Mastering Your 401(k)

By Albert B. Crenshaw June 2008 - AARP Bulletin Today

With the emergence of the 401(k) as the primary retirement plan for workers,
millions of you have become responsible for complex financial decisions once
handled by pension professionals. Not only do you have to choose when,
where and how much to save for retirement, you have to figure out how to
manage those savings so that you don’t:  1. run out of money before you die;  
2. run afoul of tax rules resulting in unexpected taxes and penalties; or  3.
leave any leftovers in a form that deprives your heirs of benefits. Even those
of you who have professional help from a financial adviser may find that you
want to understand the basics, if only to help you sleep at night and explore
the haunting question, “Will I have enough?”

The Buildup
Beginning in your 20s and throughout your
working years, you’ve had plenty of claims
on your income—a home and a family chief
among them. But you should also have
saved early and often to have enough in
retirement. But if you haven’t, you still have
choices.

Begin contributing immediately. Anytime
you start a new job, enroll in the 401(k) plan
if it’s offered. If your company enrolls you
automatically—don’t opt out. Every extra
year your account has to compound means more money in your pocket when
you retire.










Get the match. Set your contributions high enough to take full advantage of
any match your company offers. The match is free money—don’t leave it on
the table.

Choose investments that fit you. Over the long haul stocks have turned in
the best performance, so if you’re in your 50s, look to put a good chunk of
your money into the stock market. (But be cautious about investing in
company stock. You’re already depending on your employer for your
paycheck and benefits, so consider putting most of your retirement eggs in
another basket.) As you grow older, you can shift some of your money into
more stable investments, such as bonds, and, as you approach retirement,
some into cash, such as certificates of deposit (CDs) or U.S. Treasury
securities.

Rebalance. Once you’ve chosen your
investments, decide how much of each type
you want—say, 60 percent in stocks and
40 percent in bonds—and periodically check
to see if your portfolio is within these limits.
When the stock market has been doing well,
you’ll likely find your stock percentage has
gotten above the assigned level, which will
be a reminder to sell some and shift the
proceeds to bonds.

Likewise, in periods of falling interest rates,
which push up bond prices, you may see
your portfolio becoming too heavy on bonds, telling you it’s time to sell some
and shift that money back to stocks.


Rebalancing nudges you not only to sell some of whatever asset has been
riding high but also to buy those that have been not doing so well—in other
words to sell high and buy low, which can boost your return. For example,
when the market soared during the late 1990s, rebalancers sold some stock
and bought bonds. When the market went south and the Federal Reserve cut
interest rates, bonds got a big boost. Rebalancers who had sold stocks
during their rise and shifted those gains to bonds benefited from that rise.


Roll it over. When you leave one job, there’s a temptation to pull your
money out of the former employer’s plan and spend it. That triggers taxes,
often penalties, and curbs your nest egg’s tax-deferred growth. Instead, shift
the old balance to the new employer’s plan, if there is one, or roll it over into
an IRA. And make sure the money doesn’t come into your possession, which
can trigger taxes and possibly penalties. Instead, do a direct, or “trustee-to-
trustee,” transfer—ask your benefits department for help—so the money goes
straight into the new account.

Take the saver’s credit if you’re eligible.  The federal government wants
you to save, and if you are a low-income worker, it is willing to chip in to help
you. If you earn less than certain levels—this year, it’s $53,000 for a married
couple, $26,500 for a single—you can get a federal tax credit and save as
much as $2,000, depending on your income and how much you put into
retirement programs. For details, check IRS Publication 590, Chapter 5, at
www.irs.gov.

Don’t stop investing during a bad market. A 401(k) is, in effect, a “dollar-
cost averaging” program; that is, as you make your regular contributions you
buy more shares when the market is down, fewer when it is up. Those extra
shares bought in a time like this will yield bigger gains when the market comes
back.

Don’t borrow from your 401(k). Studies show that about one in five 401(k)
participants has a loan outstanding and the average balance was just over
$7,000. People in this situation are paying interest to themselves, true, but
they’re also losing tax-deferred earnings on the money they’ve taken out. And
if they leave their jobs, they must repay the loan or end up owing taxes and
penalties.

Stay away from 401(k) debit cards. These cards make it ultra-easy to tap
your account. The best way to maximize your 401(k) is to put money in—and
leave it there.

The Spend Down
Your working career is over or winding down and you’re drawing on your
assets. These years involve uncertainty—for example, do you know when you’
ll die?—and they also offer less time to correct a mistake. So it’s important to
think ahead and be careful.

Decide where to keep your account. If you have more than a minimal
balance, you are allowed to leave it in your account with your former
employer. But in most cases you’ll want to roll the money over into an IRA,
which typically gives you more investment choices and is much more flexible
when it comes to bequeathing what’s left to your heirs. Beneficiaries who
inherit a traditional IRA can take minimum required distributions each year
based on their life expectancy and leave the rest to grow tax-deferred.

Be aware of penalties. If you’re retiring early and think you may need
income, leaving your balance in the 401(k) has an advantage: Withdrawals
can be penalty-free beginning at age 55. For an IRA, the penalty-free age is
591⁄2. With an IRA you must begin taking “required minimum distributions” by
age 701⁄2; if you’re still working, that rule doesn’t apply to a 401(k) you have
with your employer. Withdrawals from both traditional 401(k)s and IRAs are
taxable as ordinary income—and if you withdraw too soon or too late you can
be hit with penalties.

The actual deadline for taking your required distribution from your IRA is April
1 of the year after the year in which you turn 70 and a half. But generally it’s a
good idea to take the first withdrawal in the year you turn 70 and a half. If you
wait until the next year, you’ll also have to take the withdrawal for that year,
giving you two in one year and potentially boosting your tax bracket. For
years after the one in which you turn 70 and a half, the deadline is Dec. 31.
Note: the Roth versions of 401(k)s and IRAs are tax-free and have no
mandatory withdrawals.


If you need money early, there’s a way to avoid penalties. With a
traditional 401(k) or IRA, you are allowed to take money out before age 591⁄2
if you use what the IRS calls “a series of substantially equal payments.” You
must use one of three IRS-approved methods for calculating the payments,
and there are penalties if you don’t stick to the schedule. Also, with a 401(k),
you must have left your job before starting the payments. This arrangement is
very complicated and you should get expert advice before using it, but it does
exist and can be very helpful in certain situations.


Don’t become too conservative. Life expectancy for a 65-year-old today is
past 80, and half of those 65-year-olds will live even longer. This means that
retirees in good health are likely to need growth in their retirement assets to
make their money last as long as they do. Bonds, certificates of deposit and
the like are good at preventing losses, but historically they haven’t provided
as much growth as stocks. Thus, you’re likely to be better off if you keep
some of your assets in stocks, especially in your earliest retirement years.

In a down market, consider taking distributions in stock. One of the
perils of 401(k), IRA and similar accounts is that you may have to sell assets
when they’ve lost value. This is why shifting some money to bonds and cash
is recommended. However, if you must take a required distribution but don’t
need the money right away, consider shifting mutual fund shares or stocks to
a taxable account. You have to pay tax on the value of the shares, but later
on, whatever value they gain in the taxable account will be taxed at lower
capital gains rates.

Protect your heirs. Keep your beneficiary
designations up to date. Marriages, births,
divorces, deaths and other changes must be
noted or your money could end up going
where you never intended—to an ex-spouse,
for example. Updating this information isn’t
difficult—you just have to remember to do it.

Genwich Life Services LLC

"Successfully guiding multi generational families through life stage planning"
Your Ad Here
Your Ad Here