401(k) — Is it Really Your Money?
This tax shelter makes you wonder about the tax
May 18, 2009
Fred Foldvary, Ph.D.
Economist

Many workers have been saving money for retirement in 401(k) accounts. These are programs sponsored by employers in which the interest and capital gains are not taxed until the money is withdrawn. The plan is called 403(b) for nonprofit organizations. Many employers kick in additional funds when the employee puts money into the plan.

There are taxes and penalties if the account holder withdraws funds before age 59 and six months. But some account owners have been shocked to find out that they cannot withdraw their funds at all, even if they have reached retirement age.

Some of the companies that administer 401(k) funds have large losses and illiquid assets, and are blocking withdrawals. So at the very time that some unemployed workers need the funds, the same recession that put them out of work has also depleted their retirement funds and even prevented them from getting their money back.

Companies that own real estate not only have lost asset value, but have not been willing to sell their properties to pay for withdrawals. Commercial real estate is crashing as shops and offices shut down. Companies that own office buildings and shopping centers could sell these at steep losses, but that would then even further plunge the value of the shares.

But even mutual funds that have shares of stock that they could sell are refusing to sell, because the realized losses would reduce the share value for all the account holders. And so they are limiting withdrawals.

What 401(k) investors don’t understand is that funds put into the plan are not fully their own property. If you really own property, you have full control over it. A 401(k) plan is really a partnership among the account holder, the plan administrator, and the government. The government is the senor partner; it can change the rules and confiscate the account if it wants to. If your wages are subject to taxation with no limit, you don’t really own your labor. The state has ownership rights to your labor and can also restrict your labor.

Many account holders do not read the contract they sign when they get a 401(k) or 403(b). In many cases, the administrator, in effect a partner to the account, can limit withdrawals, even after the account holder reaches the retirement age. If they can limit withdrawals, they have ownership rights. If you want to make sure you can get your money out within a short time, you need to keep the assets in the account in liquid forms such as in treasury bills.

The basic problem is the income tax, which penalizes savings and investment. Congress therefore allows people to put money in accounts in which the gains are not taxed until the funds are withdrawn. But that then sets up rules which may act against the interests of the account holder when they want to withdraw “their” money.

The income tax creates fundamental problems that have no good solution except the abolition of the income tax. If taxes were instead based on land value and pollution, then wages and business profits would be tax-free. There would then be no tax advantage in retirement accounts. Some employers and financial firms could still offer accounts with early-withdrawal penalties, but the account holder would have more clout, and the contracts would be more favorable to hardship withdrawals and retirement conversions such as to annuities.

In a pure free market, there would be no mandatory governmental social security or medical plan taxes. Freed from income and payroll taxes, workers would instead put their savings into retirement plans that would grow with compound interest. They would have much more choice, and financial firms would have to cater more to the desires of their customers.

Government’s gigantic subsidy to landowners causes the boom-bust cycle and makes governments grab the wages of workers to finance the state. Public goods increase rent and land value, which is a subsidy unless the landowners pay this back. Tenants are paying an implicit tax in the higher rent caused by government services, in addition to the taxation of their wage, and the deadweight loss of truncated production caused by the taxes.

But they keep electing the politicians who do this, so I ask the worker crying because he can’t withdraw his 401(k) money, why did you vote for this?

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Fred Foldvary, Ph.D.
Economist

FRED E. FOLDVARY, Ph.D., is an economist and has been writing weekly editorials for Progress.org since 1997. Foldvary's commentaries are well respected for their currency, sound logic, wit, and consistent devotion to human freedom. He received his B.A. in economics from the University of California at Berkeley, and his M.A. and Ph.D. in economics from George Mason University. He has taught economics at Virginia Tech, John F. Kennedy University, Santa Clara University, and currently teaches at San Jose State University.

Foldvary is the author of The Soul of LibertyPublic Goods and Private Communities, and Dictionary of Free Market Economics. He edited and contributed to Beyond Neoclassical Economics and, with Dan Klein, The Half-Life of Policy Rationales. Foldvary's areas of research include public finance, governance, ethical philosophy, and land economics.

Foldvary is notably known for going on record in the American Journal of Economics and Sociology in 1997 to predict the exact timing of the 2008 economic depression—eleven years before the event occurred. He was able to do so due to his extensive knowledge of the real-estate cycle.