The bing! bam! boom! guy on CNBC, Jim Cramer, recommended earlier this week that people might want to avoid their 401k plans.
Is this the same Jim Cramer who graduated from Harvard, made tons of money in stocks on Wall Street, founded TheStreet.com….who made tons of money investing and who has the ability to move markets singlehandedly?
The same one.
That’s partly why I’m so surprised. Unlike some who get wrapped up in his television antics, I have no beef with Cramer. He’s made investing more fun, something I passionately think we need more of in media. If people saw investing as a good time, I think we’d have more open discussions about money.
So before we tear him apart, let’s hear his argument:
Jim Cramer’s Argument Against the 401(k) Plan
- “The big positive….is that a 401(k) is a tax-deferred vehicle.” Because you pay taxes only when you withdraw instead of when you put money in or earn interest, dividends or capital gains, you’ll make money faster.
- Employers match 401(k) contributions, so that should be taken into account, because it’s free cash.
…and Why You Shouldn’t Use the 401(k) Plan
- BUT 401(k) plans have higher management fees that eat into your returns;
- AND you have limited fund choices in most 401(k) plans.
So his “rule” for deciding when to use your 401(k) plan? “Cramer says if an employer matches your contribution, and if the plan provides at least some flexibility, go with the 401(k) until you’ve maxed out the match.” After that, use an IRA until you hit your contribution cap.
What’s My Beef With Cramer’s “Rule”?
Cramer had me until he reached the strategy. Like much of the news in the popular press, this advice makes an “easy” conclusion when the truth is really more complicated.
Where Cramer gets it wrong:
Many people can’t contribute to an IRA, deduct the contribution, and still put money into their 401k plan. For a list of the limits, here’s the IRS page.
If you can’t do both, the 401(k) plan is clearly a superior choice. Why? Forget his fee argument. Unless the fees are amazingly huge, they can’t begin to cut into the massive tax break you get from contributing to the 401(k) plan.
Let’s say you’re in the 25% tax bracket. Dollars you contribute to your 401(k) plan are deducted off the top of your income, so you’re saving a full 25% on your tax bill. Add any state tax to the savings, and your fees would have to be between a quarter and a third of the return to justify the IRA purchase.
Is an IRA better? I doubt it.
Here’s the IRS page that covers adding to a deductible IRA: http://www.irs.gov/Retirement-Plans/IRA-Deduction-Limits
Where Cramer Could Have Scored
Had Cramer been talking specifically about a Roth IRA, I might not have written this post. Roth IRA plans work well in tandem with a 401(k) plan. Because the 401(k) is completely taxable when you withdraw money, the only way to have tax savings in retirement is to have accumulated money elsewhere. A Roth IRA provides not only this savings, but also tax deferral along the way.
Finally….Cramer’s Investment Strategy
I need to use caution here: Jim Cramer has made tons of money through successfully buying a handful of stocks. He’s also successfully published many books on investment strategy. It’s hard to find fault with someone’s investment approach when they’ve clearly crushed it. BUT….I’ve worked with many individuals who are in no way ready to hear his advice at the bottom of this CNBC article.
“…Cramer believes whole-heartedly that owning five to 10 stocks of good companies, with solid balance sheets, strong industry position and quality management is the best way to invest for retirement.”
Do I agree?
Sure I do. But you have to be willing to understand a “solid balance sheet”, evaluate “strong industry position” and what qualifies as “quality management” to take this approach. Not only has Cramer invested widely, but he has also written tons of books.
Photo: Tulane Public Relations