So you pay 00:17:56.430 --> 00:17:58.730 tax on your salary and then you use what's left 00:17:58.730 --> 00:18:01.990 to pay the interest on the loan. Exactly. But 00:18:01.990 --> 00:18:04.490 that interest you pay back doesn't increase your 00:18:04.490 --> 00:18:07.970 actor tax basis in the 401k. So when you eventually 00:18:07.970 --> 00:18:10.730 withdraw all the funds in retirement, that interest 00:18:10.730 --> 00:18:13.549 money, which you already pay tax on once, gets 00:18:13.549 --> 00:18:16.829 taxed again as ordinary income. Double taxation 00:18:16.829 --> 00:18:19.170 on the interest. It is. It makes the real financial 00:18:19.170 --> 00:18:21.569 benefit of the loan very questionable. And the 00:18:21.569 --> 00:18:25.000 risk if you default is huge. Immense. The code 00:18:25.000 --> 00:18:27.059 says you have to pay the loan back in five years 00:18:27.059 --> 00:18:29.759 max, unless it's for buying your main home. If 00:18:29.759 --> 00:18:31.640 you default on that or if you leave your job 00:18:31.640 --> 00:18:33.859 and can't pay it back. What happens? The entire 00:18:33.859 --> 00:18:36.720 outstanding loan balance is immediately treated 00:18:36.720 --> 00:18:39.500 as a taxable distribution. So you're paying ordinary 00:18:39.500 --> 00:18:42.680 income tax on the whole amount, plus the 10 percent 00:18:42.680 --> 00:18:44.759 early withdrawal penalty if you're under 59 and 00:18:44.759 --> 00:18:48.380 a half. It's a tax torpedo. It can be financially 00:18:48.380 --> 00:18:50.859 devastating. So the government lets you defer 00:18:50.859 --> 00:18:54.230 taxes for decades. But eventually, they want 00:18:54.230 --> 00:18:56.289 to get paid. They want their share. And that 00:18:56.289 --> 00:18:59.730 brings us to the mandatory drawdown rules. Required 00:18:59.730 --> 00:19:03.089 minimum distributions or RMDs. RMDs are just 00:19:03.089 --> 00:19:04.890 the government's way of forcing you to finally 00:19:04.890 --> 00:19:07.430 recognize that deferred income so they can tax 00:19:07.430 --> 00:19:10.349 it. Generally, you have to start taking distributions 00:19:10.349 --> 00:19:13.390 by April 1st of the year after the year you turn 00:19:13.390 --> 00:19:16.359 72. Is there any way to delay that if you're 00:19:16.359 --> 00:19:18.980 still working? Yes. There's a vital working exception. 00:19:19.200 --> 00:19:22.259 The RMD isn't required if you are still employed 00:19:22.259 --> 00:19:24.420 by the company sponsoring the 401k plan for the 00:19:24.420 --> 00:19:26.680 whole year and you own less than 5 % of that 00:19:26.680 --> 00:19:29.180 business. But once you retire, the clock starts 00:19:29.180 --> 00:19:31.660 ticking. The clock starts. The RMDs have to begin. 00:19:31.900 --> 00:19:34.140 And the penalty for not taking an RMD seems, 00:19:34.440 --> 00:19:38.519 well, it's draconian. 50%. Why is the IRS so 00:19:38.519 --> 00:19:40.319 aggressive on this? Because if they don't force 00:19:40.319 --> 00:19:42.720 you to take the money out. The whole tax deferral 00:19:42.720 --> 00:19:45.279 system breaks down. They let you defer tax for 00:19:45.279 --> 00:19:47.500 decades, so they have to ensure they eventually 00:19:47.500 --> 00:19:50.799 collect it. The penalty is 50 % of the amount 00:19:50.799 --> 00:19:53.200 you should have taken out. It's designed to make 00:19:53.200 --> 00:19:56.019 you comply. And just to be clear, RMDs apply 00:19:56.019 --> 00:19:59.400 to both traditional and Roth money inside a 401k, 00:19:59.460 --> 00:20:01.779 right? They do, which is a key difference from 00:20:01.779 --> 00:20:04.660 a Roth IRA, which has no RMDs for the original 00:20:04.660 --> 00:20:07.930 owner. In a 401k... You have to take them from 00:20:07.930 --> 00:20:10.490 both sides. The moment an employer decides to 00:20:10.490 --> 00:20:13.349 offer a 401k, they walk into this very complex 00:20:13.349 --> 00:20:16.390 world of compliance, specifically non -discrimination 00:20:16.390 --> 00:20:20.450 testing or NDT. And the whole point of NDT is 00:20:20.450 --> 00:20:22.630 to stop the plan from just becoming a tax shelter 00:20:22.630 --> 00:20:25.190 for the company's top earners. It's about fairness. 00:20:25.450 --> 00:20:27.170 It's about ensuring the lower paid employees 00:20:27.170 --> 00:20:30.049 actually benefit, which in turn puts strict limits 00:20:30.049 --> 00:20:32.529 on how much the highly compensated employees, 00:20:32.769 --> 00:20:36.009 the HCEs. can contribute. So let's define an 00:20:36.009 --> 00:20:38.950 HCE clearly. What is it? It's based on two things. 00:20:39.529 --> 00:20:41.809 Either your compensation is over a certain amount 00:20:41.809 --> 00:20:47.750 for 2025, that's $160 ,000, or you own more than 00:20:47.750 --> 00:20:50.069 5 % of the business. Either one makes you an 00:20:50.069 --> 00:20:52.809 HCE. And the main test they have to pass is the 00:20:52.809 --> 00:20:54.849 actual deferral percentage test, the ADP test. 00:20:54.990 --> 00:20:57.630 Explain the 2 % rule. The ADP test compares the 00:20:57.630 --> 00:21:00.430 average contribution rate of the HCEs to the 00:21:00.430 --> 00:21:02.910 average rate of the non -highly compensated employees, 00:21:03.289 --> 00:21:06.630 the NHCEs. And the rule is simple but powerful. 00:21:06.910 --> 00:21:09.589 The HCE average cannot be more than 2 percentage 00:21:09.589 --> 00:21:12.329 points higher than the NHCE average. Let's use 00:21:12.329 --> 00:21:14.730 a real example. Say the regular employees, the 00:21:14.730 --> 00:21:17.410 NHCEs, only contribute an average of 1 .5 % of 00:21:17.410 --> 00:21:19.130 their salary. But the executives are putting 00:21:19.130 --> 00:21:22.849 in 10%. The plan fails badly. Fails badly, correct. 00:21:23.029 --> 00:21:26.690 If the NHCE averages 1 .5%, the HCE average can't 00:21:26.690 --> 00:21:29.750 be higher than 3 .5%. So if the plan fails, the 00:21:29.750 --> 00:21:31.769 employer has a big problem to fix. And what are 00:21:31.769 --> 00:21:33.490 their options? The most common solution is they 00:21:33.490 --> 00:21:35.309 do a return of excess. They literally have to 00:21:35.309 --> 00:21:37.930 send taxable refund checks back to the HCEs to 00:21:37.930 --> 00:21:39.910 get their average contribution rate down. Or 00:21:39.910 --> 00:21:42.609 they can do a QNEC. A qualified non -elective 00:21:42.609 --> 00:21:44.829 contribution. This is the more expensive option 00:21:44.829 --> 00:21:47.829 for the company. They make an immediate 100 % 00:21:47.829 --> 00:21:51.869 vested contribution to all the NHCEs to artificially 00:21:51.869 --> 00:21:54.500 raise their average deferral rate. up to a passing 00:21:54.500 --> 00:21:56.779 level. So they give the lower -paid employees 00:21:56.779 --> 00:22:00.259 more money to make the test work. Exactly. If 00:22:00.259 --> 00:22:03.500 they boost that NHCE average from 1 .5 % up to, 00:22:03.519 --> 00:22:06.640 say, 4%, then the HCEs would be allowed to defer 00:22:06.640 --> 00:22:09.619 up to 6%. And that cost is what pushes a lot 00:22:09.619 --> 00:22:11.980 of companies toward a safe harbor plan. It is. 00:22:12.160 --> 00:22:15.000 A safe harbor plan is designed specifically to 00:22:15.000 --> 00:22:17.990 get out of that ADP testing altogether. The company 00:22:17.990 --> 00:22:21.230 agrees to make a guaranteed, 100 % vested contribution 00:22:21.230 --> 00:22:24.089 to all eligible employees, either as a match 00:22:24.089 --> 00:22:26.670 or as a flat contribution. And in exchange for 00:22:26.670 --> 00:22:28.470 that guaranteed cost, they don't have to worry 00:22:28.470 --> 00:22:30.470 about the testing anymore. The compliance headache 00:22:30.470 --> 00:22:32.829 just goes away. Okay, shifting gears to fees. 00:22:32.990 --> 00:22:35.269 This is often called the silent killer of retirement 00:22:35.269 --> 00:22:38.390 growth. What should you as a listener be looking 00:22:38.390 --> 00:22:40.730 for? You have to look past the performance numbers 00:22:40.730 --> 00:22:43.150 and dig into the expense ratios and administrative 00:22:43.150 --> 00:22:45.950 costs. Fees cover everything, record keeping, 00:22:46.130 --> 00:22:48.450 administration, investment management. And they 00:22:48.450 --> 00:22:51.670 add up. They do. Back in 2011, the average total 00:22:51.670 --> 00:22:55.410 fee was around 0 .78 % of assets. That's about 00:22:55.410 --> 00:22:59.420 $250 a year per participant. But for small businesses, 00:22:59.700 --> 00:23:02.759 those fees can be way higher, sometimes double 00:23:02.759 --> 00:23:05.440 the average. And the whole issue of excessive 00:23:05.440 --> 00:23:09.720 fees led to that landmark 2015 Supreme Court 00:23:09.720 --> 00:23:12.900 case, Tibble v. Edison International. That case 00:23:12.900 --> 00:23:15.299 was so important. The court ruled that plant 00:23:15.299 --> 00:23:17.539 administrators could be sued for excessive fees, 00:23:17.700 --> 00:23:20.140 and it established they have a strict, ongoing 00:23:20.140 --> 00:23:23.250 fiduciary duty to monitor those fees. What was 00:23:23.250 --> 00:23:25.650 the specific issue in that case? The court called 00:23:25.650 --> 00:23:27.809 out the use of more expensive retail class mutual 00:23:27.809 --> 00:23:30.789 funds when cheaper, identical institutional class 00:23:30.789 --> 00:23:33.289 shares were available. Plan sponsors now have 00:23:33.289 --> 00:23:35.069 to prove they are constantly monitoring fees 00:23:35.069 --> 00:23:37.349 to make sure they are reasonable. Okay, so to 00:23:37.349 --> 00:23:39.750 fight low participation, especially among the 00:23:39.750 --> 00:23:42.470 NHCEs, we've seen this big push for automatic 00:23:42.470 --> 00:23:44.529 enrollment. Right, where you're in the plan unless 00:23:44.529 --> 00:23:46.869 you actively opt out. And to protect the employer 00:23:46.869 --> 00:23:49.849 in that scenario, they created the QDIA. The 00:23:49.849 --> 00:23:52.559 Qualified Default Investment Alternative. This 00:23:52.559 --> 00:23:54.500 came out of the Pension Protection Act of 2006. 00:23:55.559 --> 00:23:58.500 If an employee gets auto -enrolled but never 00:23:58.500 --> 00:24:00.920 chooses their investments, the money has to go 00:24:00.920 --> 00:24:04.319 into a QDIA. And what are typical QDIAs? They're 00:24:04.319 --> 00:24:06.619 usually professionally managed funds that are 00:24:06.619 --> 00:24:09.259 designed to be risk appropriate. So things like 00:24:09.259 --> 00:24:12.339 target date funds, balance funds, or managed 00:24:12.339 --> 00:24:15.440 accounts. And by using one, the employer is protected. 00:24:15.759 --> 00:24:18.240 They get fiduciary relief. If the investments 00:24:18.240 --> 00:24:20.559 lose money, they're protected because they follow 00:24:20.559 --> 00:24:23.539 the legal mandate for a suitable default option. 00:24:23.700 --> 00:24:26.099 So when you leave a job, you face the rollover 00:24:26.099 --> 00:24:28.119 decision. There's a right way and a very risky 00:24:28.119 --> 00:24:30.640 way to do it. The right way is the direct rollover. 00:24:30.700 --> 00:24:33.000 The money moves straight from the old plan to 00:24:33.000 --> 00:24:36.519 a new plan or an IRA. No taxes, no penalties. 00:24:36.700 --> 00:24:39.720 It's clean. The risky way is taking the check 00:24:39.720 --> 00:24:42.130 yourself. Right. If you take possession of the 00:24:42.130 --> 00:24:44.069 funds, you have to complete the rollover into 00:24:44.069 --> 00:24:46.750 a new account within 60 days. And if you miss 00:24:46.750 --> 00:24:49.210 that 60 -day window... The entire distribution 00:24:49.210 --> 00:24:52.250 becomes taxable as ordinary income, and if you're 00:24:52.250 --> 00:24:56.049 under 59 .5, that 10 % penalty applies. And there's 00:24:56.049 --> 00:24:58.509 another catch, right? Withholding. Yeah, the 00:24:58.509 --> 00:25:01.829 employer is legally required to withhold 20 % 00:25:01.829 --> 00:25:04.440 of the distribution for taxes. Which means if 00:25:04.440 --> 00:25:06.519 you want to roll over the full amount, you have 00:25:06.519 --> 00:25:08.519 to come up with that 20 percent out of your own 00:25:08.519 --> 00:25:11.220 pocket to complete the rollover and then wait 00:25:11.220 --> 00:25:13.059 to get it back from the IRS when you file your 00:25:13.059 --> 00:25:15.619 taxes. It's a mess. What about converting traditional 00:25:15.619 --> 00:25:19.079 funds to Roth inside your company's plan? Can 00:25:19.079 --> 00:25:22.069 you do that? The IRS does allow what's called 00:25:22.069 --> 00:25:25.250 an in -plan Roth conversion, but there's a huge 00:25:25.250 --> 00:25:27.869 caveat. What's that? The company plan has to 00:25:27.869 --> 00:25:31.529 offer both a traditional and a Roth option, and 00:25:31.529 --> 00:25:33.950 the plan documents have to explicitly say that 00:25:33.950 --> 00:25:36.430 these conversions are allowed. If they do, you 00:25:36.430 --> 00:25:38.849 can do it. You pay the income tax on the converted 00:25:38.849 --> 00:25:41.089 amount that year, and then it grows tax -free 00:25:41.089 --> 00:25:43.119 forever. Okay, finally, let's touch on plans 00:25:43.119 --> 00:25:45.220 for small businesses and the self -employed because 00:25:45.220 --> 00:25:47.480 the rules there really loosened up about two 00:25:47.480 --> 00:25:50.420 decades ago. Yeah, EGTRA in 2001 was the key 00:25:50.420 --> 00:25:53.779 legislation. It raised the maximum employer profit 00:25:53.779 --> 00:25:57.220 -sharing contribution from 15 % all the way up 00:25:57.220 --> 00:25:59.980 to 25 % of eligible pay. Which was a huge deal 00:25:59.980 --> 00:26:02.900 for business owners. A massive deal. It drastically 00:26:02.900 --> 00:26:05.799 increased their savings capacity. So an incorporated 00:26:05.799 --> 00:26:09.259 person can put in their maximum employee deferral 00:26:09.259 --> 00:26:12.700 plus that huge 25 % profit sharing contribution 00:26:12.700 --> 00:26:15.920 all the way up to the total Section 415 limit. 00:26:16.140 --> 00:26:18.180 But there's a critical difference for unincorporated 00:26:18.180 --> 00:26:20.660 people, like a sole proprietor. The math gets 00:26:20.660 --> 00:26:22.920 a little tricky. It does. For someone running 00:26:22.920 --> 00:26:25.240 a Schedule C business, the profit sharing is 00:26:25.240 --> 00:26:27.799 calculated as 25 % of their net self -employment 00:26:27.799 --> 00:26:30.180 income. And because the contribution itself is 00:26:30.180 --> 00:26:32.960 deductible, it reduces the net income you use 00:26:32.960 --> 00:26:35.500 for the calculation. So the actual rate ends 00:26:35.500 --> 00:26:38.099 up being a little less than 25%. So for a sole 00:26:38.099 --> 00:26:41.200 proprietor with $100 ,000 in gross income, the 00:26:41.200 --> 00:26:43.980 actual contribution would be more like $20 ,000, 00:26:43.980 --> 00:26:47.259 not $25 ,000, because that $20 ,000 contribution 00:26:47.259 --> 00:26:50.299 lowers their income before the calculation is 00:26:50.299 --> 00:26:53.019 even applied. Exactly. You need precise accounting 00:26:53.019 --> 00:26:55.119 for that. It's a circular calculation. And one 00:26:55.119 --> 00:26:57.660 last complex maneuver we should define, ROBS 00:26:57.660 --> 00:27:00.660 rollovers as business startups. Right. Using 00:27:00.660 --> 00:27:03.200 retirement money to fund a new business, is that 00:27:03.200 --> 00:27:05.670 right? actually legal? It is if you follow the 00:27:05.670 --> 00:27:09.289 very specific IRS rules. It lets you use your 00:27:09.289 --> 00:27:13.049 existing 401k funds to buy stock in a new C corporation 00:27:13.049 --> 00:27:15.150 that you're starting. And you don't pay taxes 00:27:15.150 --> 00:27:17.250 or penalties. Correct. It's a way to get startup 00:27:17.250 --> 00:27:20.069 capital through a tax -free transaction. The 00:27:20.069 --> 00:27:23.549 IRS watches these plans very closely, but they 00:27:23.549 --> 00:27:26.549 are a valid, if very complex, financing option. 00:27:26.750 --> 00:27:30.410 Contact 6, global context, critiques, and the 00:27:30.410 --> 00:27:33.529 future. So while the 401k is uniquely American 00:27:33.529 --> 00:27:36.569 in its name and origin, the idea of a defined 00:27:36.569 --> 00:27:39.490 contribution system is global. Oh, yeah. The 00:27:39.490 --> 00:27:41.890 term 401k has almost become generic worldwide. 00:27:42.849 --> 00:27:45.029 Japan, for example, adopted what they call a 00:27:45.029 --> 00:27:48.549 Japan version 401k back in 2001. Other countries 00:27:48.549 --> 00:27:50.430 have had their own schemes for a long time. Like 00:27:50.430 --> 00:27:52.329 in the UK or Canada? Right. The UK has personal 00:27:52.329 --> 00:27:55.690 pension schemes. Canada has RSPS registered retirement 00:27:55.690 --> 00:27:57.829 savings plans, which are a little different because 00:27:57.829 --> 00:28:00.250 they're individual vehicles, not strictly tied 00:28:00.250 --> 00:28:02.890 to an employer. How is Australia's system fundamentally 00:28:02.890 --> 00:28:05.650 different from the U .S. model? Australia's superannuation 00:28:05.650 --> 00:28:08.049 funds are really interesting because of the mandatory 00:28:08.049 --> 00:28:11.029 employer contribution. Yeah. Australian employers 00:28:11.029 --> 00:28:13.150 are legally required to contribute a certain 00:28:13.150 --> 00:28:15.289 percentage of an employee's salary into their 00:28:15.289 --> 00:28:18.069 fund. This ensures a baseline level of savings 00:28:18.069 --> 00:28:20.329 that isn't dependent on whether the employee 00:28:20.329 --> 00:28:23.190 chooses to participate or not. That mandatory 00:28:23.190 --> 00:28:26.049 piece is what's missing in the U .S. And what 00:28:26.049 --> 00:28:28.490 about in Asia? What models do we see there? Well, 00:28:28.490 --> 00:28:31.150 India's national pension system, the NPS, works 00:28:31.150 --> 00:28:33.289 a lot like the 401k for government and corporate 00:28:33.289 --> 00:28:36.089 workers. Similar rules for investing in taxes. 00:28:36.349 --> 00:28:38.950 And in Malaysia, you have the Employees' Provident 00:28:38.950 --> 00:28:41.869 Fund, or EPF. It was established way back in 00:28:41.869 --> 00:28:44.910 1951. It's mandatory for private sector workers, 00:28:45.049 --> 00:28:47.670 and it ensures huge savings and broad participation. 00:28:48.279 --> 00:28:50.460 Okay, now we have to turn to the system's deep 00:28:50.460 --> 00:28:54.000 structural flaws. Flaws so severe that the inventor 00:28:54.000 --> 00:28:56.640 himself, Ted Benna, once said he felt like he 00:28:56.640 --> 00:28:59.059 had created a monster. And the first, most basic 00:28:59.059 --> 00:29:02.140 criticism is just the risk of loss. It's inherent 00:29:02.140 --> 00:29:04.920 in any defined contribution plan. Right. There 00:29:04.920 --> 00:29:06.720 is no government guarantee. Absolutely none. 00:29:06.839 --> 00:29:09.779 Unlike a pension or an FDIC -insured bank account, 00:29:09.980 --> 00:29:12.900 the assets in your 401k can go to zero. And even 00:29:12.900 --> 00:29:15.019 if you diversify and shift your risk as you get 00:29:15.019 --> 00:29:18.079 older, you're still exposed to huge market declines 00:29:18.079 --> 00:29:19.940 like what we saw in the Great Recession. And 00:29:19.940 --> 00:29:22.420 that risk is compounded by the hitter costs, 00:29:22.700 --> 00:29:26.180 the fees. A plan sponsor going bankrupt won't 00:29:26.180 --> 00:29:28.440 lose your assets, but those excessive fees from 00:29:28.440 --> 00:29:31.720 providers act like a constant silent drag on 00:29:31.720 --> 00:29:34.400 your returns year after year. The second major 00:29:34.400 --> 00:29:37.359 critique is the incredible burden of choice that's 00:29:37.359 --> 00:29:41.230 placed on the employee. Why is our entire national 00:29:41.230 --> 00:29:43.410 retirement system built on the assumption that 00:29:43.410 --> 00:29:46.809 non -experts can choose and manage complex investments? 00:29:47.150 --> 00:29:50.789 It's a huge and I think unfair assumption. The 00:29:50.789 --> 00:29:53.690 complexity of picking funds, rebalancing, updating 00:29:53.690 --> 00:29:56.329 your choices for 40 years. It's a major bill 00:29:56.329 --> 00:29:58.029 here. It's why a lot of people, especially lower 00:29:58.029 --> 00:30:00.369 income workers, just don't sign up at all. Target 00:30:00.369 --> 00:30:02.069 date funds were supposed to fix that. They were 00:30:02.069 --> 00:30:05.289 intent to mitigate it, sure. But even those require 00:30:05.289 --> 00:30:07.609 a certain level of trust and a basic understanding 00:30:07.609 --> 00:30:10.960 of risk. The third critique, and maybe the most 00:30:10.960 --> 00:30:13.579 politically charged one, is inequality. The tax 00:30:13.579 --> 00:30:16.019 breaks just overwhelmingly benefit people who 00:30:16.019 --> 00:30:19.180 can afford to save the most. Precisely. If you're 00:30:19.180 --> 00:30:21.319 a high earner, that tax deduction is worth a 00:30:21.319 --> 00:30:23.579 ton of money. If you're a low income earner, 00:30:23.599 --> 00:30:26.539 the deduction is negligible or even zero. And 00:30:26.539 --> 00:30:29.500 the stats are pretty stark. They are. Our sources 00:30:29.500 --> 00:30:31.539 cited data showing the highest earning groups 00:30:31.539 --> 00:30:35.019 save enough to get about 11 times more in retirement 00:30:35.019 --> 00:30:38.329 income than the lowest earning groups. It directly 00:30:38.329 --> 00:30:40.970 widens the wealth gap. And beyond that, there's 00:30:40.970 --> 00:30:43.490 just the participation gap. Not every employer 00:30:43.490 --> 00:30:46.170 even has to offer a plan. It's totally voluntary. 00:30:46.990 --> 00:30:49.589 Millions of workers have no access to the system's 00:30:49.589 --> 00:30:51.970 tax advantages at all. And this is something 00:30:51.970 --> 00:30:54.849 Ted Benna himself has proposed fixing. He suggested 00:30:54.849 --> 00:30:57.130 mandating that companies over a certain size 00:30:57.130 --> 00:30:59.950 have to offer a 401k to ensure wider access. 00:31:00.190 --> 00:31:02.789 And all of this leads directly to the core problem. 00:31:02.950 --> 00:31:05.349 Are people saving enough? And the answer seems 00:31:05.349 --> 00:31:07.839 to be no. This reliance on defined contribution 00:31:07.839 --> 00:31:10.160 plans means retirement income is just wildly 00:31:10.160 --> 00:31:12.640 unpredictable. What was that statistic? It was 00:31:12.640 --> 00:31:16.000 a deeply concerning one. In 2017, 49 percent 00:31:16.000 --> 00:31:19.019 of Americans between the ages of 55 and 66 had 00:31:19.019 --> 00:31:23.599 no personal retirement savings. None. Zero. That 00:31:23.599 --> 00:31:26.480 huge gap means a massive part of our population 00:31:26.480 --> 00:31:29.799 is facing either working into old age or living 00:31:29.799 --> 00:31:32.240 in poverty, relying only on Social Security. 00:31:32.460 --> 00:31:34.779 So given all these really severe criticisms. 00:31:35.630 --> 00:31:37.890 There are now some pretty big proposals on the 00:31:37.890 --> 00:31:40.549 table to fundamentally change how we do retirement 00:31:40.549 --> 00:31:43.670 in the U .S. Yeah. One bipartisan idea is to 00:31:43.670 --> 00:31:45.990 open up the federal government's thrift savings 00:31:45.990 --> 00:31:49.829 plan, the TSP to all employees, not just federal 00:31:49.829 --> 00:31:52.089 workers. And that would provide a more stable, 00:31:52.170 --> 00:31:54.940 defined. income structure. And it would leverage 00:31:54.940 --> 00:31:57.299 the massive scale and the super low cost of the 00:31:57.299 --> 00:31:59.680 TSP. And then there's the most provocative proposal, 00:31:59.920 --> 00:32:02.819 which is to just end the 401k tax break entirely. 00:32:03.299 --> 00:32:05.680 What's the economic thinking there? The researchers 00:32:05.680 --> 00:32:07.920 behind that argue that the tax break doesn't 00:32:07.920 --> 00:32:09.900 actually create new savings on a national level. 00:32:10.019 --> 00:32:12.420 It just encourages high earners to shift money 00:32:12.420 --> 00:32:14.200 they were already going to save from a taxable 00:32:14.200 --> 00:32:17.640 account into a 401k to get the break. They say 00:32:17.640 --> 00:32:19.579 the subsidy is ineffective. And if they got rid 00:32:19.579 --> 00:32:21.259 of the break, what would they do with all that 00:32:21.259 --> 00:32:23.420 new tax revenue? They estimate it would bring 00:32:23.420 --> 00:32:26.500 in about $200 billion a year in additional revenue. 00:32:26.920 --> 00:32:30.039 And they propose using those massive funds to 00:32:30.039 --> 00:32:32.799 directly support and shore up Social Security. 00:32:32.940 --> 00:32:35.599 So shifting the focus back to a universal guaranteed 00:32:35.599 --> 00:32:38.500 safety net. Exactly. It completely challenges 00:32:38.500 --> 00:32:40.539 the philosophical foundation of American retirement. 00:32:41.019 --> 00:32:43.400 It asks, you know, if the current system is failing 00:32:43.400 --> 00:32:46.579 almost half of all near retirees, should we keep 00:32:46.579 --> 00:32:49.500 prioritizing tax breaks for individuals? Or should 00:32:49.500 --> 00:32:51.700 we shift our resources back to a guaranteed benefit 00:32:51.700 --> 00:32:55.019 program for everyone? Hashtag Chag Outro. We 00:32:55.019 --> 00:32:57.930 have covered a vast amount of ground today. From 00:32:57.930 --> 00:33:01.130 the accidental birth of the 401k as a tax dodge 00:33:01.130 --> 00:33:04.190 for executives facing a 70 % rate. All the way 00:33:04.190 --> 00:33:06.470 to its current, very complex structure that's 00:33:06.470 --> 00:33:08.450 struggling with these huge questions of equity 00:33:08.450 --> 00:33:10.410 and sufficiency. So the key takeaways for you, 00:33:10.450 --> 00:33:12.809 the listener, are really critical. First, master 00:33:12.809 --> 00:33:15.930 that tax duality. Right. Traditional, or EET, 00:33:16.210 --> 00:33:19.519 means you pay tax later. Roth or TEE made you 00:33:19.519 --> 00:33:22.079 pay tax now. But remember, in both cases, the 00:33:22.079 --> 00:33:24.339 real prize is the permanently tax -free profits. 00:33:24.599 --> 00:33:27.900 Second, be hypey vigilant about compliance. Know 00:33:27.900 --> 00:33:30.740 your personal contribution cap, that 402G limit, 00:33:30.900 --> 00:33:33.920 and understand that brutal double taxation penalty 00:33:33.920 --> 00:33:36.279 if you go over, especially when you switch jobs. 00:33:36.579 --> 00:33:38.119 And you have to understand the immense burden 00:33:38.119 --> 00:33:40.200 that's placed on you, the burden of choosing 00:33:40.200 --> 00:33:42.920 investments, of monitoring fees. It's all on 00:33:42.920 --> 00:33:45.119 your shoulders. And finally, just remember where 00:33:45.119 --> 00:33:48.380 the system's flaws come from. 401k was designed 00:33:48.380 --> 00:33:51.299 as a niche tax dodge for the highly compensated, 00:33:51.299 --> 00:33:53.819 and it just sort of accidentally became the default 00:33:53.819 --> 00:33:56.359 retirement vehicle for the entire country. So 00:33:56.359 --> 00:33:58.519 that leaves us with a final provocative thought. 00:33:58.720 --> 00:34:01.319 Given its inherent market risks, the complex 00:34:01.319 --> 00:34:03.420 burden of choice it puts on the average person, 00:34:03.579 --> 00:34:05.980 and its very real contribution to inequality. 00:34:06.960 --> 00:34:09.539 Should the U .S. government continue to prioritize 00:34:09.539 --> 00:34:12.159 these massive tax breaks for individual savings? 00:34:12.400 --> 00:34:15.280 Or should the focus shift back toward universal, 00:34:15.599 --> 00:34:17.820 government -funded, defined benefit security? 00:34:18.320 --> 00:34:20.800 What are you willing to trade for that tax deferral? 00:34:20.900 --> 00:34:22.980 Thank you for joining us for the Deep Dive.