Effect of IRA & 401K Contributions to Stock Prices
Retirement and pension plans such as Individual Retirement Accounts (IRAs) and 401k plans comprise a vast bulk of the investment assets in the United States. Pension plans are among the largest of institutional investors, able to move the market by simply entering or exiting a large stock position. In the case of 401k plans, employees often contribute the maximum amount to their plan and some employers match the invested funds up to a certain percentage. These funds are invested pre-tax and on an automatic basis each pay period.
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History
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When the Employee Retirement Income Security Act (ERISA) of 1974 was enacted, the Dow Jones industrial average was approximately 850. In October of 2007, the Dow went over 14,000. There are many contributing factors to this meteoric rise, not the least of which is the explosion in stock investing spurred by the 401k plans launched by ERISA.
Retirement plans have had a profound effect on the market since 1974. However, the vast majority of IRA and 401k activity to date has been on the contribution side of the equation. Over the next decade, a massive shift will take place and the majority of IRA and 401k activity in the market will move to the distribution side as baby boomers enter retirement and are faced with government-mandated distribution requirements.
Significance
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As the single largest buy side customer in the market, retirement plans have driven stock prices to historic highs in a relatively short period of time. Unfortunately, what goes up must come down. Billions of tax dollars have been deferred over the past three decades through IRAs and 401k plans, and the government has been waiting to collect. That is why the mandatory distribution age for retirement plans is 70.5. As more and more of the American population reaches this milestone, stocks within the retirement plans must be sold to meet the requirement. This will cause immense selling pressure and is expected to drive the overall market lower.
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Time Frame
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While many investors have already reached mandatory distribution age, it is estimated that the bulk of baby boomers reaching retirement and mandatory distribution age will begin in 2012.
Effects
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The effect of IRA and 401k contributions to stock prices has been dramatic. A steady stream of investment capital entering the market month after month for over 30 years has driven technology and medical investment, created wealth for an extraordinary number of investors, and consistently spurred the market to new highs most years.
Benefits
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The benefit of tax deferred returns cannot be overstated. Anyone with a private or employer-sponsored retirement plan should endeavor to contribute the maximum amount annually. In the case of employer-matched contributions, failing to contribute the maximum amount to the plan is tantamount to throwing away free money.
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