Time To Seize 401(K) Opportunities
To sign or not to sign. For many employees that’s the question in December, when they have a chance to join their company’s 401(k) retirement plans, or to change the mix of investments they make through their plans.
For practically everyone, the advice is the same: sign up. And invest as aggressively as you can.
About the only exceptions are people who are already assured of comfortable retirements, or folks struggling with immediate financial demands, such as the need to pay off high-interest credit-card debt.
Unfortunately, studies routinely show that too many employees bypass these valuable plans completely, don’t participate fully or put far too much of their money into conservative assets, such as bonds or money market funds.
“Most people tend to be too conservative,” says David Zalles, an accountant in Lafayette Hill. “They don’t put enough into the stock side.” Over time, the stock market has always outperformed fixed-interest investments, such as bonds and money markets, he says.
To back up a second for newcomers, 401(k) plans allow participants to put aside a portion of their incomes for retirement. The money is deducted from your income for tax purposes bringing you an immediate tax benefit. If you were in, say, the 28 percent tax bracket, your federal income tax would be reduced by $1,400 if you saved $5,000.
In addition, the money earned by your savings is sheltered from tax. That means you don’t have to pay income tax on earnings every year, or capital gains tax on profits.
In addition, many employers match all or part of the employee’s contributions, making the returns even greater.
The money you accumulate in a 401(k) cannot be withdrawn until you are age 59-1/2, or you’ll pay a hefty penalty, plus taxes. You pay income tax on withdrawals you make after that age.
Studies show that about 18.5 million Americans participated in 401(k)s at the end of last year, meaning about 25 percent of those who were eligible did not. Of those who do participate, most don’t invest as much as they are allowed. The maximum varies by company, and can be as much as 20 percent of one’s income or, for 1996, $9,500 a year, whichever is less.
Only about half of the money in 401(k) accounts is in stocks, with the rest divided among more conservative assets.
A recent study by PaineWebber Inc., the New York brokerage, underscores the high price one can pay by being overly conservative. PaineWebber calculated the performance of two $100,000 portfolios over 20 years.
The first was invested in a fixed-rate asset that earned an annual return of 5 percent, about what you’d get today in the typical money market fund offered in many 401(k)s. In 20 years, that portfolio would grow to $265,330.
The second portfolio was split into five equal parts, each invested in a different type of asset. One $20,000 chunk returned 15 percent a year, what you might get in an aggressive-growth stock fund. A second returned 10 percent a year, what you’d get in an index mutual fund that mirrors the performance of the stock market overall. The third $20,000 portion earned the 5 percent a year a conservative portfolio would. The fourth part earned nothing, remaining at $20,000 for 20 years, and the final $20,000 was put into an investment that was wiped out.
What did this portfolio grow to? Just under $535,000 - more than double the conservative portfolio.
The lesson is clear, says PaineWebber vice president Carl Sheusi: Join your company’s 401(k) plan. And earmark a good portion of your contribution to stocks.
xxxx 401(k) PLAN WARNING SIGNS The Boston Globe The U.S. Department of Labor suggests workers be cautious if they see these signs of trouble in their company’s 401(k) program: Statements are consistently late or come at irregular intervals. The account balances don’t appear to be accurate. The employer holds contributions for more than 90 days. A significant drop in an account balance that can’t be explained by market activity. Statement show contributions from paychecks weren’t made. Investments listed on statements aren’t what was authorized. Former employees are having trouble getting benefits paid on time or in the correct amounts.