Photo by Laura Chouette on Unsplash
Hello,
Welcome to Known Unknowns, a newsletter that fully supports and encourages saving for retirement (tax-deferred or not)—but not if it means you never leave your parents’ basement.
The 401(k)’s days are numbered
I give it another ten years, tops. This may seem like a bold call—after all, outside of inner Pension Geek circles, no one is talking about phasing out the 401(k). And don’t get me wrong, this is not the end of individual retirement accounts, we are not going back to old school pensions. But I reckon the tax benefit will not last.
It all started about ten years ago, when research uncovered that the tax benefit does not induce people to save more, as we thought. It turns out you just need automatic deductions. And the studies since have found the same thing. I am convinced that the tax treatment does not have much impact on flows in; but not so sure about flows out. The penalty is an incentive to not withdraw and, without the tax benefit, why would you bother with an illiquid account?
If people aren’t moved by the tax benefit, it suggests they won’t miss it if it were gone. And we are going to need tax revenue soon, or now, and doing away with the deduction will make fewer people mad than increasing the payroll or marginal tax rates. So goodbye, 401(k).
But if people save in more liquid accounts, will that mean more early withdrawals? Is that even a bad thing? I am not sure. But one benefit we get from 401(k)s and regular IRAs is that they also force the government to save more, because they defer tax revenue. And if they aren’t saving here, what else do we have?
TikTok personal finance is not awful
I spent several hours watching personal finance videos on TikTok. And while there are some cranks pushing terrible advice, many of the most popular influencers are not so bad. They get some things wrong: they don’t seem to understand the fundamentals of risk management, and they have a misguided objective (get rich when it should be consumption smoothing), but you can say the same of most personal finance gurus, in any medium. And as much as I would like everyone to understand the fallacy of time diversification, it may be second order compared to some of the basics TikTok personal finance does get right.
For example, the videos walk people through how to open a brokerage account and select funds. They remind people that you don’t just need to open an account; you need to select funds too. I did not even know people needed to be told this! The videos also suggest an S&P 500 index fund, which is not terrible—much better than picking stocks, even if I think it leaves people under diversified.
The one odd thing is how common it is to suggest that people in their 20s should consider living with their parents to save rent. When I was that age, living with your parents was only something you did if your life fell apart. Now it is a popular way to save money. And I guess it does save money but living on your own before 30 also seems like an important part of becoming an adult.
Then again, I did not know how to buy an index fund when I was 25. I had no money to save; I was spending it all on rent.
Universities are in trouble
Not what you think, but that too. I was dismayed to read that my hometown university, UCONN, is facing draconian budget cuts. It seems they were counting on the COVID-19 relief money they received becoming a regular thing and now that it has run out, they are facing huge deficits from years of overbuilding, bloated administrations, stagnating enrollment, and less money from the state. It suggests very poor strategic management.
But UCONN, like many land grant universities, is not alone. The University of West Virginia is mostly targeting the humanities rather than across-the-board cuts. This is just the start. The coming generations are smaller and hungrier for value. I suspect other state schools will face similar financial challenges. Some state universities will come for the humanities (probably in Red States), and others will cut everything, which will put their STEM-type majors at a disadvantage.
These universities were originally intended to provide education in agriculture to students of diverse means. Back then, agricultural science offered the skills people needed. But over time, as they became the flagship state institutions, the land grant universities adapted to serve the state’s needs. They will need to do so again. If so, does that mean cutting the humanities or everything? I am not sure what is the better model. I think the humanities are underrated (even if lately they have failed in their mission) and an important part of the university experience.
In this case, there may be an interesting sorting.
The future of work
I am excited about the future of AI. But so far, whenever I am on ChatGPT, I feel like I am talking to a very clever and entertaining know-it-all who can’t admit it when they don’t know something and just make their answer up.
I am sure it will get better. I enjoyed this essay by David Autor about how AI may revive the middle class and reduce inequality. I think that’s right, but if you are very smart and skilled, then you may be even more turbo powered.
Until next time, Pension Geeks!
Allison
Secure 2.0 is forcing companies to add Roth 401ks in order to have catch-up savings because they will be required to go into Roth 401ks. That was delayed a year or so in order to let the companies make the change since it is very complex legally and paperwork-wise. Once the Roth 401ks are in place across all 401ks, then it would be very easy to eliminate the tax deductible part. for individual contributions. I recommended to all my kids when they started working to put their savings into Roth IRAs, 401ks, or 403bs to the extent practicable.
Corporate matches will likely still need to have the option of being tax deductible because otherwise people will be paying taxes on income they can't access to pay those taxes, unless it is structured for the companies to pay that tax.
I think the big change that is needed for 401ks is to limit the total amount that can be contributed into these accounts in a year. The current value is so big that very few people can get there, both on an individual basis and including the corporate contribution - I am in the top 10% and my individual and corporate contributions do not hit the combined allowable maximum. Something like an individual contribution limit equal to 20% of median household income with a similar limit on corporate contribution would be rational. That would halve the total maximum contribution levels with much of it exposed to immediate income taxes. The catchup provision is good because it is not particularly big, will need to go into Roth, and will give people the chance to do savings in their peak earning years, including after putting kids through college etc..
Regarding basic education like "you have to pick funds too" - I have been helping my family with personal finance for years. There is zero usable personal finance taught in schools and the US has a very complex system, largely structured by the corporations and accidental savings structures like the 401k. The concept that 401ks are under ERISA and have fiduciary protections while 403bs are only lightly regulated without fiduciary protections is not understood at all and is mind-blowing that the difference is allowed to exist.
People have no idea how to do the most basic functions in this complex system and are quickly overwhelmed by the paradox of choice which is why the automatic enrollments have been so successful. The system is deliberately set up to be as complex as possible so that people can be "guided" through it to corporate advantage. My basic instructions are very simple and fly in the face of all of the financial advertising which in turn is contrary to the academic recommendations that closely track with my recommendations. So simply save an emergency fund, 15% in a Roth 401k or IRA in a low-cost target date fund, avoid most debt, don't rush to buy a house (certainly don't buy more than you can comfortably afford), don't watch financial TV, and don't compare yourself to other people. Most people can end up with over $100k net worth by their mid-30s doing this. Compounding will mushroom this by age 65. People do not understand that their assets will double between age 55 and 65 if positioned and managed properly.
The 401k isn't a very good deal since you're only saving a little up front and potentially paying a lot of taxes when withdrawing. As Mercenary says above, from the government's perspective, the Roth is costing them more in the long run. In fact I've been rolling as much as I can from my 401k to a Roth (when the market is down especially, so I pay less taxes).