|
Your Resource
for
Retirement and Life Planning Issues. | ||
| - | ||
401(k) Plans |
|
|
|
Your employer may establish a defined contribution plan that is a cash or deferred arrangement, usually called a 401(k) plan. You can elect to defer receiving a portion of your salary which is instead contributed on your behalf, before taxes, to the 401(k) plan. Sometimes the employer may match your contributions. There are special rules governing the operation of a 401(k) plan. For example, there is a dollar limit on the amount you may elect to defer each year. The dollar limit on the amount you elect to defer each year. The amount may be adjusted annually by the Treasury Department to reflect changes in the cost of living. Other limits may apply to the amount that may be contributed on your behalf. For example, if you are highly compensated, you may be limited depending on the extent to which rank and file employees participate in the plan. Your employer must advise you of any limits that may apply to you. Although a 401(k) plan is a retirement plan, you may be permitted access to funds in the plan before retirement. For example, if you are an active employee, your plan may allow you to borrow from the plan. Also, your plan may permit you to make a withdrawal on account of hardship, generally from your funds you contributed. The sponsor may want to encourage participation in the plan, but it cannot make your elective deferrals a condition for the receipt of other benefits, except for matching contributions. Investing in a 401(k) plan
Once you request information about a 401 (k) plan, you will be given three pieces of information: (1) an enrollment form, (2) a summary plan description, and (3) information on specific investment options. The summary plan description details the plan's rules and regulations including amounts employees can contribute, employer matches, vesting rules for employer contributions, distribution rules, and grievance procedures. The information on investment options may be a short description of each option or a prospectus if mutual funds are offered. Where to put tax-deferred funds
Once you decide on the amount to invest, the next step is to elect a place to put this money. Since January 1, 1994, companies offering 401(k) plans have been relieved of much of their fiduciary duties if they offer at least three asset classes, such as a money market fund, bond fund, and stock fund. Some companies offer a whole menu of mutual fund types, along with company stock and a Guaranteed Investment Contract (GIC), which has a guaranteed interest rate. Most companies have at least six choices.
Be aware that tax-deferred plans are long-term investments. This means you can afford to take greater risks. Consider investing the major portion of your funds in stocks, since historically they have out-performed other investment options. The portion invested in stocks may change over your working life. Those in their twenties might consider investing 75 to 80 percent in the stock market, in their thirties and forties, 70 percent, in their fifties, 60 percent, and in their sixties, 50 percent. While you may think this is a risky strategy, the longer you hold on to stocks, the less risk of loss of principal and the greater chance your funds will grow to a level that will adequately finance your retirement lifestyle. To survive market downturns, you may want to invest 15 to 25 percent in bond funds and the remainder in a money market fund. If your company stock is an investment option, experts advise limiting your investment to 25 percent of your total 401 (k) stock allocation. This assumes that you are working for a profitable company; if not, limit the percentage even further.
Equity mutual funds Many plans offer mutual funds with a variety of objectives and risks. Your choice of mutual fund depends on the amount of risk you want to assume. The following types of funds are commonly offered by companies.
Growth funds invest in both small and large companies that pay few or no dividends. Socially conscious funds invest in companies that do not harm health or the environment. Value funds buy undervalued stocks. Growth and income funds invest in dividend paying stocks. A balanced fund invests in stocks and bonds. An index fund invests in stocks found in a particular stock index, such as the Standard and Poor's 500 (S&P 500) stock index. An S&P 500 index fund provides the approximate return of the stock market as a whole. The prospectus for each of these types of funds explains the risks. Depending on your risk tolerance, you may want to vary the proportion of funds you put into several of these options.
Fixed income alternatives A Guaranteed Investment Contract is a contract between an insurance company and the tax-deferred plan. The interest on the account is guaranteed for a specific period of time, however, the funds themselves are not. The funds are invested in mortgages and bonds, which mature at the same time as the contract. In addition to GIC's, tax-deferred plans frequently offer a series of bond funds. Some common examples are corporate bond mutual funds, and U.S. Treasury Agency bond mutual funds with various maturity lengths. When purchasing a bond fund, remember to check the maturity of bonds held in the portfolio. A fund containing bonds that will reach maturity in 5 to 10 years is common and not as risky as a fund containing longer term bonds. In addition, most 401(k) plans offer a money market mutual fund with a maximum maturity of only 90 days. The adoption of 401(k) plans by a state or local government or a tax-exempt organization is limited by law. What Is a 403(b) Plan?Similar to 401(k) plans and also named after a provision in the tax code, a 403(b) plan is a Federally approved annuity-type retirement plan for certain educational and nonprofit organizations. You contribute to your 403(b) tax-deferred until you withdraw money. Ordinary income taxes are generally due upon withdrawal. Withdrawals prior to age 591/2 are generally prohibited. Those that are allowed may be subject to a 10% tax penalty. Some Tips for Savvy 401(k) Investing An employer is legally required to provide a Summary Plan Description (SPD) of your 401(k), including information about eligibility, vesting and benefit payouts. However, employers are not required to distribute prospectuses and financial statements on the investments themselves. Information on your plan. s investment options may come from the investment manager directly. Remember, a prospectus is required by law for all mutual funds. To make sound judgments regarding your 401(k) plan, you. ll want to know the following:
|
| |
|
Copyright 2005 Retirement Planning Basics. All Rights Reserved. | ||
Burdened by high-interest credit
card debt? Get a free quote for
Credit Card Debt
Consolidation and reduce your debt up to 60%.