How a 401(k) plan, (which may be employer-matched), could
help you fall in love with the thought of a comfortable retirement.
There can be a lot of confusing numbers floating around when you try to invest. 529s, 401(k)s, 403(b)s, it
can get hectic. One thing which isn’t confusing is knowing you want the opportunity to retire in comfort.
General George S. Patton once said, “I always believe in being prepared,” and while he may not have
been talking about retirement specifically, he makes a good point. Be ready.
So what are your best options for being prepared to live out your golden years? Well, for many years
there has been the theory of the three-legged stool in preparation of retirement. The three legged stool
consists of Social Security (public), your own investments and savings (private), and some sort of
employer involved retirement plan such as a pension plan or a 401(k). No matter what political party you
come from, you know you probably shouldn’t rely heavily on Social Security for retirement. Your personal
savings are extremely helpful in retirement, but the beauty of the employer sponsored retirement plan, in
this case, a 401(k), is that in many cases your employer will make some sort of matching-contribution.
That’s free money for your retirement!
What is it?
401(k)s got their start back in 1978, when the IRS established a new provision to allow employees to
defer some of their compensation into an account with their employer. The beauty is that in many cases,
your employers will match your contributions to a certain point. Employer matches come in a wide variety
of options depending on the employer’s discretion. Some employers match contributions dollar for
dollar. Others match 25 or more cents on the dollar. That means each time you contribute, your employer
adds money, for free! Often times your employer will only match up to a certain percent of your salary. But
regardless, they’re adding to your retirement for you!
When you first enroll in a 401(k) plan, you’ll be given a list of investment options.
It’s best to sit down with a financial professional and figure out how you wish to
invest your money. Your options for investments will vary from conservative
fixed income investments to aggressive stock portfolios. You are able to
allocate your money into investments in different combinations depending on
how much growth you want to achieve, and how much risk you can tolerate.
Benefits of a 401(k)
All the contributions you make to your 401(k) are on a pre-tax basis. By
deferring money to your 401(k) before taxes, you not only avoid paying taxes
now, but you reduce the amount of taxable income that Uncle Sam can take.
You will have to pay federal and state income taxes when you withdraw from
your 401k, but there’s always a chance you’ll retire in Florida, or another state
which doesn’t have a state income tax. According to the IRS, those states,
besides Florida, include: Alaska, Nevada, New Hampshire, South Dakota,
Tennessee, Texas, Washington and Wyoming.
Another added benefit of an employer-matched 401(k) (besides the free
money!) is that the money is available in case of an emergency withdrawal. In
some cases, you may be able to borrow money from your 401(k), penalty free.
However, if you quit your job or are laid off, before paying back the loan, you
may be required to pay the full amount at termination. Always check with your
financial professional before borrowing any money from your plan.
Keeping your 401(k) prepared
Besides being prepared for retirement, you also want to be prepared with your
individual 401(k) and the restrictions and limits placed on it. These limits and
rules can apply to switching jobs, borrowing from your account, and the
penalties that may be incurred if you withdraw early from the account. As soon
as you enroll in a 401(k), you should receive a Summary Plan Description. Your
employer should provide it to you. If not, ask for it. This will describe your
retirement plan and the options available to you regarding withdrawals, rollovers,
and collections. You want to share this document with your financial professional so the two of you can
decide what options fit you best when planning for the future. Many companies have restrictions on what
can and can’t be done with your retirement fund. As with most financial planning, a little education goes a
long way, and knowing the details of your plan will help make future job transitions a bit smoother.
A Few Restrictions
No such thing as a free lunch, you say? Well, there are restrictions, and in the case of 401(k)s you can
only contribute the lesser of $16,500 or 100% of your compensation for the year 2010. If you work
multiple jobs and have more than one 401(k), you are still limited to $16,500 a year total. However, that
number may increase based on inflation in 2011. If you’re over 50 and you’re trying to catch up, the law
allows you to defer an extra $5500 for the year 2010. There is also a limit to when you can withdraw from
your account penalty free. You must wait until age 59 ½ until you withdraw from your 401(k). Withdrawals
before age 59 ½ are subject to a 10% penalty.
401(k)s aren’t the only option for retirement, but they’re definitely one of the most attractive. In a lot of
cases, they offer free money and are relatively easy to roll over when you change jobs. You also have the
convenience of deferring taxes and paying less each year to the government. Social Security probably
shouldn’t be relied upon, and personal savings don’t often give you the chance for free money, so it only
makes sense to participate in your employer’s 401(k) to add to your retirement plan.
By sitting down with a financial professional, you can make sure you’re prepared for retirement with a
401(k) that fits your investment style and your stage in life. You can also make sure that your financial well-
being is prepared for any changes of career or investment styles by working with someone closely to
handle it all with ease. Who knows, with a small amount of effort working with your financial professional,
your preparation might even make General Patton proud.
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