An Abney Associates Ameriprise Financial Advisor for Taking Retirement Plans
by Chinee Lim Ameriprise Abney AssociatesTaking
advantage of employer-sponsored retirement plans
Employer-sponsored
qualified retirement plans such as 401(k)s are some of the most powerful
retirement savings tools available. If your employer offers such a plan and
you're not participating in it, you should be. Once you're participating in a
plan, try to take full advantage of it.
UNDERSTAND YOUR EMPLOYER-SPONSORED PLAN
Before you
can take advantage of your employer's plan, you need to understand how these
plans work. Read everything you can about the plan and talk to your employer's benefit
officer. You can also talk to a financial planner, a tax advisor, and other
professionals. Recognize the key features that many employer-sponsored plans
share:
·
Your employer automatically
deducts your contributions from your paycheck. You may never even miss the money--out
of sight, out of mind.
·
You decide what portion of your
salary to contribute, up to the legal limit. And you can usually change your
contribution amount on certain dates during the year.
·
With 401(k), 403(b), 457(b),
SARSEPs, and SIMPLE plans, you contribute to the plan on a pretax basis. Your
contributions come off the top of your salary before your employer withholds
income taxes.
·
Your 401(k), 403(b), or 457(b)
plan may let you make after-tax Roth contributions--there's no up-front tax
benefit but qualified distributions are entirely tax free.
·
Your employer may match all or
part of your contribution up to a certain level. You typically become vested in
these employer dollars through years of service with the company.
·
Your funds grow tax deferred in
the plan. You don't pay taxes on investment earnings until you withdraw your
money from the plan.
·
You'll pay income taxes and
possibly an early withdrawal penalty if you withdraw your money from the plan.
·
You may be able to borrow a
portion of your vested balance (up to $50,000) at a reasonable interest rate.
·
Your creditors cannot reach your
plan funds to satisfy your debts.
CONTRIBUTE AS MUCH AS POSSIBLE
The more you
can save for retirement, the better your chances of retiring comfortably. If
you can, max out your contribution up to the legal limit. If you need to free
up money to do that, try to cut certain expenses.
Why put your
retirement dollars in your employer's plan instead of somewhere else? One
reason is that your pretax contributions to your employer's plan lower your
taxable income for the year. This means you save money in taxes when you
contribute to the plan--a big advantage if you're in a high tax bracket. For
example, if you earn $100,000 a year and contribute $10,000 to a 401(k) plan,
you'll pay income taxes on $90,000 instead of $100,000. (Roth contributions
don't lower your current taxable income but qualified distributions of your
contributions and earnings--that is, distributions made after you satisfy a
five-year holding period and reach age 59½, become disabled, or die--are tax
free.)
Another
reason is the power of tax-deferred growth. Your investment earnings compound
year after year and aren't taxable as long as they remain in the plan. Over the
long term, this gives you the opportunity to build an impressive sum in your
employer's plan. You should end up with a much larger balance than somebody who
invests the same amount in taxable investments at the same rate of return.
For example,
you participate in your employer's tax-deferred plan (Account A). You also have
a taxable investment account (Account B). Each account earns 8 percent per
year. You're in the 28 percent tax bracket and contribute $10,000 to each
account at the end of every year. You pay the yearly income taxes on Account
B's earnings using funds from that same account. At the end of 30 years,
Account A is worth $1,132,832, while Account B is worth only $757,970. That's a
difference of over $370,000. (Note: This example is for illustrative purposes
only and does not represent a specific investment.)
CAPTURE THE FULL EMPLOYER MATCH
If you can't
max out your 401(k) or other plan, you should at least try to contribute up to
the limit your employer will match. Employer contributions are basically free
money once you're vested in them (check with your employer to find out when
vesting happens). By capturing the full benefit of your employer's match,
you'll be surprised how much faster your balance grows. If you don't take
advantage of your employer's generosity, you could be passing up a significant
return on your money.
For example,
you earn $30,000 a year and work for an employer that has a matching 401(k)
plan. The match is 50 cents on the dollar up to 6 percent of your salary. Each
year, you contribute 6 percent of your salary ($1,800) to the plan and receive
a matching contribution of $900 from your employer.
EVALUATE YOUR INVESTMENT CHOICES CAREFULLY
Most
employer-sponsored plans give you a selection of mutual funds or other
investments to choose from. Make your choices carefully. The right investment
mix for your employer's plan could be one of your keys to a comfortable
retirement. That's because over the long term, varying rates of return can make
a big difference in the size of your balance.
Research the
investments available to you. How have they performed over the long term? Have
they held their own during down markets? How much risk will they expose you to?
Which ones are best suited for long-term goals like retirement? You may also
want to get advice from a financial professional (either your own, or one
provided through your plan). He or she can help you pick the right investments
based on your personal goals, your attitude toward risk, how long you have
until retirement, and other factors. Your financial professional can also help
you coordinate your plan investments with your overall investment portfolio.
Finally, you
may be able to change your investment allocations or move money between the
plan's investments on specific dates during the year (e.g., at the start of
every month or every quarter).
KNOW YOUR OPTIONS WHEN YOU LEAVE YOUR EMPLOYER
When you
leave your job, your vested balance in your former employer's retirement plan
is yours to keep. You have several options at that point, including:
·
Taking a lump-sum distribution.
This is often a bad idea, because you'll pay income taxes and possibly a
penalty on the amount you withdraw. Plus, you're giving up continued
tax-deferred growth.
·
Leaving your funds in the old
plan, growing tax deferred (your old plan may not permit this if your balance
is less than $5,000, or if you've reached the plan's normal retirement
age--typically age 65). This may be a good idea if you're happy with the plan's
investments or you need time to decide what to do with your money.
·
Rolling your funds over to an IRA
or a new employer's plan if the plan accepts rollovers. This is often a smart
move because there will be no income taxes or penalties if you do the rollover
properly (your old plan will withhold 20 percent for income taxes if you
receive the funds before rolling them over). Plus, your funds will keep growing
tax deferred in the IRA or new plan.
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