Relief for Retirement

Good news, the 401(k) match is back!  According to Chavon Sutton at CNN Money, 80% of the companies that suspended or reduced their 401(k) programs are planning to restore them this year.  When many companies stopped their 401(k) match programs last year, I suggested that people stop contributing to their 401(k) accounts and instead start investing elsewhere, such as by opening a Roth IRA account.  But now that they are back, if you’re given the option, jump back into the game and start contributing to your 401(k) accounts again.  Click here to find out why the match is such a great benefit offered by companies and why you can’t afford not to match.  If you have had to scale back on saving for retirement or have simply never been able to save because more urgent matters keep cropping up, this is the perfect incentive to start.

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Rollover – Not in Your Bed, But to a Roth IRA

With less than three weeks of work left, my calendar is quickly filling up with farewell lunches.  I have not, however, neglected other more important things related to my departure, such as making sure I will get paid for unused vacation days and that my calculation is the same as HR’s.  ALSO, I have been researching on what to do with my 401k once I leave, and below is a list of dos and don’ts.

  1. Do not withdraw  – Apparently one of the biggest mistakes that people make when they leave a job is to withdraw the money from their 401k.  Not only will you be making a HUGE dent to your retirement funds, you will be paying heavily for it – income tax for the distribution plus an additional 10% tax  (the IRS says tax, I say penalty) for withdrawing before you hit the magic age of 59 1/2.
  2. Do not just leave it in its current account – Now is the time to assess how well the account has been growing.  Do you like the investment options offered by your company and the investment company they have selected?  Are you satisfied with the services?  If not, you are free to take your business elsewhere, whether to one you select individually or another 401k account offered by your new job.
  3. Do roll it over – If you do decide to transfer your 401k to a new account, do a rollover.  Once a check gets cut to you – even if you deposit it directly into a new retirement account – the IRS will consider that a withdrawal and you’ll be hit with the income tax and the 10% penalty.  It’s better to play it safe and arrange for a direct transfer, so that no money passes through your hands.
  4. Do consider a Roth IRA – As mentioned in previous posts, you contribute post-tax dollars to a Roth IRA but it then grows tax-free.  This is what I plan to do with my 401k account.  And while I’ll get hit with taxes in the beginning (because I contributed only pre-tax dollars to my 401k initially and Uncle Sam always gets his cut), I will never have to pay taxes on any subsequent earnings.  This is crucial, because I expect that I will earn more money as I get older and will be taxed at a higher tax bracket.  So this is not just a matter of paying taxes now vs. paying taxes later, it’s also a matter of paying less taxes now vs. paying more taxes later.  Further, I’m not required to roll over the entire balance at once.  I can control how much I want to roll over each year, so I can spread out my tax burden over several years.

Roth If You Can’t Match

A few weeks ago, we wrote about checking to see if your employer offers matching contributions to your 401K and, if they do, making sure that you start contributing.  The economic downturn, however, has led many employers to cut benefits, and matching contributions have been frequently one of the first ones to go.  If you find yourself in this situation, stop contributing to your 401K account immediately.  Instead, open a Roth account and start saving towards retirement there.  Click here to learn the difference between these two accounts.

Like your 401K , your investment options for Roth range from CDs to bonds to stocks.  You are only limited by the investment firm you choose.  Companies, such as Fidelity, Vanguard, and T. Rowe Price, have fund options that do not charge sales fees or commission.  There might be, however, initial deposit requirements ($3,000 at Vanguard), minimum monthly contribution requirements ($200 per month at Fidelity) and annual fees if the account is below a certain threshold ($10 a year at T. Rowe Price for mutual fund accounts with balances of less than $5,000).

As for the 401K account, you have the option to roll it over to a traditional or Roth IRA when you terminate employment.  But for now, just let the money sit and grow.  While these retirement funds have been hit hard, the economy is rebounding and good news is all around.  Just this quarter, my account actually accrued earnings!  Soon enough yours should too.

You Can’t Afford Not to Match

By “match,” I am not talking about your work outfit (although that goes without saying). I am talking about your employer’s matching contributions to your 401K.  401K  (so-called because of the section of the Internal Revenue Code that governs such plans) is a type of retirement plan that allows individuals to contribute pre-tax dollars to a fund and have the savings grow tax-deferred until withdrawn at retirement.  Most recent graduates do not get paid enough as it is, so I am always quite surprised to hear about people who did not even bother to find out if their employers offer matching contributions. Hello? It is free money!

Leaving aside the arguments that recent graduates are too young or too poor to save for retirement, let’s talk numbers. For example, let’s say you make $35,000 a year and your employer offers a matching contribution to your 401K at a rate of 50 cents for every dollar you contribute, up to 6% of your salary. This means if you put in $1,000 for your 401K ( less than $20 each week), your employer will just give you another $500. If you make the maximum contribution of $2,100, your employer will give you more than $1,000 in free money. Some companies match at a higher rate and/or set even higher matching ceilings. So while it may be hard, you should really figure out a way to put aside enough money to maximize your matched contribution. In the end, you will be receiving free money from your employer and it will all be growing exponentially in an account somewhere.

Unfortunately, in this economy, many employers are scaling back their costs by cutting out the matching contribution benefit, in which case you should no longer contribute to your firm’s 401K but set up a Roth IRA (more in the next post).

The other major component of matching contributions is how long it will take for them to be 100% vested – meaning they belong to you completely even when you quit. Some firms, such as mine, are 100% vested when they are matched; others require that you work for a few years with them. If you are not sure how long you will stay at your current company, then you should also consider opening your retirement account elsewhere.

Bottom line – this is a HUGE benefit that your employer is providing and you would be crazy not to cash in on it.

Hands Off the Retirement Fund

Our blog hasn’t talked about retirement yet, but expect several posts on it soon enough. For now, let me start with a short introduction, particularly useful for those of you who are interested in setting up a retirment account but do not know where to start (or even what all the codes mean) and those who might already have a retirement account but want to explore other options.  Despite the fact that most of us are more than 40 years away from retiring (but maybe some of us will retire early!), it is never too early or too late to start planning.

I would categorize retirement funds into two major categories: pre-tax and post-tax accounts.

Pre-tax accounts: As the name suggests, these are IRA or 401K accounts (401K are so-called for the section of the Internal Revenue Code that governs such plans) that use pre-tax dollars.
Pro: You get to sock away money for your retirement before Uncle Sam gets his cut and your account grows tax-deferred.
Con: Uncle Sam gets his cut eventually, such as when you start withdrawing money for retirement.

Post-tax accounts: Also known as Roth, these are IRAs or 401K accounts that use post-tax dollars.
Pro: Your earnings grow tax-free, and because you have already paid taxes on the money you put in, you can also withdraw the money before your retirement age without penalty (just the amount you contributed though, not the money the account has earned).
Con: You don’t get the tax break in the beginning.

Within these two broad rubrics, your choices of investment run the gamut from CDs to mutual funds to stocks, which we will discuss at a later time.

The most important tip to keep in mind, though, is NEVER dip your hands into your retirement fund until you actually retire. Obviously, there are exceptions, such as medical emergencies and home foreclosure, but these should be few and far in between. Try to internalize this way of thinking about your retirement account. And should you find yourself in the unfortunate situation of needing to access that money, WSJ’s has a good recent article going through the rules and accompanying taxes and penalties for early withdrawal.