401(k)---An Employee's Perspective
Your employer has provided you with a unique opportunity to save for a comfortable and enjoyable retirement through your Company-sponsored 401(k) Retirement Plan.
Remember, your employer is under no obligation to provide you with a retirement plan. You cannot start your own 401(k) retirement plan or participate in your spouse's plan. These plans are only available to the employees of the company sponsoring the plan. That's why you should take full advantage of this outstanding opportunity so you and your spouse can enjoy the fruits of your labor during your retirement years.
Read This Page Carefully!
Your employer wants you to 'make the most' of your 401(k) plan. Make sure you review all of the information in this booklet very carefully. By doing so, you'll be better equipped to face the important decisions you need to make in order to accumulate the dollars that will be necessary to maintain a comfortable standard of living during retirement.
What is a 401(k) Plan?
Simply stated, your plan is a great benefit for you and your family. And it's a benefit you're fortunate to have. Millions of workers nationwide do not have access to a plan. But you do, and you should take full advantage of this undeniably useful benefit. Because in reality, if you ask yourself: 'What is my retirement plan?' the answer is:
It's Your Future
There are many different directions your future can take, and it isn't a matter of being lucky enough to hit the bull's-eye. Where we end up depends largely on the decisions we make-or fail to make. As the old saying goes, "People don't plan to fail, they only fail to plan."
Making sure you will have a comfortable and enjoyable retirement requires only that you stay on the path of savings. And there's no better way to save for retirement than through your continued participation in your Retirement Plan.
Save More, Pay Less
With your 401(k) plan, you can save for retirement and reduce income taxes. That's because each and every dollar you contribute to your 401(k) plan reduces your taxable income, dollar for dollar. When you withdraw money from your plan during retirement you're usually taxed at a lower rate. That means each and every time you put money into your plan, you're lowering your income taxes. Contributing to your plan is one of the few ways in which you can achieve these two objectives with one simple savings maneuver.
When You Retire...
Most experts agree that you will need to have a retirement income at least equal to 70% of your current household income at retirement in order to maintain your current standard of living during your retirement years.
Your retirement nest-egg should be comprised of two components: A small portion of your retirement nest-egg may be provided by Social Security benefits; and the major portion of your retirement nest-egg can come from your 401(k) plan.
Your 401(k) plan is one of the best savings vehicles. It may allow you to grow a substantial retirement nest-egg. Even if you are already saving through the 401(k) plan, consider contributing more. (Remember the 70% requirement.) Gain Access to Otherwise Unavailable Investment Options.
Another great reason for saving through your 401(k) plan is that it enables you to gain access to institutional investment funds not available to the general public. The 'no load' (no sales charge) investment options available to you through your 401(k) plan are among the most highly ranked for performance. You benefit from the large pools of money being invested by your 401(k) plan's trustee. This allows you to gain access to quality performing investment options which no single individual investing modest amounts of money could access. The advantage of institutional investing power is one more reason to save and invest through your 401(k) plan.
Although there are many different types of retirement plan options available to corporations, they fall into two general categories: defined benefit plans and defined contribution plans. The following pages provide a brief overview of these plans and their benefits. Figure 1 offers a quick means of identifying the plan that best suits your current needs. Target Laboratories in California (www.targetlab.com) has selected a defined contribution plan because it is easier to setup and less expensive to operate.
Making Your Account Grow: Understanding Investments
Investment success is the result of taking the long-term view. Don't assume that investment success is right around the corner-it's not. Think of investment success as a destination far off on the horizon, and you'll be better off. Even the experts agree that trying to 'time the market' by frequently moving your money from one investment to another rarely works. Taking the long-term view will almost always lead to the kind of investment return you're seeking.
It's also important to diversify-in other words-don't put all your investment eggs in one basket. Most experts agree on the importance of asset allocation as a means of reducing taxes and increasing returns.
Asset allocation is the act of diversifying your money between equities (stocks), fixed-income investments (bonds), real estate, and cash. Most experts agree that the general rule-of-thumb is to have more money in stocks when you are younger and to slowly shift your money, over time, until you have more money in fixed-income investments as you get older.
That's why it's important to select investment options that best reflect your goals, risk tolerance, and the number of years you have until you reach retirement. It's also important to remember that there was a time when many people felt that, after retiring, they should get out of stocks altogether. But times have changed, and almost all experts will tell you to maintain some type of position in the stock market even after retirement.
Since it is not uncommon for people to live 15, 20, or 30 years after retirement, this becomes an even more valuable strategy.
The Damage of Inflation
When selecting investment options, don't forget to factor in the damage of inflation. Even when inflation levels are low, inflation will still have an impact on your investment earnings. If you invest exclusively in an investment option with an annual return of 6%, while inflation hovers around 4%, it's easy to see that your real return is extremely low and your buying power may be eroded. That's why, as previously observed, it's best to have an investment strategy that includes diversification and long-term goals.
Risk vs. Reward
When selecting investment options, you need to weigh the risk against the reward. Almost always, the lower the risk, the lower the reward. However, it's important to remember that when an investment option has a higher risk, the reward (returns) can be greater, too. Statistically, over the long term, higher risk investments (stocks) have performed quite well. That's why it is important to diversify and to avoid investing too conservatively.
A Historical Perspective
While most of the equity, or stock, investment options carry greater risk than fixed-income options, these investments have provided much higher returns over the years. In fact, since 1926, stocks have consistently outperformed fixed-income investments by a wide margin.
The charts above and below provide a better illustration of how stocks have consistently outperformed fixed-income investments (bonds). Although the amount of your retirement funds which you may choose to invest in stocks from time to time may vary from all to none, depending on your age, retirement goals and degree of risk-comfort, this type of investment should be considered if you have concerns about the protection of the real returns on your money in an inflationary economy.
Think Retirement's a Long Way Off?
Many people, especially those in their 20s and 30s, think that their retirement is still a very long way off. It's almost as though they think that their retirement is at the end of a very long road, way off on the horizon. But in reality . . . it's closer than you think.
Time Passes Quickly
Wedding, birth of children, kids in college, first house- It may seem like many of these milestone events took place only a few years ago, or are a long way off, but in reality, they're just around the corner . . . That's why the time to start saving is NOW!
Why Continue to Save Through a 401(k) Plan?
If you think that Social Security benefits alone will provide you with sufficient income to have a comfortable and enjoyable retirement, or even allow you to maintain your current standard of living- you'd better think again. Social Security was never intended to be the sole source of a person's retirement income, and it is fair to assert that such benefits will not come close to affording you and your spouse a comfortable retirement at a standard of living comparable to your present one.
enefit From the Miracle of Compounding
Another great reason to continue participating in your 401(k) plan is the 'miracle' of compounding. It may sometimes seem like your 401(k) plan account balance isn't growing very quickly, but through compounding and the reinvestment of investment earnings (which are not taxed while held in the plan), your contributions can really add up! The graphs above and below illustrate the growth of a $1,200 and $1,500 annual contribution with an 8% annual investment return. Please note: your account balance could be greater depending on the amount of your contributions, market conditions and your asset allocation mix.
Additional non-profit websites that include relevant unbiased information about 401k plans include: www.smallbusiness401k.com and www.retirement-plans.com.
More Information You Should Have Regarding Your 401(k) Plan
How Does It Work?
As a participant, you determine how much money to contribute to your 401(k) plan account. These monies are placed into your account for your exclusive benefit. Best of all, each and every dollar you contribute is tax deductible, dollar for dollar, and the taxes you do pay are deferred until retirement, and usually at a lower rate. Saving in your 401(k) plan allows you to save for retirement through payroll deductions and reduce your income taxes automatically. There are no special income tax forms to complete at the end of the year.
Here's an Example:
John Smith makes $20,000 a year. He contributes 6%, or $1,200, of his gross pay to his 401(k) plan. As a result, John only pays federal income taxes on $18,800 instead of $20,000.
You might say to yourself, "This 401(k) plan sounds like a great idea, but I think I'll wait a year before I start saving. After all, it's only one year's worth of savings, and in the long run, that can't amount to much."
To the contrary, one year amounts to much more than you might think, especially when you consider the effect of compounded earnings. If your total contribution for one year is $1,200, waiting one year will cost you plenty.
Let's say that John Smith in the preceding example decides to wait two years. Mary Jones begins her saving now, contributing the same amount as John. Twenty-five years later, Mary will have earned over $8,000 more than John! That's right, over $8,000 more than John, just because she began saving earlier.
The important point to remember is that, even if money is somewhat tight today, it may not be in the future. And you can always adjust the amount of your contributions. So even if you can begin by making a small contribution, your best bet is to begin saving right away. Building a retirement nest egg is more the result of regular contributions than the size of those contributions.
Get a Dollar's Worth of Benefit...
Without Paying a Dollar
Remember how your 401(k) plan contributions reduce your taxable income dollar for dollar? This enables you to receive a dollars worth of benefit without costing you a dollar. How?
Let's look at the John Smith example again. John contributes $1,200 to his 401(k) plan each year. This means that instead of paying income taxes on his $20,000 salary, he pays on only $18,800. This saves John $180 in taxes every year. As a result, the $50 contribution John makes each pay period only costs him $42.50 (after factoring in the tax savings).
Wouldn't it be nice to go to the grocery store, purchase $50 worth of groceries and, when you get to the checkout, pay only $42.50 (without using coupons!)? Wouldn't it be great to get $5 worth of gas for only $4.25? In essence, your 401(k) plan provides you with the same level of value.
Choosing Your Investment Options: How It Works
If your 401(k) plan offers a menu of 'No-Load' Institutional Mutual Funds, YOU must decide on which funds to use AND how your money will be allocated (divided) between your choices. You can choose as many funds as you want, but the percentages of your choices MUST add up to 100%.
For example, you could put 70% into the S&P 500 Index Fund and 30% into the Growth Fund. As another example, you could put 20% into the Money Market Fund, 30% into the Growth Fund, and the remaining 50% into the Bond Fund.
Again, these are just examples and NOT suggestions of how you should allocate your savings. If your 401(k) plan offers a menu of funds, the funds may be different than those used in the examples.
Remember that your employer cannot give you investment advice. You must make the choice or choices of investment options yourself. However, if you wish, you may seek out and use suitable investment counsel to assist you.
Like all retirement plans, your 401(k) plan has some rules. Most of these rules involve eligibility and distributions. Review the Plan Summary in your Employee packet to determine which specific features your plan offers. You can also check with your plan administrator if you have questions about any of these features. Please note, however, that your own contributions are always 100% vested. In other words, you always own 100% of any and all contributions you make to your account, plus their investment earnings!
Although your contributions are not taxed when made to your 401(k) plan, they are taxed when distributed to you.
Moreover, by law and design, 401(k) plans were not created to function like a Christmas Club or a savings account for a rainy day. Since your contributions are meant for retirement, they cannot be withdrawn prematurely without incurring tax penalties. However, money can be withdrawn from your 401(k) plan account prior to your actual retirement, without penalty, in the event of:
- Attainment of Age 59 and 1/2
- Termination of Employment (if rolled into an IRA or another qualified retirement plan)
In most cases money can be withdrawn from your 401(k) plan account in the event of hardship (a Hardship Withdrawal). However, there is a tax penalty if taken before age 59 and 1/2. This feature allows you to withdraw money for:
- Purchasing a Home
- College Education Expenses
- Medical Bills
Another way in which you may be able to withdraw money from your 401(k) plan account without incurring a penalty (and unlike other premature withdrawals, without taxation) is in the form of a Participant Loan. This feature allows you to loan yourself money, so long as the money is paid back to your 401(k) plan account within five years.
Certain restrictions apply to both Hardship Withdrawals and Participant Loans, so check with your Company's benefits specialist for details. Please consult your Human Resources Representative for availability of this option.
Plan to Enjoy Your Retirement
When you're in your 20s, 30s, or even in your 40s, it may be very difficult to think about retiring some day. But as we've said again and again, time passes quickly. In order to obtain the benefit of compounded earnings, you'll need to start saving now if you are going to achieve the 70% goal referred to earlier.
If you remain diligent, and you put a reasonable amount of money away each pay period, the investment earnings* from these savings and Social Security benefits will combine to provide you with a comfortable and enjoyable retirement. In saving for your retirement, your money will grow tax deferred and you will significantly reduce your annual income tax obligation.
After all, you work hard, and you owe it to yourself to make your retirement years the best years of your life!