401(k)
This is perhaps the best know of the defined contribution plans. (The name - 401(k) comes from the Section within the Internal Revenue Code which provides for its existence.) As the name implies, a certain amount of money is contributed by you via payroll deduction and matched at a certain level by your employer. You typically are responsible for deciding how this money is to be invested in a variety of mutual funds pre-selected by your employer. Here again, be pro-active in the selection process. Do your homework under our other sections i.e., Mutual Funds and Planning and then decide how to best use the offered funds.
The sponsoring company’s plan is likely to say that if you as an employee will contribute a certain percent of your income to the plan, e.g. 5%, the company will match, 3%. The company match will vest in 5 or 7 years, which means that it becomes your money to keep. Up till then, if you quit, the company would keep the contributions it made. The money you contributed is always yours to keep. In our view, it is critical that you contribute sufficient dollars to maximize the company match. Example: A client recently called and stated that he was now eligible for the 401(k) plan and they would match up to $14,000 this year (a dollar for dollar match). Contributing that would crunch the family budget but could be done. Should they do it? Note that this was mid year so that the matching amount required of $1,500 per month would end at year’s end. Next year the match contribution would be about half and would be manageable. I pointed out that they would be making 100% on their investment in the first year, plus what ever it might earn, and the $1,500 per month cost would be mitigated by reduced income taxes for both State and Federal.
The essence of this kind of plan is what is being pushed by the current Administration for the Social Security system and many companies that want out from under the burden of the defined benefit programs. With the 401(k), you the owner of the plan assume all responsibility for success or failure of your retirement account. Do your homework and learn all about the individual choices available to you. Ask the company for details on all the available funds. We have found it difficult to evaluate some of these options because they are often clones of a publicly traded mutual fund, but which one is being cloned, or are only privately traded and the internet resources do not list your funds options. Look at its history and if it is the current manager’s history and if it invests in sectors you want to own.
403(b) or TSA (Tax Sheltered Annuity)
The 403(b) plan is similar to the 401(k) but is for individuals working for a non-profit organization, e.g. churches, states, counties, schools, etc. Typically there are no matching funds provided by the employer, it is only your money going in. We consider it a good plan to set aside part of your paycheck, before you see it, and build an additional nest egg. It must be a payroll deduction by the employer as is the 401(k).
Since the employer is involved to the extent of making arrangements for your deductions, they may have a limited number of companies they will work with. The organization and for that matter, the State Attorneys General, make no endorsement of any of these available companies, so do your checking first. Of all the ways to invest, we have found more really bad products in this kind of investment than any other.
The term TSA comes from the fact this program, at one time, was only done by insurance companies using annuities. We are not saying that this is not a good way to save on taxes and set aside money for retirement, but rather, ask questions first. Now days products are better in general than they once were and mutual funds are also in the 403(b) game. Questions to ask:
1. What are the fees? Under our Annuity Section we examine these extensively.
2. What commissions are involved? Look under our Annuity or Mutual Fund sections for a better understanding of these options.
3. Find out what investment products are available and if they fit your plan.
4. If you are looking at an annuity, absolutely understand the penalties for early withdrawal. You may want to move or change your plan. The most egregious plan I have seen was one that carried a penalty period of 18 years with a 20% penalty for most of those years. (Typically a penalty period will start at 5-8% and decline to zero in 7 or 8 years.)
There are several other kinds of retirement plans that a company may select. Generally the owners are looking for a plan that will help them individually, and benefit employees while encouraging employee retention. The employer choice of plan is made to a large degree on affordability. We will not review each one as the basic principals are similar, but we will provide a spreadsheet to help you understand the rules around each particular plan.
Remember, the advantage of having one of these defined contribution plan is that you are in charge and can withdraw lump sum amounts if you need to, hopefully in retirement after age 59 ½. The last time we checked, neither SS nor defined benefit plans let you draw ahead on next month’s payout.
Withdrawals from the Traditional IRA and most defined contribution plans
Congress says we can begin making withdrawals from or retirement accounts without penalty or restrictions when we reach the age of 59 ½ and that we must begin withdrawal at the age 70 ½. Making a withdrawal too early carries a 10% penalty and too late and not enough has even harsher penalties. You may make withdrawals under the following exception provisions, but they must conform to certain requirements. One of which is being dead, let’s discuss the others.
1. Disability (the rules are about the same as for SS disability.)
2. Certain high medical expenses
3. Part of substantially equal periodic payments. Be careful here as the tap can’t be turned off until you are 59 ½ or 5 years later, which ever is longer.
If you have money in an IRA, (not other kinds of plans), there are exceptions for certain situations involving health insurance and unemployment, higher education expenses, and first time home purchases.
When you retire early, check the rules on withdrawals and remember, we suggest using only 5 -6 % of your principal each year.
At Retirement
When you reach retirement there are many decisions to be made, not the least of which is what to do with your 401(k), 457, 403(b) etc. Some companies will allow you to leave your funds with them, others will not and most will not let you leave money with them past age 70 ½. It is quite common to ‘roll’ your retirement to an IRA where you have greater discretion and control. This change will give you someone to meet with and talk to on a regular basis. Once again look for experience, credentials and costs. Make certain the person is listening and not just telling you what to do. This transaction from a plan to an IRA is tax free when done properly. If your account is very large, and more than you are likely to need, you may not want to move all of the money. Or if you need a lump sum at early retirement, you may take a direct payout from the plan, and then consider moving the balance. These circumstances need to be reviewed by you and a professional.
Retirement Plans
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