What are your best options for preparing to live out your golden years? For many years, the theory of the three-legged stool for retirement preparation has reigned: Social Security, private investments and savings, and an employer-sponsored retirement plan, such as a pension plan or a 401(k), if you are fortunate enough to have this option.
The beauty of a 401(k) is that many employers will make a matching contributionâ€”that's free money for your retirement. If you don't have access to this type of program but your spouse is employed with a company that offers it, make sure that they participate.
In 1978, the IRS established a new provision that allowed employees to defer some of their compensation into an account, and the 401(k) was born. Some employers match contributions dollar for dollar, while others match 25 cents or more on the dollar. Often an employer will only match up to a certain percentage of your salary.
When you first enroll in a 401(k) plan, you'll be given a list of investment options. It's best to sit down with a financial professional and figure out how you wish to invest. Your money can be allocated into investments in different combinations depending on how much growth you want to achieve, and how much risk you can tolerate.
All the contributions you make to your 401(k) are on a pretax basis. By deferring money to your 401(k), you not only avoid paying taxes now, but you reduce the amount of taxable income that Uncle Sam can take. You will have to pay federal and state income taxes when you withdraw from your 401(k), but there's always a chance you'll retire in a state that doesn't have a state income tax. According to the IRS, those states are Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.
Another added benefit of an employer-matched 401(k) is that the money is available in case of an emergency. In some cases, you may be able to borrow money from your 401(k) penalty-free. However, if you quit your job or are laid off before paying back the loan, you may be required to pay the full amount at termination. Always check with your financial professional before borrowing any money from your plan.
Always prepare for the restrictions and limits placed on your 401(k), such as changing jobs, borrowing from your account, and the penalties that may be incurred if you withdraw early. Employers should provide a summary plan description, which describes the retirement plan and the options available in addition to information about withdrawals, rollovers, and collections. Share this document with your financial professional so the two of you can decide what options fit you best.
You can only contribute the lesser of $15,000 or 100% of your compensation for the year 2006. If you work multiple jobs and have more than one 401(k), you are still limited to $15,000 a year total. If you are over age 50, the catch-up contribution limit is $5000. There are also restrictions to when you can withdraw from your account penalty-free. You must wait until age 591/2 to make withdrawals or you will be subject to a 10% penalty.
401(k)s aren't the only option for retirement, but they're definitely one of the most attractive. In a lot of cases, they offer free money and are relatively easy to roll over when you change jobs. You also have the convenience of deferring taxes and paying less each year to the government. By sitting down with an advisor, you can make sure you are prepared for retirement with a 401(k) that fits your life. Make sure that your finances are prepared for any changes in your career by working with an experienced professional.