Contributing to Your 401k Plan

I received a question recently regarding investments beyond a 401k.  I think this advice might be helpful to others, so I will respond with a post.  The question was as follows:

"If I'm currently putting say 6% into a company-sponsored 401k (which is the point at which they'll match 50%) and am not making any other investments, what would be the best next step? I'm thinking of maxing out my 401k contribution, but I've also read recommendations that I should *first* max out a Roth IRA, and *then* (if I still have available money), bump up my 401k contribution. Both of these (401k and Roth IRA) have tax advantages, but if you feel that other types of investments (e.g., Gold) would be even more important before opening a Roth IRA or bumping up my 401k, I'd appreciate that info."

My opinion on this matter is that you should only contribute to a 401k up to the amount of your employer's match.  If you are contributing up to the match and you have extra money to invest, you absolutely should not contribute more to your 401k plan.  The reason is because of all of the uncertainties and inflexibilities that come with a 401k plan.  You are subject to the decisions of your employer's plan along with the government.

First, you have no idea what the tax rates will be when your retire.  This would be a reason to favor a Roth IRA or Roth 401k over a traditional IRA or 401k.  Second, you are locking up your money until the age of 59 and a half.  You cannot withdraw your money before then, unless you pay taxes on it along with a hefty penalty.  And this is only if your employer's plan will even let you withdraw any money.

A third reason against further investing in a 401k plan is that the government could change the rules at any time.  The government could change the age for withdrawal.  It could even make tax rates higher for retirement plan income.  I am not saying that this will happen, but that it can happen.  Could you not imagine some politician saying that it is unfair that some retirees have big 401k balances while others have nothing saved?  Could you not imagine the same politician saying that we need to tax the big retirement plans to even things out?

An even bigger threat is that the government could try to confiscate retirement plans.  It would not happen all at once, as this would cause a revolt.  Instead, imagine a scenario where the stock market crashes and the government steps in with special government bonds where you will get a "guaranteed" safe investment with a "guaranteed" rate of return.  These special bonds would be optional at first.  Then the politicians would slowly take steps to move them from optional to mandatory.  While I don't expect this to happen, anything is possible.

So what should you invest in?  First, I am assuming that you have paid off all credit card and other high interest debt.  Second, you should put a little money aside as a rainy day fund.  This would just go into an FDIC insured bank account.

Next, I would recommend investing in some gold and gold related investments.  This is especially important because it is hard to invest in gold related investments in a 401k plan.  In addition, we are in a very shaky environment right now where anything can happen.  Look at gold investments as an insurance policy as much as an investment.

After all of that is taken care of, you could look at a Roth IRA.  While there is still the problem of unpredictability from the government, there are advantages over a 401k plan.  With the Roth, you pay your taxes now and don't have to worry about the tax rates when you retire (assuming the government doesn't change the rules).  Also, another great benefit is that you can withdraw your principal investment (not gains) from your Roth plan and you will not pay a penalty.  This gives you more flexibility in case you need money for something important.

I am still a big advocate of Harry Browne's permanent portfolio plan as laid out in his book Fail Safe Investing.  If you are looking for a mutual fund to imitate this, then you can buy PRPFX.  You can do this in a Roth IRA or a regular trading account.  I hope this information helps.