By: Ciaran John
In theory, the U.S. dollar could become worthless if a severe recession spiraled out of control. Needless to say, such an event would have a diabolical impact on a 401(k) containing American stocks and bonds. However, a 401(k) typically contains a wide variety of instruments and your account need not become worthless just because the dollar plummets in value.
Devaluation
The value of the U.S. dollar fluctuates over time as the national economy strengthens or weakens in relation to the economies of other nations. Occasionally, national currencies become virtually worthless when economic problems rapidly deteriorate. High unemployment can lead to reduced income for businesses and falling revenues for the government. In turn, governments, consumers and businesses fall behind on debt payments and creditors raise interest rates. Rising rates drive inflation and this exacerbates the problem. Eventually, rising prices can evolve into hyperinflation during which the value of the national currency plummets on a daily or even hourly basis. This occurred in Germany during the 1920s when the currency became practically worthless.
Securities
The shares in publicly traded U.S.-based companies are denominated in dollars. The share price is based on the value of the company as a whole. If the dollar collapsed, the actual price share price may increase as a result of hyperinflation but the real value of your shares when compared with other currencies would decrease. In the longer term, the economic collapse would likely cause many firms to file bankruptcy in which case your 401(k) shares would essentially become worthless.
Protection
The federal government sells Treasury Inflation-Protected Securities or TIPS, which are designed to rise or fall in value in line with inflation. Some of your 401(k) mutual funds may contain TIPs in which case you have a measure of protection against hyperinflation. Mutual funds holding foreign stocks and bonds would increase in value if the dollar collapsed. Additionally, asset prices rise when the dollar drops in value. This means any commodities-based funds you own that contain gold, oil futures or real estate assets would rise in value if the dollar collapsed.
Tax
Your 401(k) grows on a tax deferred basis. You pay income tax on your withdrawals and a 10 percent penalty on withdrawals made prior to reaching the age of 59 1/2. If the dollar collapsed, the federal government might attempt to rectify the issue by raising taxes to settle debts. This would mean you would lose more of your money to taxes when you eventually made withdrawals.
