Financial Literacy 2007 - Retirement
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Retirement planning with a 401(k)

6. Think before you borrow.

Ideally, you'll leave your 401(k) untouched until well into your retirement. Then again, life throws plenty of curve balls, and there may be a time when you want to borrow against your 401(k). In fact, most plans let you borrow up to 50 percent of your plan, up to $50,000.

Try to resist the temptation. "I think one of the most harmful things you can do is take a loan against your 401(k)," says Mike Scarborough, author of "401(k) Knowledge." "People latch onto the idea that they'll pay themselves interest, but it's not that simple."

If you must borrow, beware of the pitfalls and make an informed decision.

First, scratch that notion that you're paying yourself back. When you take a loan from your 401(k), you will be paying back the borrowed funds with interest, but often it's at a lower rate than the investment would otherwise gain. If you have to borrow from your retirement fund, too, it's unlikely that you'll be making enough in regular contributions. That's replacing money that has been taken out, not growing the account.

Another pitfall: Some employers won't let you make contributions until you pay back a loan.

Next, you don't have an eternity to make good on the loan -- just five years in most cases. If you lose your job or quit, you'll put yourself at further risk. That's because employers can allow you to keep repaying the loan, but they frequently don't, experts say. The means your outstanding balance will be subject to income taxes plus the early withdrawal penalty.

Then there are fees. Seven out of 10 plans charge a one-time loan fee that can range from a modest $3 up to $100, according to the PSCA. And a quarter of programs charge an annual service fee on top of that.

With so many hazards, it's not surprising that financial advisers often recommend borrowing money somewhere else. A home equity loan is one popular alternative, since interest is generally deductible and won't be subject to time limits or put you at risk of defaulting if you lose or change jobs.

Or don't borrow at all.

7. Consider a Roth 401(k).

You may not be aware of it, but employers have been busy rolling out a new addition to retirement programs: the Roth 401(k) plan. About 22 percent of employers now offer such plans, and that number is growing, according to Hewitt Associates.

As their name suggests, these new products blend elements of both a traditional 401(k)s and the Roth IRA.

Here's the lowdown. Roth 401(k) contributions are made with after-tax dollars, so you'll pay taxes now but not when earnings are withdrawn in later years. You can save as much as you do in a 401(k). For 2007, that's $15,500, with an extra $5,000 for individuals over 50. Your take-home pay will be lower than with a regular 401(k), but there are advantages long-term.

For instance, the tax treatment makes Roth 401(k) plans potentially more lucrative for entry-level employees in low tax brackets, says Bill Baldwin at Pillar Financial Advisors.

"If you're in the 15 percent or other low bracket you might consider the Roth 401(k) since you'll likely owe higher taxes in the future," he says.

If you have no idea what tax bracket you'll be in when you retire and you want to hedge your bets taxwise, you can participate in both plans as long as the combined contributions don't top the total $15,500 limit ($20,500 over 50).


8. Take advantage of catch-up contributions

Worried about hitting your retirement goals? Well, if you're 50 or older, you get even more opportunities to save, thanks to so-called "catch-up" contributions. These allow you to chip in $5,000 more than the maximum. That's not including employer contributions, either. In fact, 28 percent of companies match funds on employee's catch-up contributions.

What's that extra bit worth? Try this: A 50-year-old saver who stashes an additional $5,000 a year and earns 8 percent annually will have saved an extra $78,000 by the time he or she is 60.

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