Retirement
The 411 on 401(k)s
As more companies move away from traditional pensions, 401(k) investment plans have emerged as the primary retirement vehicle for many workers. These plans offer terrific opportunities for building a retirement nest egg and reducing your tax exposure, but they require careful attention to detail.
Here are some tips:
- A 401(k) account is a retirement savings plan that offers three major benefits: 1) It can reduce your taxable income because contributions come out of your pay before taxes are withheld. 2) Most 401(k) accounts include a matching contribution from your employer (often 50 cents on the dollar, up to about 6 percent of your salary). 3) The money you invest benefits from tax-deferred growth, allowing it to compound more quickly than if it were taxed yearly.
- Find out if your employer offers a 401(k) plan and the amount of the matching contribution. Take full advantage of this "free money." Be sure to ask about the vesting schedule (the point at which you can walk away with 100 percent of your company's matching contributions).
- Here's how it works: If you earn an income of $50,000 annually and contribute $3,000 (6 percent of your salary) and your employer matches that by giving you $1,500 (a 50 percent match of your contribution), you end up investing $4,500 every year. You also save hundreds of dollars in income taxes.
- Most plans offer you a variety of mutual funds and you pick the type and mix of funds. Three things to look for in picking a good fund are:
- Better than average returns
- Low price/expense ratio
- Solid management
Don't stop investing during a bad market. Instead, take full advantage of the phenomenon called "dollar-cost averaging."
What this means: Let's say you invest $100 a month, the market is strong and a share in your selected mutual fund is going for $50. Your $100 will buy you two shares. Now, let's say the market is weak and a share in that same mutual fund is going for $40. Now, your $100 will acquire 2.5 shares. Over time, with luck, the mutual fund will gain in value and you will have more shares working for you at the end. Put another way, ideally you want stocks to be low during the years you are in buying mode (so you can acquire more shares) and high during the years you are in selling mode (so those shares are worth more).
- Under some conditions, you can borrow against your 401(k), but try not to. Every dollar you borrow is one less dollar that is working for you and your retirement.
- What to aware of: You will pay federal income taxes on your withdrawals, but most likely at a lower rate when you are retired than when you are still working. Under most circumstances, you will be hit with a 10 percent penalty if you withdraw any money before you reach age 59 (55 if you are no longer employed). The government requires that you begin withdrawing money from your 401(k) at age 70.
- You get to control the investments by picking the type and mix of funds. Four things to look for in picking a good fund are:
- Better than average returns
- Low price/expense ratio
- Solid management
- Reasonable size
A great deal of information about 401(k)s and other retirement plans is available here: www.aarp.org/money/financial_planning/sessionseven/retirement_accounts_at_work.html
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