The 411 On The 401k
If you have to ask, you probably don't have one. And if you do, you're probably only doing it because you've heard it's the right thing to do. And you'd be right. But rather than invest your money blindly, why not bone up on the basics?
The 411 on 401ks
401k plans are a smart and efficient way to bolster your savings for retirement. Established and maintained through your place of work, these company-sponsored plans are easy to sign up for and contribute to. A pre-determined percentage of your income, chosen by you, is automatically deducted from your regular paycheck.
As much as you don't want to think about it, one day you're going to be old, so you've got to sock some cash away. And 401ks are one of the easiest, most painless ways in which to do so.
The beauty of the 401k is that the money is tax-deferred. Note the distinction between tax-deferred and tax-free. Tax-deferred means you don't have to pay taxes on the money until you dip into the funds upon your retirement. You might be thinking, "What difference does it make if I pay the taxes now or several decades down the road?" Well, grasshopper, it makes a big difference. Twenty, thirty or forty years down the road, you'll be of retirement age (which officially begins at 59.5) and thus most likely in a much lower tax bracket, which will make the government's tax bite significantly less painful.
How much to contribute
Government legislation stipulates that participants can contribute between 1 and 15 percent of their annual earnings. The maximum pre-tax dollar amount for 2000 is $10,500. This figure is set by the government and adjusted for inflation annually. The average participant's contribution for 1999 is between 5.1 and 6.1 percent of their pre-tax salary, says the Profit Sharing/401k Council of America.
The 401k is a great way to salt away money for your retirement. But it's even better when your company matches your contributions, especially since they are not obligated to do so by law. More than 85 percent of employers who offer 401k plans match a portion of their employees' contribution, according to a 1998 study by human resources consulting group William M. Mercer. Employers' contributions can take several forms. Many companies see it as a smart investment because it helps them retain and attract top talent.
Max out your plan
To get the most out of your plan, financial advisors recommend contributing the maximum amount allowed that you can afford. If possible, pick the highest possible percentage permitted by your employer and the IRS. Because the money is untaxed, it's actually worth more in the 401k plan than it would be in your paycheck.
For people who don't trust themselves with their own money--compulsive shoppers, Atlantic City enthusiasts, and financial space cadets--401ks are especially appealing. Once you sign up, responsibilities are next to nil. The deductions are automatic and the money is invested and maintained per your specifications by a third party administrator. The only time you need think about your 401k again is if you get a new job or want to increase or decrease the amount of your contribution. ~
Rolling it over
If you quit your job, are fired or get laid off, you can take your money with you by rolling it over into a new plan at your new company. By consolidating accounts, you are simplifying your finances and essentially making your life a little easier. The less spread out your assets are, the tighter your rein on your money.
Exceptions and penalties
Rolling over an account is one of few instances where you can withdraw the money before retirement age and not be penalized. The other penalty-free early withdrawal situations are if the participant dies or incurs a qualifying permanent disability. Otherwise, any withdrawals before age 59.5 may be subject to a 10 percent penalty. As a general rule, plan participants must begin taking withdrawals from their 401k accounts when they reach age 70.5. There are two other exceptions. A hardship withdrawal (which is both rare and discouraged) allows participants to retrieve money in extreme instances of financial adversity. The other exception is for a 401k loan, which can often result in exorbitant penalties, fees and taxes. Both should be approached with extreme caution.
Why is it called 401k?
Yeah, they could've come up with a better name. At least something a little more descriptive like "Pay Now. Play Later" or "Sock It Away For Another Day." But nope. It's taken, literally, from section 401k of the Internal Revenue Code that bore the plan in 1978.
If you're still not sure a 401k is right for you, or you simply want more information, talk to someone in your human resource department. Studies show that participation in 401k plans increases when employees engage in worker education programs.
Hallmark Alert: September 4, 2001 is 401k Day
Founded by Profit Sharing/401k Council of America, this "annual celebration of success" aims to encourage employees to reevaluate their savings efforts and to-gasp!-save even more. The site, psca.org offers tools to help employees determine for themselves whether or not their retirement savings are on the road to riches. Or at the very least, Wellville. And for those of you who are professional procrastinators, PSCA says it's a good reminder to talk to your employer about your retirement plan options. It's never too late to start, and the sooner you do, the bigger the rewards.