Back in February when the President made his State of the Union address, one item he discussed was limiting the size of people's 401k's. One example he cited was the massive size of Mitt Romney's 401k. If I read some of the sentiment after the speech correctly, some people called it government overreach and limiting 401k's to $3.1 million would hinder people's retirement. Although I don't have a crystal ball, I wanted to see how "damaging" this would be. The following were my assumptions I made: 1) Theoretical person starting at age 22 2) Starting salary of $50,000 3) Managed to put away the maximum contribution of $17,500 in first year (2014) 4) Company/group match is 0.045 of salary; takes full advantage 5) Increase contribution by 1% per year; assumes each year the government allows 1% more to be added 6) Invests in S&P 500 or Vanguard Total Market Index; reinvests dividends 7) Dividends paid at 2.5% on average every year 8) Investment growth is 7% per year (a pretty fair average growth rate for both) Using this approach, the resulting age that the person's 401k balance will equal $3.1 million is between age 50 and 51 (the catch up contribution has not even come into effect). Okay, so this could cap a person's retirement account but stay with me as a make one last assumption and calculation. Much like the maximum 401k contribution which is increased each year, lets assume the same application to the $3.1 million dollar cap is applied. Lets assume the government allows the 401k max to increase by 2.5% per year. By age 51, the government maximum will be $6-6.2 million. Though if we chose a governmental increase of 1%, by age 51, the 401k max value will be $4-4.1 million. In both cases, the government would not constrain a person's retirement growth. However, if we continued it out to age 55, in both scenarios the "person's" 401k balance would exceed the government's allowable max before age 60 without the catch up contribution. My conclusion is some of the ire may be deserved if Obama can implement the 401k max. However, this all depends on the implementation and future results. If the $3.1 million is a hard and fast rule, the person above will be forced stop contributing to their 401k before they even reach the catch up contribution age. Likewise, if it's implemented and adjusted over time, it may not effect the "person" at all and they could continue to contribute up to age 60. I also tinkered with the initial contribution. I assumed the newly employed was only able to contribute $8,750 (half the max but still able to take the 4.5% match) and never took advantage of the catch up contribution. They would break the $3.1 million mark by age 56, exceed the 1% government increase by age 60, and overtake the 2.5% government increase by age 67 (assuming they continued to work). A win for compound interest!
Interesting analysis. Really. The only problem is your assumptions assume consistency over decades. Aside from Obama and his czars are members of the Alinsky-Cloward-Piven school and hopefully this reign of loon thinking ends in late 2016, do you really whatever the executive and legislative branches evolve to could resist tampering over time with potential sources of revenue? As much as I'd like to see the end of social engineering within the tax code and a move to a flat tax akin to Steve Forbes' 1996 campaign, I doubt if there is any will power to pull it off. The $18T national debt and the size and spending levels of the federal government only exacerbate the situation.
Good points, baudwalk. And yes, this is more big govt overreach. It's basically penalizing you for smart investing - many people manage to earn far more than such "assumed" returns. It's not the government's job to dictate to you how much you're allowed to earn by investing wisely. If they want to set contribution limits, that's one thing. Setting caps on the amounts you're "allowed" to accumulate before you're penalized is pure socialism as far as I'm concerned. Those marxist assholes can't let us have very much growth, can they? And executives like Romney often took advantage of stock options within their retirement plans that sometimes eventually paid out far more than what the options were originally worth. Good for him!
I agree; that theory assumes no dynamic changes to both the financial state of the country and said investor. However, I am unsure as to how the government intends to curb potential corruption with this imposition. While I understand the need to limit the top one percent's economic power over the country, this does put a damper on the hard-working, fiscally responsible citizens who have wisely saved their money. I hope that the government soon realizes that this measure was petty and does not aid ordinary citizens.
Too aggressive assumptions.... Try more realistic assumptions... Your contribution %, total return % and overall asset allocation assumptions are all very aggressive. Very few 22 years olds will be able to contribute 30% of their salary to their retirement considering they likely have some or all types of debt... student loan, automobile, credit card debt let alone rent, food and fun costs. They may actually try to build a rainy day fund or save for a down payment on a house. With respect to your return assumption, you're assuming continued annual compounded returns of 9.5% returns (2.5% dividend) which is not at all reasonable. Average returns over the past 50 years are most likely not going to be repeated especially considering the size and maturity of the U.S. economy. The SPY will be lucky to return 7% annual total returns over the next 30-50 years --- also consider the annual return of the S&P over the last 15 years (it's not pretty). The same applies to the Total Market Index which as a better chance of beating the S&P over the next 30-50 years however it is also likely to face more boom and busts (when factoring in EMs) and large mature economies like USA, EU and Japan will drag performance returns. Last you're assuming the average person can handle or should be 100% allocate to the S&P 500 / Total Market. If you had $1.0 or 2.0 million and it went down 35% in a year which is more common than you think...how do you think the average person could handle that? Also, as the average person gets closer to retirement the less chance it has to overcome a major downdraft. As such, I recommend you reassess your assumptions to something more realistic.
Read your post CFACPAman and believe you missed some of the point of my post but adjusted my analysis hopefully to meet your concerns. You point of matching 30% of the initial salary is valid, I've adjusted to match 15% of the starting salary ($8,750). Also, took the total return from 9.5% to 4.7% (2.2% for the S&P 500 for last 15 years annualized and 2.5% dividend reinvestment). All other factors remained the same as the original analysis. By age 62, portfolio value of $1.8 million is reached. Not nearly what the original analysis shows. However, I would like to make one point. The 9.5% total return was selected as the average return since 1985 to 2015 (average return over 30 years less 10%). So I would agree with you that over 15 years, assuming 9.5% return is ridiculously aggressive. Though assuming that same average return over 30 years is not overly aggressive. Also, your comment on the US market being mature, don't know if that is exactly true. I believe some industries in the US have not only matured but are dying/died out. The S&P 500 and Total Market 30+ years from now will look very different. However, business is business. Companies, whether they current exist now or will be formed in the next 30 years, always seek growth. Also, many companies will expand beyond the confines of their current country. By extension, the S&P 500 and Total Market Indexes will add, remove, or change with the market. So, my opinion is a return of 2.2% for 15 years, as you've made me analyze, is reasonable to assume; nevertheless, assuming the same 2.2% for the next 30 years is too conservative (again my opinion). You've touched on an important point, the look-back bias but it's the only analysis tool I have. As for your comment about the market dropping 35%, my goal of this article was merely theoretical exercise. Although there may be perceptions and reactions that will decrease (and increase) a person's portfolio size, the point was theoretical to see if an average person could reach the limit, not if they do/what they need to do to meet it. If you what me to test other conditions or build in a decreasing portfolio size for certain years, let me know.
We have no way of knowing whether or not the S&P will return an average of 7% or 10% or more or less or whatever over the next 30-50 years. I have averaged 15% in my fairly aggressive taxable accounts over the last 21 years, including the ups and downs we've had over the last 15 or so years. I've averaged 12% during that time in my retirement accounts, which have been a mix of mutual funds, a handful of stocks and short term debt here and there, and some commodities ETF exposure in recent years. It also helps that I dollar cost average in both my taxable and tax-advantaged accounts. If I really didn't think I could average any more than mid single digits annually in my stock investments over the next several decades, I'd either stick to corp and emerging markets bonds, or find other ways to invest the money. Either way, it's not the government's job to limit how much I can accumulate through smart investing.
I am hearing you JR and I agree. It seems like there has been way to much interest in what the population at large has for way to long. I have a theory that it was inevitable that things would get bad economically once electronic banking went main stream. Sure there is no way that ship will ever change course, but it is bad in that it makes it to easy for big brother to start salivating over your/my/anyone's piece of pie. You better believe if they want it bad enough they will devise scheme after scheme to try to get it.
