Investing in 401K Plans

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Investing in 401(K) Plans Universit
y of Maryland, Cooperative Extension Patricia
M. Tengel, Family Resource Management Specialist

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Amount to Save for Retirement Age to
Start Percentage Amount 25 5 35 9 45 1
8 55 44 Yields the same amount at retirement
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401(k) Plans

• Voluntary way to save for retirement
• All contributions tax-deferred
• Work for company, non-profit or State of Maryland
• 401(k) stands for section of IRS Code

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How Plans Work

• Enroll in plan
• Designate amount to contribute on pre-tax basis
• Lowers taxes

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• Employer sets maximum contribution percentage
• Maximum annual amount10,000
• Employer usually matches at least 25
• Contribute enough to receive full match

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Employers contribution may not belong to you
right away Cliff vesting Right to employers
contribution after 5 years in plan Graded
vesting Right to employers contribution 20 in
3rd through 7th year Participationage 21 or 1
year of service
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Material received from employer

• Enrollment form
• Prospectuses for mutual funds
• Summary Plan Descriptionrules regulations
• Contribution amounts
• Vesting rules
• Distribution rules
• Grievance procedures
• Investment options

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Where to put tax-deferred funds Likely to have
at least 6 choices GICGuaranteed Investment
Contract Company Stocklimit to 25 of
stock allocation Stock mutual funds Bond
mutual fund Money market account Other
companies offer many funds
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Consider investing in stocks for greatest
returns Age Percentage in stock 20s 75-80
30s-40s 70 50s 60 60s 50 Little or
no risk of loss of principal if held for 5 to 10
years
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401(k) Investments Equity funds Growth
funds Value funds Balanced funds Index
funds Socially conscious funds Growth income
funds
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Prospectus details risks and lists objectives Cho
ose funds with different objectives to moderate
risks
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Fixed Income Alternatives Guaranteed Investment
Contracts Guaranteed fixed interest
time period Funds are not
guaranteed Invested in mortgages and bonds
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Bond mutual funds Corporate U.S. Treasury
Notes5 to 10 years Agency bonds Money
market funds
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Investment Performance

• Statement6 weeks after end of quarter
• Itemized account of
• Contributions
• Ending balance
• Loans (if any)
• Capital gains losses
• Beginning balance
• Income earned

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• Review statement for accuracy
• Rebalance to maintain desired allocation
• Be careful not to have too much company stock
• Pay attention to investments that are not doing
  well and sell them

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Removing funds in an emergency Loans 50,000
or 1/2 of invested total 10,000 minimum,
even if gt half Account value Borrow
80,000 40,000 150,000 50,000
10,000 10,000 11,000 10,000
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• Repay at least quarterly in 5 years
• Interest paid goes to your account, must pay
  taxes on interest in retirement
• Home mortgage loans
• Longer payment schedule
• Interest not deductible (comes from pretax 401(k)
  money)

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Hardship Withdrawals Use in dire emergency when
loans not available Meet two conditions 1.
Immediate heavy financial need payment of
medical expenses purchase principal
residence payment of educational
expenses payment to prevent eviction or
mortgage foreclosure
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2. Funds unavailable from other
sources can borrow only enough to meet
need borrower has no other funds to
use including other loans insurance
payments Expensive Income taxes on withdrawal
10 penalty under age 591/2 10,000
withdrawal yields 6,200 in 28 tax bracket
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Leaving a Job before Retirement AgeChanging
jobs

• Leave funds with former employer if greater than
  5,000
• Rollover funds to IRA
• Transfer funds to new employers plan

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• Must be direct transfer or 20 withheld for
  income tax payments
• Check in your name must come up with other 20 to
  make rollover in 60 days

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Layoffs, temporary illness, disability, or care
of ill family member

• Expensive to withdraw from 401(k) (10 penalty
  20 withheld for taxes
• After age 55, can take equal payments, no
  penalty, based on life expectancy

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Removing funds at RetirementOptions at age 59 1/2

• Leave with employer, withdraw as needed
• Roll over to IRA, withdraw as needed
• Take partial lump sum, roll at least 50 to IRA
• Take all as lump sum, use 5 year averaging to
  reduce taxes
• Leave invested to age 70 1/2

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Withdrawals at age 70 1/2

• By age 70, inform provider of beneficiary
  withdrawal method
• Withdrawal choices
• Term Certainlife expectancy minus 1 each
  succeeding year
• Recalculationrecalculate life expectancy each
  year using chart

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• Last date for first withdrawal
• April 1, year after age 70 1/2
• Second withdrawal by December 31

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Using a 401 (k) wisely Investigate investment
choices Should have 10 to 12 choices If too
few, lobby for more
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Part of salary matched 6 common 10
generous Amount matched 50, common 100
match, only 20 of companies
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Information Quarterly statements returns
matched with benchmarks Annually accountin
g of fees 3 and 5 year returns current
balances
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Statistics1995 Average plan 6.3
investment choices 72 offer growth fund 43
international fund Only 78 of employees
participate 90 of companies use
personalized statements 42 in GICs 34
in equities
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Summary 1. Start now to plan for
retirement. 2. Retirement income will be pooled
from several sources. 3. Use tax deferred
savings plans before other accounts. 4.
Contribute the maximum each year.
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5. Employer match is like free money 6. The
younger you are, choose more risk 7. Put
most funds into stocks rather than fixed
interest (GICs) 8. Modify riskstocks, bonds,
cash 9. Leave funds alone until retirement
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10. When leaving a job, roll over
account to IRA. 11. Let all funds grow as long
as possible 12. Elect method of
withdrawal before age 70. Term certain best
choice for survivors.
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Percentage of Mutual Funds that equaled of beat
the S P 500 1971 78 1980 48 1990 36
1991 55 1992 54 1993 58 1994 22
1995 15 1996 22 1997 10