Many Americans either neglect or completely ignore the need to save for retirement. Alarmed by this situation, the Department of Labor is trying to turn the tide by encouraging companies with 401(k) plans to enroll their employees automatically.
What Is a 401(k)?
The 401(k) is a long-term savings plan instituted by an employer and managed by an investment or brokerage company such as Smith Barney or New York Life, which determines, with your help, how your money is invested in stocks, bonds, certificates of deposits, money market accounts, or other similar investments.
Two very good things about a 401(k) are:
1. Employer’s often contribute matching funds to your 401(k), e.g., if you deposit 1% of your salary, your employer deposits a matching amount of money.
2. Federal (and sometimes state) taxes are deferred until you withdraw the money (typically at retirement) so less is taken out of your paycheck.
What Is Automatic Enrollment?
Instead of you signing up for your employer’s 401(k) plan once you become eligible, a percentage of your paycheck—usually 3%—is deposited in the 401(k) automatically. You must notify the plan manager if you don’t want to participate. Employers are also incorporating automatic increases. If your employer includes this feature, your contribution will increase each year, usually by 1%.
Defined Benefit Plans and Contribution Plans
A defined benefit plan is a pension plan that is managed by your employer. It guarantees you a specific amount of money when you retire, usually paid in monthly checks for as long as you live. They are protected by the federal government which, ensures you will receive the benefits. The 401(k) is a defined contribution plan. Other defined contribution plans include:
403(b) Tax-Deferred Annuities: Works like a 401(k), but participation is limited to nonprofit organizations.
Keogh Plans: These plans are designed for self-employed workers. Limits apply to annual contributions and to the total amount of contribution.
Small Business Plans: The Simplified Employee Pension (SEP) and the Savings Incentive Match for Employees of Small Employers (SIMPLE) are for small businesses that do not have other plans available. For information visit www.dol.gov.
Questions You Should Ask
When you start a new job, be sure you find out:
1. When you will become eligible for your employer’s participating retirement plan;
2. What percentage is deducted from each paycheck;
3. How and when you can change the amount you contribute and the funds your money is invested in;
4. How and when you can stop making contributions at all if you so choose;
5. What the vesting schedule is for your employer’s contribution;
6. What the penalties are for early withdrawal.
Individual Saving Options
There are excellent retirement-savings plans available for individuals. Talk with a financial advisor to see which are suitable for you and put your money to work.
Individual Retirement Account (IRA): Anyone, regardless of income, can contribute up to specific annual limits. Contributions are tax deferrable until withdrawal and may be deductible. Roth IRA: You can start this plan anytime you are earning taxable income within specified limits. Deposits are not tax deferrable, but earnings and withdrawals are tax free within Roth IRA guidelines.
Annuities: A contract with an insurance company to which you contribute one lump sum or a series of payments. You receive payments for life or over a specific time period depending on the type of annuity.