Labor Day, celebrate 401(k) Day --
If your employer matches a portion of your
contribution -- and many do -- you'd be foolhardy not to take advantage of this
free money. Consider it an instant return on your investment.
of a 401(k) plan
There's no good excuse for not enrolling
in a 401(k) plan. Following are several recent changes that make it easier to
- New employees welcomed to join. According
to a recent
study by the Bureau of Labor Statistics, younger boomers,
those born between 1957 and 1964, worked at 10 jobs on average
between ages 18 and 38. That's a lot of ricocheting between employers.
Fortunately, the majority of workers can join their 401(k)
plans within a relatively short time. Nearly 60 percent of the
last year by the PSCA allow workers to sign up for a 401(k)
plan within the first three months of employment. Back in 1998,
only 32 percent of plans offered such quick eligibility.
- You can take it with you. The portability
of 401(k) plans is a very attractive feature for
a mobile workforce. We may lament the passing of that bygone era
when loyal employees were rewarded with a defined-benefit pension
plan, but that's like yearning for the simpler days depicted in
1950s sitcoms. Those days are gone forever.
In some ways, things are better now. We have opportunities to
grow since we're not stuck in the same job for decades on end
just to get a pension. Sometimes we get unstuck through no choice
of our own, due to the warped priorities of American companies.
But at least we can take our 401(k) plans with us
-- and transfer the proceeds to an IRA rollover or to our new
employer's plan. It's almost always a better idea to move the
money once you've moved on to another company. Just make sure
it's a trustee-to-trustee transfer of funds so that you don't
have to pay taxes or penalties on a premature withdrawal.
- Vesting is faster. You can always take
your own contributions with you, that is, the amount that you
deferred into the plan. But whether you get to keep the company
match depends on whether you're vested in the plan. Employer contributions
can be vested all at once within three years, or they can gradually
become vested over as many as six years. Some companies allow
employees to be fully vested as soon as they are eligible to join
the plan. Prior to 2001, vesting could be dragged out for five
to seven years.
- Tax-favorable savings. The amount you elect
to defer into a 401(k) plan is not subject to federal
income taxes. The downside, of course, is that Uncle Sam gets
his mitts on the money on the back end -- when you take distributions
at retirement. A new type of Roth
401(k) comes on the scene in January 2006 that
reverses the rules: You invest taxable income up front, but you
don't pay taxes when you take distributions at retirement. In
either case, you get a tax break.
charge of your retirement
The younger you are when you start packing
money into these plans, the better off you'll be at retirement. Never mind about
the student loan you're paying off or the mortgage down payment you're trying
to save for. You'll be way ahead of the game if you start putting money into your
401(k) plan at age 25 as opposed to waiting until age 35, when the reality of
retirement first begins to dawn on many people.
How far ahead?
Let's say at age 25 you start saving $300 a month for 10 years and earn an average
return of 8 percent over that time. At age 35, your nest egg will have grown to
$54,884. Now, if you stop investing in a 401(k) plan altogether and just leave
that amount to grow until you reach age 65, your nest egg will grow to $552,279
(again assuming an 8 percent annualized return over that time).
if you wait until you're age 35 to begin investing $300 a month, you'll have to
invest that amount for 30 years until, at age 65, you'll have saved $447,108,
assuming the same rate of return.
The difference: The total
amount the 25-year-old invests in the plan is $36,000 ($300 x 120), vs. $108,000
for the procrastinator ($300 x 360).
OK, this example may
not completely reflect reality. After all, returns fluctuate a lot, and the amount
you invest will vary through the years, depending on your circumstances. You may
end up having to wait an entire year before you can even join a new employer's
401(k) plan. Roughly 25 percent of employers make you wait a year or longer.
the example reveals the big difference that 10 years can make to improve your
chances of attaining a savings goal. It can determine whether you will enjoy a
sumptuous or a meager standard of living when you cross the finish line into retirement.