401(k) plans can be GREAT
Feb 23 '00
Okay, I work in the 401(k) and retirement plan industry, as a legal assistant in a law firm. So that makes me somewhat of a natural cheerleader for contributing to a 401(k) plan if you have one available. But that doesn't mean I don't advocate other savings methods as well.
First, a little background - the name "401(k)" comes from the section of the Internal Revenue Code that allows for the establishment of such plans. It's that simple. Didn't you always want to know that? :-) The reason 401(k) plans are hyped so much is because there is one distinct advantage - if you elect to have a percentage of your yearly salary contributed to a 401(k) plan on your behalf, then that percentage is taken away from your salary BEFORE any taxes for federal withholding are deducted. So let's say you have a paycheck that would be $1500 gross, and you elect to contribute 10%, or $150, to your employer's 401(k) plan. That means that only $1350 ($1500 minus the $150 contribution) will be used when the federal withholding tax is determined - so even though you think you'd be getting $150 less due to the contribution, you're really only getting something like $125 less because of the tax savings! (Note, I didn't do ANY real withholding computations to get to that $125 number, it's just an illustration to show your check won't be as much less as you may have thought it would be!) However, the social security and medicare taxes are still calculated based on the $1500 pre-contribution amount - that's just the way the law works.
That right there is the only sure-fire advantage, other than the fact that you're saving *something*. There are other *possible* advantages as well. Your employer may let you choose the investments that your contributions will be invested in, either from a menu of 10-15 pre-selected funds (the most common), or by letting you do whatever you want with your own broker helping you. Your employer is not required to give you this option, and may invest it in certain funds without your input. Don't worry, they still have a legal responsibility to be careful with the funds that they choose, they can't just invest it in FundsRUs. Some people prefer to let their employer take the responsibility, others like to have a say in their 401(k) plan investments.
A lot of employers, BUT NOT ALL, will also "match" all or a portion of the contributions you make. They are not required to do so, and regardless of what the general media may make you think, NOT ALL DO. Most advice I see screams at you to put in the maximum allowed just so you can get the matching contribution - automatically assuming that there is a matching contribution. NOT ALL EMPLOYERS MATCH THE 401(k) CONTRIBUTIONS. Sorry to keep shouting, but I'm trying to outscream the others. :-) The most common matching contribution formula that I've seen in my 10+ years in the business is 50% of your contributions, up to 6% of your salary. So if you contribute 10% of your salary, such as the $150 example above, only the first $90 (6% of $1500) will receive the 50% match, so you would get $45 in matching contributions for that $150 contribution for that one paycheck. Some employers make their matching contributions every pay period, at the same time your contributions are withheld from your check, and some only do it once a year. There's a lot of flexibility in what they can do, but plenty of rules to keep them "honest" about it. (Keeps me employed! LOL) So if your employer makes a matching contribution with a similar limit, I highly recommend that you at least contribute the minimum amount needed (6% of salary in this example) so that you can get the full matching contribution. It's basically free money, although you won't necessarily be entitled to the whole amount if you immediately left employment (that gets into a whole other subject of "vesting", which I'll sadly forego since this is a novel already).
I don't necessarily agree that you should always contribute the maximum allowed by law each year ($10,500 for 2000, subject to certain *other* limitations that I won't bore you with now) no matter what. First make sure you have the standard emergency savings account of up to X months of your monthly expenses. That's more important than even pre-tax savings with a 401(k) plan. Oh, and obviously you should make sure you would still be able to easily meet your monthly expenses if you did start making 401(k) contributions.
I'd definitely recommend putting as much money in your 401(k) plan as you can - but only after you have that rainy-day savings established, because it can be VERY difficult to get your money out of the 401(k) plan while you're still employed. The laws were written to make it difficult on purpose, to deter you from frittering away your retirement money (okay, I don't think the legislative history uses the word "frittering", but that's what they meant).
Oh and I almost forgot - the general media also seems to assume that ALL employers even offer a 401(k) plan. NOT ALL EMPLOYERS DO! Some may have other retirement plans in place that don't require any employee contributions. Some may have nothing at all. But if your employer DOES offer a 401(k) plan, learn about it, find out what your options are, and start contributing as soon as you can!
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slhansen
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Member: Steph ~
Location: Texas
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