In a world of financial instability and declining pension programs, more people are taking a closer look at 401(k) plans and the future income they can generate for retirement.
“The 401(k) plan, in many instances, is the primary method of saving for retirement during your working years. This type of employer-sponsored retirement plan has become the most popular way to save for the future, as the offering of pension plans are significantly less prevalent in the industry,” says John Grech, a Middleburg Heights financial advisor with Edward Jones.
A great feature of a 401(k) plan is the possibility of an employer 401(k) match where an individual’s company adds money on behalf of the employee, typically up to a maximum predetermined percentage, based on the amount that employee contributes, he adds.
An individual has the flexibility in the amount of money he or she decides to contribute toward retirement.
Currently, employees can put away up to $18,000 per year in retirement savings. These funds are able to grow tax deferred until they are withdrawn from the retirement plan. And, if you’re 50 or older, you can contribute an additional $6,000, Grech says.
UNDERSTAND YOUR INVESTMENTS
Independent Mentor financial planner Ernest Brass warns there are good and not-so-good 401(k) plans.
“There are things about 401(k)s a lot of people don’t understand, which is why a good plan should give you someone to talk to and ask questions, rather than let you try to figure things out yourself,” Brass says.
If possible, Brass and Grech say conferences should preferably be face-to-face rather than by phone.
“If you are not familiar with investing, having someone to talk to can add a lot of value,” Grech says.
“There are various factors involved with a 401(k) plan that you should be aware of as you are saving for retirement.”
Withdrawing funds from a 401(k) before 591/2 may cause an individual to incur an early withdrawal penalty in addition to the typical taxes owed on the withdrawal, Grech says.
After age 591/2, there is no early withdrawal penalty to access your retirement plan assets, although taxes on withdrawals still apply.
At age 701/2, however, an individual must start to take withdrawals in the form of a required minimum distribution, or RMD, or face a penalty of up to 50 percent of the amount not withdrawn, he adds.
This forces 401(k) holders who have taken advantage of the tax-deferred nature of their accounts to start paying taxes. Only people who are continuing to work for the company through which their 401(k) plan is offered may be exempt, Grech says.
401(k) holders can take short-term loans from their account, although they must pay it back with interest.
“But the interest is a benefit to you,” Brass says. “The way it works is that the interest charged on the loan is repaid by you into your own 401(k).”
THE ROTH OPTION
Both advisors say the Roth 401(k) has been steadily growing in popularity over the last several years.
With a traditional 401(k), you make contributions with pre-tax dollars so you get an upfront tax break.
Holders of a Roth 401(k) make contributions with after-tax dollars, meaning there’s no upfront tax deduction.
In addition, contributions and earnings withdrawals are tax-free at age 591/2, provided you’ve held the account for five years.
LOOK FOR A PLAN WITH INVESTMENT CHOICES
Many 401(k) plans have fixed- income funds that hold U.S. Treasury bonds, TIPS (Treasury Inflation- Protected Securities) that maintain value should inflation strike, and money market funds.
“The key is to have diversification, a mix of investments,” says Grech. “In the early investing years for an individual, investments with a higher risk may be appropriate but, as you get older and consequently closer to retirement, you may want to be more conservative and look at investments that carry a lower amount of risk.”
Regularly look at your 401(k) statements, “preferably quarterly,” Brass says.
“Since the markets are constantly fluctuating, it is beneficial to consistently review your retirement accounts” he adds. “You can make changes within your account, which is another reason for having a good adviser.”
Make sure your 401(k) has low, transparent administrative fees. The greater the administrative fee, the smaller the return on your 401(k) investments after 20 to 30 years, Brass says.
Money you contribute to a 401(k) is yours, but there is a minimum time you’re required to work for a company before you can retire with all of its matched contributions, Brass adds.
