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Employee Considerations
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Taking Advantage
of Your Employer-Sponsored Retirement Plan
Before you
can take advantage of your employer's plan, you should understand how these plans work. Read everything you can about the
plan and talk to your employer's benefits officer. Inquire about key features shared by many employer-sponsored plans…..
Will your employer automatically deduct your pre-tax contribution from your paycheck?
Will you decide what portion of your salary to contribute, up to the legal limit? Will your employer match all or part of
your contribution up to a certain level? Will your funds grow tax deferred in the plan? No tax on investment earnings until
withdrawal? Will you pay income taxes and possibly a penalty if you withdraw money from the plan? Will you be able to borrow
a portion of your vested balance at a reasonable interest rate?
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
lower your taxable income for the year. This means you save money in taxes as you contribute to the plan… a big advantage
if you're in a high tax bracket.
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).
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Employee Considerations
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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. That's an automatic,
risk-free return of 50 percent on your investment!
Evaluate
your investment choices carefully
Most employer-sponsored plans give you a selection of mutual funds 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 advisor. 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 advisor 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. Find out how the reallocation
process is handled?
Know your options when you leave an
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). 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 tax consequence or penalty if you do the rollover properly. Plus, your funds will
keep growing tax deferred in the rollover IRA or new plan.
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