Employer-sponsored qualified retirement plans such as 401(k)s
are some of the most powerful retirement savings tools available.
If your employer offers such a plan and you're not participating in
it, you should be. Once you're participating in a plan, try to take full
advantage of it.
Before you can take advantage of your employer's plan, you need to
understand how these plans work. Read everything you can about
the plan and talk to your employer's benefits officer. You can also
talk to a financial planner, a tax advisor, and other professionals.
Recognize the key features that many employer-sponsored plans
share:
- Your employer automatically deducts your contributions from
your paycheck. You may never even miss the money--out of
sight, out of mind.
- You decide what portion of your salary to contribute, up to the
legal limit.
- With traditional plans, you contribute to the plan on a pretax
basis. Your contributions come off the top of your salary before
your employer withholds income taxes.
- With Roth plans, you make after-tax contributions and your
qualified distributions are entirely tax free.
- Your employer may match all or part of your contribution up to
a certain level. You typically become vested in these employer
dollars through years of service with the company.
- Your funds grow tax deferred in the plan. You don't pay taxes on
investment earnings until you withdraw your money from the
plan.
The more you can save for retirement, the better your chances of
retiring comfortably. If you can, max out your contribution up to the
legal limit. If you need to free up money to do that, try to cut certain
expenses.
Why put your retirement dollars in your employer's plan instead of
somewhere else? One reason is that your pretax contributions to
your employer's plan lower your taxable income for the year. This
means you save money in taxes when you contribute to the plan--a
big advantage if you're in a high tax bracket. For example, if you earn
$100,000 a year and contribute $10,000 to a 401(k) plan, you'll pay
income taxes on $90,000 instead of $100,000.
Another reason is the power of tax-deferred growth. Your investment
earnings compound year after year and aren't taxable as long as
they remain in the plan.
If you can't max out your 401(k) or other plan, you should at least
try to contribute up to the limit your employer will match. Employer
contributions are basically free money once you're vested in them
(check with your employer to find out when vesting happens). If you
don't take advantage of your employer's generosity, you could be
passing up a significant return on your money.
Most employer-sponsored plans give you a selection of mutual funds
or other investments to choose from. Make your choices carefully.
The right investment mix for your employer's plan could be one
of your keys to a comfortable retirement. That's because over the
long term, varying rates of return can make a big difference in the
size of your balance. You may want to get advice from a financial
professional (either your own, or one provided through your plan).
He or she can help you pick the right investments based on your
personal goals, your attitude toward risk, how long you have until
retirement, and other factors.
When you leave your job, your vested balance in your former
employer's retirement plan is yours to keep. You have several
options at that point, including:
- Taking a lump-sum distribution. This is often a bad idea, because
you'll pay income taxes and possibly a penalty on the amount
you withdraw. Plus, you're giving up continued tax-deferred
growth.
- Leaving your funds in the old plan, growing tax deferred (your
old plan may not permit this if your balance is less than $5,000,
or if you've reached the plan's normal retirement age--typically
age 65). This may be a good idea if you're happy with the plan's
investments or you need time to decide what to do with your
money.
- Rolling your funds over to an IRA or a new employer's plan if
the plan accepts rollovers. This is often a smart move because
there will be no income taxes or penalties if you do the rollover
properly (your old plan will withhold 20 percent for income
taxes if you receive the funds before rolling them over). Plus,
your funds will keep growing tax deferred in the IRA or new plan.
Have questions about retirement planning? Contact me at (585) 419-0670, ext. 57712 or by email at [email protected].
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