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401(k): Methadone for the Middle Class

Written by Gary North on February 6, 2015

Methadone is a legal drug that is taken by former heroin addicts. It eliminates the “rush” that heroin offers, but it also eliminates withdrawal symptoms. It lets heroin addicts escape the need to buy the expensive illegal drug.

Methadone is for heroin addicts who just cannot bring themselves to go cold turkey from an addictive drug that distorts their perception.

That is what a 401(k) retirement plan is for middle-class workers.

Most workers have no retirement program other than Social Security. About 55% of American workers are eligible for a 401(k) plan, but only about 38% participate. This, according to a 2014 CNBC article perceptively titled, “The right ways to get workers hooked on a 401(k).”

Plans offer as little as 3% of salary from the worker, which is matched by the employer: 3/3. The maximum is 6/6.

The first question that someone being offered a 401(k) program is this: “What has been the rate of return for the program since March 2000?” Why March 2000? Because that was the month in which the heroin rush ended. It began on the weekend of August 13, 1982. The bottom was on Thursday, August 12, when the Dow Jones Industrial Average was 777, and the S&P 500 was 102. The S&P 500 peaked on March 24, 2000, when it closed at 1527.

Why do I say it peaked? It is over 2000 today. We must discount for price inflation. The best way to do this is to go to the inflation calculator of the Bureau of Labor Statistics. It is here. Insert 1527 into the box. Click “Calculate.” As of 2014, you get 2099. That is the break-even point for an investment in the S&P 500. Depending on dividends minus fees, that is a losing investment or close to it, compared with buying Treasury bills.

When you find out what the performance of a 401(k) program has been since March 2000, discount by 15%. That is what price inflation has done to the dollar’s purchasing power.

But what if the fund’s managers won’t tell you what the rate of return has been? Then they are embarrassed by the performance of the program. Why stay in it?

Is the program keeping pace with price inflation? Then ask this: to be relevant for retirement purposes, what rate of return do you need to retire at age 65?

To do this, you need a nest egg that will fund your retirement in comfort. If you reduce this nest egg by the traditional 4% per annum, will it sustain you through retirement? That depends on your life expectancy. To calculate this, you need a life expectancy calculator. Actually, you need two or three. Take the average. Set it for age 65. Then calculate, given your present weight and lifestyle.


What will Social Security provide if you wait until age 67 to retire? (Age 70 is better.) Find out. The younger you are, the lower the likelihood that Social Security and Medicare will outlast you. Both systems are statistically bankrupt. The unfunded liabilities are over $200 trillion. The trust funds are empty: IOU’s from the Treasury.

Then there is your equity in your home. This will do you no good unless you move into low-cost housing and rent your existing home for income, or unless you take out a reverse mortgage. Will you have a mortgage at retirement?

Prof. Alicia Munnell recently wrote an article for MarketWatch on home equity for people in their 60’s. It reveals that the median equity — half have more, half have less — for Americans immediately before retirement is $110,000.

In 2013, 77% of households in their early 60s owned a house. The median house price was $185,000. But 63% of households in their early 60s continued to have a mortgage. Subtracting outstanding mortgage balances from the gross house price yields median home equity of $110,000, which accounts for more than 40% of the homeowners’ total wealth as conventionally measured. The fraction is lower if Social Security wealth and that from defined benefit plans are included in the wealth measure.

That is home equity. So, what is the median value of a 401(k) program for the typical American, age 55-65? A pathetic $104,000.

Combined, the home equity and the 401(k) total about $215,000. But the home equity is being used for consumption: a place to live.

Now, here is my favorite figure. Retirement experts for decades said that the typical family must withdraw 4% per year from capital in order to live comfortably. Today, everyone knows this is fake. I did a Google search. Take a look at the articles. But it was fake back then, too. You can’t take 4% out of your 401(k) nest egg without getting taxed. It’s not your money. It’s the federal government’s money and the state government’s money. They hit you at ordinary income tax rates on withdrawals.

So, you get maybe 3%, not the 4% you pull out. Let’s see: 3% of $104,000 in year one. Then 3% of $100,000 in year two. Then 3% of $96,000 in year three. You think this is the road to comfortable retirement? At the top (beginning), that’s $3,000 a year. How far will that get you? Nowhere. Your goose is cooked. The “experts” who talked about 4% annual withdrawals were trying to sell the suckers investment schemes at high commissions.

(For the rest of my article, click the link.)

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