Jaspreet Singh: 401(k) ‘Nightmares’ You Need To Understand
The most popular retirement plan in the U.S. for working-aged individuals is the 401(k). A 401(k) is an employer-sponsored retirement plan that allows you, as an employee, to contribute a portion of your income to the plan before taxes are deducted. Sounds simple enough, right? Well, no. Not at all.
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The fact of the matter is that 401(k) plans, which vary widely, are complex and multi-faceted. Most people don’t really understand how these crucial retirement plans work, which is alarming but very understandable.
Given our weak understanding of 401(k) plans, it’s only natural that we know the least about the trickiest aspects. Recently, financial expert Jaspreet Singh shared a video on his Minority Mindset YouTube channel titled 401(k) Nightmares: What They Don’t Tell You. In the video, Singh broke down five of these aspects you absolutely need to know about 401(k) plans.
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Taxes Are Still an Issue
Singh’s first talking point was about taxes. He clarified that while you’re not paying taxes on your 401(k) contributions, you will be paying taxes on that income once you collect it. It’s a manner of deferring taxes, not avoiding them.
“It does not let you avoid taxes, and the amount of taxes you’re going to pay and when you pay … are going to depend on if you have a Roth 401(k) or a traditional 401(k),” Singh pointed out.
How and when you pay taxes depends on which type of account you have.
“So let me start by talking about the traditional 401(k),” Singh said. “If you make $1,000 from your job, and then you put all $1,000 into your 401(k), that means all $1,000 gets to go into your 401(k). The money then grows in your 401(k) for as long as your money is sitting there. And then, when it comes time to retire, hopefully this $1,000 will grow to say $10,000. You pull $10,000 out of your 401(k) — that’s when this money is going to be taxed. You pay taxes when the money comes out, but all $1,000 gets to go in the 401(k) [initially].”
A Roth 401(k) is a whole different beast. You make the same $1,000, but before putting it in the plan, you pay the taxes on it.
“The money is taxed before it goes in,” Singh said. “Now depending on your tax rate, you might be paying, say, 30% of this money in taxes. So now, only $700 goes into your 401(k). So you have less money working for you, but then, when you go to pull this money out, you don’t have to pay any [taxes].”
This is a very important distinction to note, because you will need to deeply explore, ideally with a retirement planner, which type of 401(k) plan works best for you in terms of the taxes aspect.
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There’s a Fee
A 401(k) isn’t free. It’s charging you a fee.
“This fee is called an expense ratio,” Singh said. “It’s a fee that you pay on every dollar that you invest, and every dollar of profit that you make for every year that your money is invested in your fund. This little fee can end up costing you tens of thousands or hundreds of thousands or even millions of dollars in little fees.”
To really understand 401(k) fees, you need to know your expense ratio. It’s a smart idea to work with a financial advisor on determining this very specific figure, if you don’t want to do all the homework on your own.
“I’ve seen people pay one and a half percent expense ratio,” Singh said. “So you can just get an idea of how much money is going into Wall Street’s pockets. I want most of this money going into your pockets.”
You’re Not Really in Control
The third thing that Singh urged viewers to understand about 401(k) plans “has to do with control — more particularly control from employers and control from Wall Street.”
This is a complex concept. Here’s how Singh broke it down.
“When it comes to your employer, some companies will offer you a 401(k) match, which says for every $1,000 you invested in 401(k), your boss is going to give you an additional $200, an additional $500, maybe even an additional $1,000.”
Financial experts recommend taking your employer up on the offer of a 401(k) match, but they don’t always go into the fine print of how it works.
“What you gotta understand about this is that some employers are going to put restrictions on how this works, meaning a vesting schedule,” Singh said. “This says that in order for you to actually get that money and keep that money for yourself, you have to work at the company for at least five years.
“Every company is going to have different rules and regulations on this. But you want to understand this, just in case you quit, just in case you leave or just in case you get fired. Because this could be a way to keep you at a company longer than you might like.”
Bottom line: There are clear benefits to employer matches, but you’re still working for that “free” money.
Now let’s talk about Wall Street, because your 401(k) money is in their pockets, too.
“Just know that you have limited control when it comes to investing with a 401(k) because you have to invest your money into whatever those money managers [working with your company] offer you,” Singh explained. “And those money managers then pretty much manage your money for the next 10, 20, 30, 40 years. And they’re going to charge you a fee for every year that they manage your money.”
There Are Limitations, So Diversification Is Key
The fourth “nightmare” Singh tackled was 401(k) limitations. Singh was once so passionately against these limitations that, for a time, he was pretty anti-401(k). He’s since softened on the matter, but what exactly are these limitations?”
“So when I talk about limitations to 401(k)s, what I mean here is, well, kind of like what I just said: There are a limited number of places where you can invest your money … You can’t diversify out of those things. All of your money is tied up in paper investments, all your money is tied up with money managers on Wall Street.”
He continued, “So if the stock market crashes, all refunds go down. Maybe some will go down more than others, but you get hurt when the stock market goes down. That’s not real diversification.”
For “real diversification,” Singh advises looking beyond 401(k) plans when it comes to retirement planning. You can have multiple ways of investing.
“I want you to understand that your 401(k) is a great place to start investing,” Singh said. “It’s not where you want to stop investing. A 401(k) is a great place for the average person to start investing, but it’s a horrible place to keep all of your investments.”
In other words, though 401(k) plans are great for initial investing, you need to diversify. You can do this through a few alternatives.
“Now, your 401(k) is one way that you can invest in stocks, but it’s not enough,” Singh said. “What are other ways you can invest in stocks? Well, you can invest in stocks through something like an IRA.”
Singh said you might also consider opening up a brokerage to invest in stocks. By using different brokerages, you can invest in individual companies. You can also invest money in an index fund, a mutual fund or an ETF. Or, you could also invest in startups or in real estate.
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