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Retirement and 401k’s: What You Should Know
During the past few years, many U.S. based companies have changed the retirement outlook of this country by straying away from traditional retirement pension plans and focusing towards more profitable 401k plans. This trend has been growing fairly consistently and the statistics prove this point. Today, nearly one-fourth of the Fortune 1,000 companies have already changed or are considering changing their pension plans to individual 401k plans.
Computer giant IBM is the latest company to follow this new trend and joins the list along with other big names such as Sears, Hewlett-Packard, Motorola and Verizon Wireless.
To help consumers understand the basics of 401k plans, we at CreditGUARD of America, Inc. have put together the following Do’s and Don’ts of 401k plans.
What You Should Do
If your employer offers a 401k plan and matches a certain percentage of your contribution, you should take advantage of this opportunity without delay. An average employer matches 50 cents for a dollar and up to 6 percent of an employee’s salary. What most employees do not understand is that the employer contribution match is basically ‘free money’.
The contributions you make towards your 401k come out of your paycheck before taxes are taken out. As a result, you do not pay income tax on the money you contribute to your 401k. The 401k earnings or capital gains are also tax deferred until you reach your retirement age, hence allowing your investments to compound and grow at a healthy rate.
If you are middle aged and have not yet put aside enough savings towards your retirement, you should contribute the maximum amount allowed by the government towards your 401k. In 2006, the government increased the maximum contribution limit from $14,000 to $15,000 per year. For those who are 50 years or older, the government may allow you to contribute an extra $5,000 towards your retirement, also known as “catch-up” contributions.
You should carefully review your employer’s 401k plan and learn your rights as a participating employee. Under U.S. law, you are eligible to start contributing to a 401k plan after one year’s employment with a company, provided one is offered. The U.S. Department of Labor provides a publication detailing all consumer rights and obligations relating to 401k plans on their website. Please click on the following link to view the publication – http://www.dol.gov/ebsa/publications/wyskapr.html .
Finally, you should design your 401k investment portfolio to meet your specific financial goals. Most 401k plans offer employees various risk/return options ranging from conservative to aggressive portfolios. For instance, an investor who prefers a stable and uninterrupted flow of future returns can opt for a conservative portfolio when compared to another investor who likes to take on higher risk levels while reeking in higher returns by investing in an aggressive portfolio. Investors who prefer the middle ground can choose a moderate, balanced or a growth portfolio.
What You Should Avoid
401k’s can be a great retirement tool for as long as you do not break the piggy bank until you reach the age of 59-1/2. If you decide to withdraw money from your 401k before that date, you must pay income taxes on your withdrawals in addition to the 10 percent early withdrawal penalty. Also, when you tap into your 401k funds early, you basically sacrifice your future compound earnings, which will substantially shrink your nest egg.
Another good point to remember is that when you leave your current job for whatever reason, you should follow proper precautions when rolling over your 401k to another employer or to an Individual Retirement Account (IRA). Most people when leaving their jobs request the employer to cash out their 401k’s and write out a check for them. In such a situation, the employer is required by law to withhold 20 percent of the funds for tax purposes. However, if you request your previous employer to arrange a direct rollover (money transferred from your previous employer to your new employer) without going through your bank account, the tax withholding can be avoided.