Things I wish people knew about 401(k) plans

A 401(k) is an employerowned plan. I sometimes have people call me to “start a 401(k)”, and I have to explain that an individual doesn’t start a 401(k)… an employer does. The typical term for an individual retirement plan is an IRA, though there are many variations and special circumstances.

You can rollover when you leave. No matter your age, when you leave your employer, you can transfer the vested balance of your 401(k) plan into an individual retirement account, without this being a taxable event. This is known as a rollover. Remember that “vested” refers to the portion of the plan you get to keep, typically all your own contributions and a portion or all of your employer’s contributions, depending on the length of time you worked. Each plan is different regarding those rules.

I do advise moving plans held with former employers into something over which you have more control. Just last week I met with a man who had $230,000 in his former company’s 401(k). To his

horror, the company has filed for bankruptcy and those funds are locked up indefinitely, if not permanently. His entire retirement plans crashed with a phone call.

Creditors cannot touch your 401(k) money. (U.S. News and World Reports) These plans are protected by law from creditors. For this reason – if no other – it is not advisable to use your 401(k) money to pay off debts, avoid foreclosure or start a business. In the case of future bankruptcy, your 401(k) money is a protected asset. Don’t touch your 401(k) money except for retirement!

Age 55 can be important. Typically, if you take a withdrawal from a 401(k) plan prior to age 59-1/2, Uncle Sam grabs 10% of that withdrawal amount, in addition to the taxes due on the withdrawal. However, there is a special provision in 401(k) plans for people who leave their employer between the ages of 55 and 59 1/2 that allows for penalty-free withdrawals, without having to take a lifetime payment option. Is this always the best choice? Of course not. But it is sometimes a viable option AND the thing to know is that once you rollover the money into an IRA, that choice ceases to exist. (U.S. News and World Reports)

Roth accounts can be found in 401(k) plans. More and more 401(k) plans are offering the ability to make Roth contributions, referred to as a “designated Roth account”. Such contributions, unlike a regular 401(k) contribution, are not tax-deductible, but they grow tax-free, and in retirement, withdrawals will be tax-free.

Many people don’t consider making Roth contributions because they just assume they are better off getting a deduction today, but this is often not the case. Check to see if your plan offers a Roth option, and if so talk to your CPA and/or other financial professional to see which choice is advisable for you.

Automated portfolios are not just lazy options. Most 401(k) plans today offer the opportunity to self-manage your portfolio, choosing individual investments yourself, or to choose what’s called a “target date” fund.

These funds are automated portfolios designed to allocate investments according to a particular target date; in this case, your year of retirement. For example, I might choose a Target 2032 fund. Money is allocated across many asset classes, typically becoming more conservative as the participant nears retirement.

Unless you are a student of the market, or unless you seek professional guidance in choosing your investment options within your 401(k), I recommend target-date portfolios. Your 401(k) administrator should have a questionnaire to help you determine your investment style within the target-date fund – conservative, moderate, aggressive, etc.

Stable funds are a good choice. There’s a theory that says the percentage of money you have in fixed investments, as opposed to market-based investments, should equal your age. (A 30-year-old should have 30% in fixed, for example.) Today’s professionals are aware that people are living much longer, so that rule of thumb isn’t as strictly followed, but I do agree that as you get HYPERLINK “http:// money.usnews.com/ money/personal-finance/ slideshows/6-steps-to-theretirement-lifestyle-youwant” \o “Link: http:// money.usnews.com/ money/personal-finance/ slideshows/6-steps-to-theretirement-lifestyle-youwant” closer to retirement, you’ll want some of your retirement money in a safe investment option. Many 401(k) plans offer such options, typically with a low, but fixed, rate of interest.

One strategy that I like is that if, for example, you plan to retire in 3 years and you’ll need to withdraw $30,000 a year in retirement, you should keep 2-3 years’ worth of income in a stable fund – in this example, $60,000$90,000.

It’s true that 401(k) plans have some complications, but anything that helps us to save for retirement is worth learning and using well. Ask the questions. Learn the basics of your plan. And above all, know that you’re making investment decisions suited specifically for you, rather than listening to the water cooler talk.