Employer-Sponsored Retirement Plans: What You Need to Know

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Finding retirement planning puzzling?

 

Here are some helpful tips to consider when evaluating your long-term retirement plan.

 

The 401(k) Plan:

401K Puzzle

In 1978, 401(k) plans for business employees were enacted into law, and they became more widespread in the 1980s. Other similar retirement vehicles include the 403(b) for employees of certain tax-exempt organizations and the 457(b) for certain state and local government employees. All three of these plans are the primary retirement savings vehicles for many full-time employees. Under an employer-sponsored retirement plan, participants can make contributions from their paychecks either before or after-tax, depending on the options offered in the plan. In some plans, the employer also makes contributions, sometimes matching the employee’s contributions up to a certain percentage. The contributions go into a 401(k) account, with the employee often choosing the investments based on options provided under the plan, most often mutual funds.

 

Other than performance, how do I know which mutual fund(s) to choose?

A fund’s month-to-month, quarter-to-quarter and even year-to-year performance can vary a lot. If there hasn’t been a significant change (portfolio manager change, for example) that calls into question the reason you invested in the fund in the first place, then we think it’s important to look at performance over the long term, like 5-10 years. Other mutual fund attributes that participants may want to consider include the tenure of the portfolio manager(s), the objective(s) of the portfolio and the expense ratio relative to the fund’s objective. If a fund’s objective is to mimic an index (Index Fund), its expense ratio ought to be relatively low versus a fund that is actively managed and seeking to outperform the index over the long term.

 

How does a 401(k) fit in my overall retirement plan?

We recommend that an employee contribute the maximum allowable to their retirement plan, or at least enough to receive the full company match, if offered. Investors also need to have an emergency pot of money—three to six months of expenses—so that a temporary crisis does not require taking money out of their retirement plan. Generally, if assets are withdrawn from a retirement plan before retirement age, income taxes and often a penalty will be applied to the amount withdrawn. There are certain circumstances where a loan or withdrawal may be allowed, but it’s best to not do it. Additionally, with today’s more mobile workforce, it’s very important not to cash out your retirement plan money if you change jobs. Instead either roll the money over to your new employer’s 401(k) plan, or roll it into a Traditional IRA. Remember, this money is for your retirement, so let time and the “miracle of compounding” work in your favor.

 

Are there other investment vehicles I should maintain?

If you’re satisfied with your retirement plan participation level and you have fully funded your emergency account, you may want to look at additional investment tools like a 529 plan for a child’s college education or a Traditional or Roth IRA. There are income limits and deduction rules when investing in an IRA, especially if you also participate in a retirement plan, so you’ll want to familiarize yourself with those restrictions before moving forward. Roth IRAs have some unique features that can make them very attractive. Gains are sheltered from future taxes, so a person may protect themselves from the risk of a substantial tax rate increase. In addition, Roth IRA contributions can be withdrawn without tax implications, subject to some limitations.

 

How can I minimize risk?

Diversification is an important element of investing—we are all aware of the risks of putting “all your eggs in one basket.” But over-diversification is unnecessary and can limit your long-term return potential. Warren Buffett has said, “Risk comes from not knowing what you are doing. Don’t be involved in 50 or 100 things. That’s a Noah’s Ark way of investing—you end up with a zoo that way. Put meaningful amounts of money in a few things you know well.” For the average investor, “a few things you know well” may simply be a few different mutual funds. If you own many funds that all together resemble Noah’s “two of everything,” you are probably over-diversified and paying unnecessary fees.

 

Are there any tax or regulatory changes on the horizon?

The future of tax-advantaged savings is very difficult to predict. IRAs and 401(k) plans have been around for more than 30 years, so if they were to be scrapped, it would be costly for both the economy and taxpayers. However, assets in these vehicles have grown substantially over the years, and our government has its eyes on them. We would not be surprised to see some people in Washington attempt to restrict the tax-deferred growth of these assets in order to raise government revenue.

 

All investments are subject to risk, including the possible loss of the money you invest. Past performance does not guarantee future results. There is no guarantee that any particular asset allocation, or mix of funds, or any particular mutual fund, will meet your investment objectives or provide you with a given level of income.