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Top 10 Reasons to Join Your 401(k) Plan
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By Clifton Linton
Senior Writer, mPower |
When Sandra Kessler quit her job in 1990 to go to
graduate school, she got a pleasant surprise when her former employer handed over the
401(k) savings she planned to roll into an IRA.
She wasn't expecting much, considering she had only
contributed 2 percent of her pay to the plan for two years. But the employer had a
generous dollar-for-dollar match, and Kessler got a $5,200 check. "I remember being
incredibly stunned" at the amount, she recalled.
She became a 401(k) convert. Today, at age 37, she is still
a big fan, contributing 7 percent of her salary and getting the full match from her
employer.
"We get the statements. I say to my husband, 'look how
much is in there and we aren't missing it,'" Kessler said.
Because of the publicity surrounding Enron employees' lost
401(k) savings, some people may be leery about contributing to their own 401(k) plans. But
the problems encountered by Enron employees were not the fault of the 401(k) savings tool
-- they had to do with choices the employer and employees made concerning company stock in
the plan.
Compared to other savings plans available to private sector
workers, the 401(k) plan has many good points. Here are our top 10 reasons why you should
join your plan.
Top Three: Saving Made Easy
1. It's painless. Your employer automatically
deducts your contributions every time you are paid. You don't need to remind yourself to
write a check. And, like Sandra Kessler, after a while most people don't miss the money.
401(k) strategy: Your 401(k) enrollment form may
allow you to make contributions as a specific dollar amount or as a percentage of pay.
Choose the percentage of pay, recommends Brian Mattson, consulting actuary with Watson
Wyatt Worldwide. "That way, when you get a raise, you are giving yourself a raise to
the plan," he said.
2. You get free money with an employer match. In
2001, over 70 percent of plans offered some kind of matching contribution to encourage
participation, according to the 44th Annual Survey of Profit Sharing and 401(k) Plans, by
the Profit-Sharing/401(k) Council of America (PSCA). If your plan is among them, don't
pass up this freebie.
3. You get two tax breaks when you save in a 401(k)
plan. First, the money you contribute doesn't count toward your gross income for the
year, lowering your taxable income.
Second, your money grows tax-deferred. If you saved money
in a savings account or brokerage account you would have to pay taxes on your interest or
dividends at the end of the year. With a 401(k) plan, your earnings are rolled back into
the plan and don't have to be listed as income on your tax return until you withdraw them.
Your savings grow faster this way.
Three More: Good Strategies
4. Interest compounding. This can be a difficult
concept for new 401(k) savers to grasp, but it's what makes a 401(k) plan a powerful
savings tool. Put simply, your earnings are plowed back in to the account so you earn
interest on your original principal plus interest. Over the short term, the gains
can appear small. But over the long term, you can see exponential results.
For example, take the number two and double it, then double
that number, and again. After you have doubled two only 10 times you reach 2,048. Interest
compounding works the same way. Assuming an 8 percent average return, you can reasonably
expect a one-time 401(k) savings contribution to double every nine years. If you consider
most folks have at least a 35-year working life, their initial contributions could double
at least four times. If you are adding to your original contribution each year and receive
an employer match, you can see your savings have some real growth potential.
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| "We get the statements (and) I say
to my husband, 'look how much is in there and we aren't missing it.'" |
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| Sandra Kessler, 37, enthusiastic 401(k)
participant |
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5. Dollar cost averaging lets you buy low, sell high.
Sophisticated investors use this strategy. Instead of looking (and waiting) for the bottom
price at which to buy, you consistently use the same amount of money to buy securities
over time. When prices are high you buy fewer shares, but when prices are low you buy more
shares. This tends to lower the average cost of all of your shares. Since 401(k) savers
make a contribution with every paycheck, by default they use this strategy.
6. You can contribute more to a 401(k) than to an IRA.
In 2002, federal law permits 401(k) participants to contribute up to $11,000 tax-deferred,
or $12,000 if they are 50 or older. (Your plan's limits may be lower; ask your benefits
office.) Comparatively, you are only allowed to save up to $3,000 in an IRA in 2002 (or
$3,500 if you are 50 or older), and this amount may not be tax-deductible if you
participate in a 401(k), depending on your salary.
Final Four: Building an Account
7. It's an inexpensive way to create a professionally
managed, diversified portfolio. Earning money in the markets is a tough, full-time
job. Do you have the time to do that? The advantage 401(k) plans offer is that in most
cases someone does have the time -- the managers of the mutual funds you invest in.
But, it costs a fee. If the fee is reasonable, it's worth
it, says Dee Lee, co-author of The Complete Idiot's Guide to 401(k) Plans. "I
don't have a problem with them making a bonus. If they make money, I make money," she
said.
With a 401(k), you also avoid the minimum investment that
many mutual funds require of other investors. These can start at $500 and run up to
$10,000 or more. If you want to create a portfolio with five funds on your own, you might
need a minimum of $2,500. With a 401(k) plan, you can put money in the same or similar
funds with no minimum investment.
Finally, most of the legwork to find appropriate
investments is done by your employer. If you wanted to create an investment portfolio on
your own, you would have to choose from more than 8,200 mutual funds and 7,700 listed
equities, not to mention corporate and government bonds, savings accounts and money market
mutual funds. By comparison, the average number of funds available for to 401(k)
participants is 13, according to the PSCA.
Still, you need to do some homework to find the right mix
of investments for you. Indeed, the reason many Enron employees lost much of their savings
is that they overloaded their portfolios with company stock. Not only was their employer
match made in Enron stock, but these employees also used their own contributions to buy
Enron stock.
8. Loans and hardship withdrawals may let you withdraw
money in an emergency. Many plans offer loans (which you repay) or hardship
withdrawals (which you don't) as a way of getting your money out in an emergency. But,
because this money is supposed to be for retirement, taking it out early comes with a big
set of attached strings. It's best to investigate all other options first.
9. You can take your money when you change jobs. New
retirement savings plan rules that took effect in 2002 make it easier than ever for
workers changing jobs to roll their retirement savings into a new employer's plan or an
IRA. Doing this simple procedure will keep your savings tax-deferred.
10. Social Security won't be enough. It's widely
accepted that Social Security is only meant to provide a modest percentage of your
retirement income (possibly one-third of your income). Financial planners generally say
you'll need between 70 percent and 90 percent of your pre-retirement income to live
comfortably in retirement. Where is that money going to come from? A 401(k) plan could be
a good source.
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The information provided here is intended to help you understand the general issue and
does not constitute any tax, investment or legal advice. Consult your financial, tax or
legal advisor regarding your own unique situation and your company's benefits
representative for rules specific to your plan.
mPower is the
premier online community resource for 401(k) participants
Copyright ý 1996 - 2000 mPower. All Rights Reserved.
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