Even job-hoppers should
contribute to retirement plans
contributing to a tax-deferred retirement plan such as a 401(k), 403(b), or 457
plan make sense if a job change is looming? Those mulling a career change or seeking
a move from part-time to full-time employment may identify with this.
off, contributions made by the employee are not "lost money." Your own
contributions, plus or minus any investment gains or losses, are yours to keep.
Employer contributions, however, may be subject to a vesting schedule.
Those plans subject to a vesting schedule enable the investor to own more and
more of the employer contributions over time. Even if only fractionally vested,
that fraction is free money.
For example, consider
a part-time employee who earns $10,000 a year and contributes 6 percent -- or
$600 -- to a 401(k). Let's say the employer matches 50 cents for every dollar
contributed by the employee, up to a maximum of 3 percent of the employee's salary,
a common policy. The employee contributed $600, and the employer kicked in $300.
If the employee was only 25 percent vested upon leaving the company, the employee
departs with $75 of the employer's contribution. While it may not sound like much,
that sum represents a 12.5 percent return on the $600 employee contribution. And
this is before considering any investment earnings in the interim.
participation may involve a longer waiting period than many realize. Take, for
example, someone who plans to change jobs within the next year and decides to
bypass the enrollment opportunity in the current retirement plan. However, once
changing jobs, the investor will likely have to wait before becoming eligible
to contribute to the new plan. Those who switch jobs after a year and then hit
a six-month waiting period in the new job have delayed any participation for 18
months. Also, not every employer offers a retirement plan, so delaying participation
now may mean an indefinite delay to saving for retirement.
employees who begin contributing now begin to amass a retirement nest egg that
can grow for a longer time. It also establishes a good habit: paying yourself
first. This builds financial discipline and will come in handy when encountering
that waiting period upon switching employers. Already in the habit of living on
less, the investor is more likely to use wisely the extra cash in the new paycheck.
That six months of excess cash can be used to fund an IRA contribution, or can
be stockpiled to double-up on 401(k) contributions once eligible. For 2002, those
younger than 50 can contribute up to $11,000 to a 401(k), and those 50 and older
can contribute up to $12,000.
What happens to the vested balance after a
job switch? Depending upon the balance, you may be able to leave it intact in
the current plan. Or the new employer may permit a transfer into its plan. A third
consideration is a direct rollover into an IRA. It is very important not to cash
out the balance, as mandatory 20 percent withholding and a 10 percent early withdrawal
penalty apply. This isn't the down payment for a new car -- this is your retirement
security in its infant stages.
One final caution is to refrain from borrowing
from a 401(k), as any outstanding loan balance must be repaid shortly after termination
from the current employer.
Greg McBride is
a financial analyst for Bankrate.com.