It only takes a little to make the most of 401(k)
Copley News Service
Most of us know little about Wall Street, or investing.
And that explains why most Americans who are eligible to sign up for a company 401(k) savings plan usually leave it alone once the paperwork has been turned in to the human resources department, reported the Pension Research Council in 2005.
That's not to say that we are totally ignorant. Most of us know the 401(k) plan is an employer-sponsored retirement plan named after a section of the U.S. Internal Revenue Code, and that what makes a 401(k) attractive is that it allows workers to divert a pretax portion of their paycheck into an interest-bearing account.
We might even know the tax code is written to encourage Americans to save for their retirements and that, once placed in a 401(k) account, our money is allowed to grow tax-free.
Most of us look at the quarterly statements we receive in the mail or online from the plan administrators showing how our money has grown, or not, in the previous three months. But beyond that, we tend to pin our hopes on benevolent neglect.
According to a study commissioned by AARP, most Americans fail to properly manage their 401(k) plans. One important reason they fail to do so, according to the University of Michigan Retirement Center, is because they feel "uneducated about the process." Consequently, U.S. workers tend to sign up for the company 401(k) plan and hope for the best.
But the AARP says on its Web site (www.arp.org) the process is not really so difficult and can be narrowed down these steps:
- Max out
Contribute the maximum, or enough to obtain the total employer match.
Money Magazine reported on a 2005 study by Putnam Funds, which found that if you were making $40,000 in 1990 and started saving 2 percent of your salary, you would have $40,000 in 15 years. But if you contributed 6 percent, your savings would be $120,000.
What's more, contributing the maximum amount allowed by your plan won't reduce your paycheck as much as you might think. The amount you save is not a dollar-for-dollar loss in pay, because the money goes into the plan before taxes.
Experts recommend that you spread the money you contribute to your plan among a variety of "asset classes," such as stocks and bonds, and then decide what proportion of your assets to assign to each one.
Sometimes this is called not putting all your eggs in one basket. This is a good idea because as one area of the investment market goes down - as tech stocks did in 2000 - others could be going up.
You might decide to put 75 percent of your contributions in the stock market and 25 percent in bonds, for example. History shows that over the long term, stocks have the greatest return on investment. But in the short term, stock values can crash significantly in a single day.
Bonds are more reliable, but historically they grow at a slower rate.
How much to invest in stocks, bonds and other asset classes depends on your age, years to retirement and ability to tolerate risk. You might consider talking to an expert to help you decide the best allocation for you.
- Keep watch
Check once a year or so to see if your percentages still hold. If you decided on 75 percent stock and 25 percent bonds and then the stock market surged, your stock portion might drift to 85 percent. You could return it to 75 percent by transferring money from stocks to bonds.
Become informed. If your employer offers financial education meetings and newsletters, take full advantage.
- More is better
If you have been working for awhile, it is possible that you have more than one retirement plan from past employers. By combining them, you can simplify your finances, receive one consolidated statement, and be able to see at a glance how much money you have and how it's invested.
If you transfer money from other employer plans to that of your current employer, you gain a unique advantage - if you are planning to work into your later years.
"Normally, the IRS requires you to start taking retirement plan payments after you reach age 70," said retirement law specialist Ian Davies at financial services firm TIAA-CREF. "But if all your money were in your current employer's plan, you wouldn't have to begin any payments until after you retired."
E-mail Ven Griva at [email protected] or write to P.O. Box 120190, San Diego, CA 92112.
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