|
Getting the
most out of your employer's 401(k) retirement savings plan seems simple
enough in theory: Contribute the maximum you're allowed, choose your
investments carefully, and keep your mitts off the money until you hit 59
1/2. The advantages of the plans are equally straightforward: You get a
tax shelter against your current income, tax-deferred investment returns
and, best of all, a tax-free gift from your employer who usually matches
your contributions with some of his own green.
Trouble is, it's easy to screw up in an
employer-sponsored savings plan. "A 401(k) could well become your
largest asset, but people mismanage that money for all sorts of
reasons," says Dee Lee, president of Harvard Financial Educators, a
consulting firm in Harvard, Mass. Some blunders, unfortunately, can't be
easily repaired. What follows are the five most common 401(k) mistakes and
how to avoid making them:
Failing to maximize your company's
match.
You are, of course, contributing to the plan (right?). But are
you getting all you can out of the boss' portion? Commonly, an employer
will match 50% of an employee's contributions, up to 6% of salary. In
other words, the most he'll kick in is 3% of your wages--and that's only
if you put in the full 6% yourself. Salt away less, and so will he. So be
sure to sign up for a 6% payroll deduction if you can afford to do so.
Some company plans let individuals invest as much
as 10% of their pretax pay, even though the match doesn't go that high.
Now here's where things can get tricky. Say your gross is $125,000 and you
want to earmark 10% for the 401(k), or $12,500. Figure that your boss will
match your 401(k) contributions up to 3% of your pay--$3,750, or $144
every two weeks. But the law says an employee's tax-deferred plan
contributions cannot exceed the federal limit--$9,500 this year. Odds are,
your employer would simply take 10% out of your biweekly paycheck until
you hit the $9,500 ceiling sometime in October. Then your contributions
would stop--just the way your employer quits withholding Social Security
taxes once you've hit this year's limit of $64,500.
Stop the clock on your contributions, however, and
you'll lose the company match for November and December--more than $500.
"If you make a lot of money, you can get screwed by putting in too
much too soon," says Rich Koski, national director of pre-retirement
and financial planning for Buck Consultants in Secaucus, N.J. The
solution: Divide the $9,500 maximum 401(k) contribution by your salary to
get the percentage of your pay that you can invest each pay period--in
this case 7.6%. Have that amount taken out of your biweekly paycheck, and
you'll extend your contributions--and the company match--over the entire
year.
Not paying enough attention to the
investment allocations in your 401(k) portfolio.
The biggest headache for many plan participants is deciding where
to invest their 401(k), since the choices are wider than ever. According
to the benefits consulting firm Hewitt Associates of Lincolnshire, Ill.,
52% of 401(k) plans now offer six or more investment flavors, up from 22%
with that many in 1993.
Too often, however, participants put too much money
in one type of investment. That is partly because many plan sponsors
inadvertently encourage them to invest too heavily in fixed-income
options. The plans usually provide at least one choice that is expected to
hold its value, such as a stable-value fund, which aims to preserve
capital plus pay a stated rate of interest. In addition, many employees
want a money-market account, where they can safely stash their
contributions while deciding where to invest them. As a result, many
401(k)s with a variety of fixed-income funds have been slow to add stock
funds. "Employees often view these choices as a subtle message to
invest more heavily in fixed income than in stocks," says financial
planner Tim Kochis, president of Kochis Fitz Tracy & Gorman in San
Francisco.
Alternatively, your 401(k) might be too heavily
weighted in your own company's stock. According to Frank Bermani,
executive director of the Society of Plan Sponsors in Windsor, Conn., 45%
of all 401(k)s now offer company stock as an investment option, and some
employers match contributions exclusively with that stock. Moreover, some
employers restrict participants from shifting the money out of their
company stock and into another 401(k) offering.
It's unwise to have more than 20% of your
retirement account in your own company's shares, since you are already
dependent on your employer for your job, your health benefits and possibly
a pension. If you can't touch the shares already in your 401(k) account,
be sure to hedge them with investments in the plan's other stock
offerings.
Finally, companies are increasingly funneling
employees' profit-sharing bonuses into their 401(k) accounts. If yours
does, be sure you don't blithely assume that this money will automatically
be allocated in the same fashion as your regular 401(k) contributions. It
often goes straight into a money-market account in the plan unless the
participant fills out a special form for these bonuses and chooses another
investment. So if you expect to get a profit-sharing bonus for 1997 and
aren't sure how it will be invested, check with your benefits consultant.
Turning into a stock jockey.
Some 401(k) participants become so obsessed with the idea of
riding winners that they shift in and out of stock funds, trying to time
every dip in the market. They can get away with it because there are no
immediate tax consequences for moving money around inside a plan and no
sales charges for switching. But stock jockeys can pay a huge performance
penalty. While the average U.S. stock fund returned 14.5% annually from
1984 through 1996, the typical fund investor earned just 6.1% a year
because he got in too late, pulled out too soon or both, according to
Dalbar, a financial services research firm in Boston.
You know you're investing
herky-jerky, says Hewitt
consultant Wendy Rhodes, when you're frequently "hitting the phones
at the end of the day to make transactions in your 401(k)." Instead,
size up your 401(k) portfolio once a year. At that time, rebalance any
allocations that a rising (or falling) stock market may have thrown out of
whack and consider taking advantage of new investment choices.
Using your 401(k) as a quickie loan window.
Access Research, a 401(k) consulting firm in Windsor, Conn.,
reports that 78% of plans let employees borrow some of their accumulated
assets and, as of 1996, 23% of employees had loans outstanding. You can
usually get a five-year 401(k) loan for any reason or a 10- to 30-year
loan to buy a home.
On the surface, 401(k) loans are a sweet deal
because you pay yourself back at an interest rate slightly above prime,
which is 8.5% today. By contrast, you'd pay about 15.4% for an unsecured
personal loan at a bank. But borrowing from your plan has an unfortunate
domino effect on your portfolio. Not only are you removing money whose
sheltered earnings could be compounding, your loan's interest rate is
likely to be lower than the portfolio's return. As a result, you can drag
down your 401(k)'s overall performance. Worse, you get socked for taxes
twice: You repay the loan with after-tax dollars, and your money gets
taxed again when the funds are distributed, typically at retirement. So
before you borrow from your 401(k), ask yourself: Will the money I receive
be used to fund a future goal as important as my retirement? If the answer
is no, borrow somewhere else.
Triggering unnecessary tax penalties with
inadvertent withdrawals.
You probably know it's expensive to withdraw money from a 401(k)
before age 59 1/2. In most cases, you'll owe ordinary income taxes on the
distribution plus a 10% tax penalty. (The IRS waives this penalty for
certain cases like disability or for the amount of medical bills in excess
of 7.5% of your taxable income.) But 401(k) participants sometimes take
withdrawals without meaning to and get pummeled in the process.
Suppose you leave your company and decide to roll
over your 401(k) balance into your new employer's plan or into an IRA. If
you do not have the check sent directly to your new employer or to the
custodian of your IRA within 60 days of quitting, your former company will
give you the money after withholding 20% for taxes. You can't reclaim that
20% until you file your income taxes the following year. Meanwhile, you
will have lost tax-deferred compounding on one-fifth of your total
distribution.
Another potential pitfall:
If you leave your job
and roll over your 401(k) balance into a new plan before paying back an
outstanding loan against it, the loan balance usually becomes a taxable
distribution, warns Bill Chapman, president of the retirement plans group
at Zurich Kemper Investments in Chicago. So if you can't afford to repay
the loan before leaving your job, see whether your benefits department
will let you keep the 401(k) with the employer and pay back the money over
time. Otherwise, get a cash advance equal to the loan balance from a
credit-card issuer dangling one of those 6%, six-month teaser rates and
repay the loan before you quit. Then, either pay off the credit-card
balance before the rate rises or keep rolling it over into new teaser
rates. That way, you'll help keep the IRS from ruining your retirement.
|
|
