By Jon L. Ten Haagen, CFP ®
With the demise of the pension plan (some unions still have them) for most of us, we have to fund our retirement ourselves. One way is to contribute to your company’s 401k plan. One of the reasons a company starts a qualified plan is to retain key employees. Basically, you can participate in your company’s 401k (there are also 403b and 457 plans which are very similar) after a certain time on the job – usually 6-12 months until you are eligible.
Why should you participate, and what should you look for? By participating, you contribute toward your future. When you put some of your paycheck into a 401k, this reduces your taxable income and puts money to work growing tax-deferred toward you’re retirement. When reviewing the plan offered to you, look to see if the company offers a matching plan. This is where the company will match to a certain percentage what you contribute for yourself. One popular plan is for the company to match your contribution up to 4 percent of pay and then to match 50 percent for the next 2 percent you contribute. This is found money, and you only have to be a participant to get this bonus. Bottom line is if your company offers a match to your contributions you must invest at least up to the match amount. If you don’t, you are literally throwing money away.
Next you should look at the sub-accounts offered in the plan. These are the individual investment choices offered to you. Some plans have very little choice or diversification of investment choices, and some do not have sub-accounts which have good historic rates of return over the years. Also, look to see how expensive the fees are. A few years ago, the IRS created rules which said the funds had to be transparent showing the costs clearly. In most cases this was done, but it is still a good idea to look carefully.
If the funds you are offered have less than stellar rates of return compared to their indexes consider investing only up to the match percentage, then look elsewhere for tax-deferred vehicles. One way is to look outside the company to a self-directed IRA or ROTH IRA. Make sure you check with your Certified Financial Planner or CPA to be sure you are making the right product choice. Your income (AGI) make be too high for you to participate in a ROTH IRA, however, you can invest in an IRA even if your income phases out your ability to take a tax deduction. You can still get tax-deferred growth of your investments.
Another thing to check with you HR department is to see if they have a 401k ROTH IRA option in the plan.
The bottom line is for you to put away 15 percent of your paycheck every time you get paid. I ask people to put 15 percent away off the top and they say, “Oh, I can’t afford that much,” but when I reword the question by asking: Can you live on 85 percent of your income? Most say, “Yes I think I can do that.” You have to find a way to increase you investing in your future. No one else cares about you like you have to.
As always, if you would like a second opinion to get comfortable with you decisions, or would like to get these investing concepts clear in your mind, reach out to the ‘Ask the Expert’ – That’s why we are here.