A company sponsored retirement plan is one of the best
benefits your employer can offer you; but in order to realize the
greatest success with this benefit, you need to play an active
role. There are a number of common mistakes to avoid and steps
you can take that will help put you well on your way to making
the most of what your plan has to offer.
Mistake: Not contributing.
The reasons many do not contribute are numerous: cannot afford
it, too overwhelming to review the plan and pick choices, or just
forgetting to set it up. The reality is you cannot afford to pass
up the savings opportunities available with a company sponsored
retirement plan. Each day you are not contributing is a day
missed in savings.
Contributions to company sponsored retirement plans, whether a
401(k) or 403(b), are tax deferred; this means funds are taken
out of your income before taxes whereby reducing your current
taxable income. You only pay taxes on contributions and earnings
when the money is withdrawn and it is likely that you are at a
lower tax base. For instance, if you make $50,000 a year and
contribute $1,000 a year to your plan, your income will be taxed
on $49,000 not the $50,000. So, in a 25 percent tax bracket,
every $1,000 you contribute before taxes will save you $250 in
taxes. If you are in a state that has high taxes, the savings can
even be more.
Not contributing also means you are likely not taking advantage
of the company match that many companies offer - who wants to
walk away from free money! Down the road, the company match could
mean all the difference to your retirement savings.
Even a little adds up! If a plan is offered, take advantage of
it. Even if you can't fund much, funding something gets you
started and you can always increase the amount later. If you
breakdown what a $1,000 contribution a year is on a bi-weekly pay
schedule, that's only a difference of $38 in take home pay per
pay period - think of that as six lattés. Finally, if you feel
like getting started is too overwhelming, then find out if your
company offers access to a financial professional as part of set
up or use the online tools many plans offer to help you walk
Mistake: Paying too much or too little attention to the
The good news is that you started funding the plan, but now what?
Like any investment, company sponsored retirement plans should
not be ignored, but over-managing can be just as dangerous.
When you initially signed up for the plan, maybe you chose the
money market to get started and never changed it, or you chose
the S&P 500 Fund for all the money, but now you are older and
are invested too aggressively. Sometimes, the plan will change
fund options and employees just go along with the changes but
never investigate if the new funds offered are actually what are
best for them. The fact is that circumstances in life change and,
as you age, allocations and risk tolerances should be adjusted.
So it is important to not take a "set-it and forget-it" approach.
On the flip-side, over-managing can lead to problems as well.
Because of the nature of how investing into a 401(k) or 403(b) is
set up, you are allowed to take advantage of a dollar cost
averaging approach. This means that every pay period, the same
amount of money goes into the same funds. So when the prices
drop, you buy more shares and when prices rise, you buy fewer
shares. If you over manage by changing funds frequently due to
market panics, then you lose the dollar cost averaging advantage
and possibly find yourself buying high and selling low, a
strategy designed to fail. Assuming that you are not touching the
money in this account for a number of years, a better strategy is
to leave things in place during the volatility.
Review your accounts on a semi-annual basis. Taking a more
systematic approach will allow you to re-allocate based your risk
tolerance, timeline and model that is best for you. By doing
this, you will be forcing yourself to sell sectors that have
appreciated and buy others that have underperformed. In other
words, buy low and sell high - a winning strategy over the long
run. Finally, do not be afraid to turn to a professional for help
when you need to, especially, if you are already working with a
financial planner as he or she can help you review your plan
options and choose reallocations when necessary.
Mistake: Holding too much company stock.
Some 401(k) plans offer the ability to buy company stock within
the confines of the plan and this may be in addition to a stock
purchase plan that is offered outside the 401(k) plan. It is
great that you have confidence in the company you work for and
want to buy more stock, but if you are holding too much stock and
the company suffers financial problems, then the stock price
inevitably falls thereby causing your retirement plan balance to
be at risk. Remembering Enron and how its employees retirement
plans suffered will quickly remind you of how this can go bad.
Limit company stock to an overall 10 percent of total retirement
portfolio. Diversification is important and by owning too much of
one investment, you are adding unneeded risk to your portfolio.
Mistake: Leaving your account behind.
When you leave a company at or before retirement, do not forget
about the retirement assets you have accrued in your 401(k) or
403(b) accounts. The money you have put into that account is
yours and depending upon the company's vesting schedule, so is
your earned company match. It is also important to realize that
leaving the company may not be the only way you are leaving your
account behind - an unexpected death without beneficiaries named
on your account could mean the plan money gets distributed to
your estate and can possibly incur unwanted tax implications.
Know what your distribution choices are. It is recommended that
when you leave a company you rollover the funds to an Individual
Retirement Account (IRA) or a plan at your new job (if allowed).
Often the best option is the IRA rollover. Rolling over the
account, gives you complete investment flexibility as you are no
longer limited to the choices offered by your previous employer.
And, if you do have company stock in your plan, you can either
roll-it-over as well or use a strategy known as Net Unrealized
Appreciation (NUA). With NUA, you pay tax on the cost basis of
the stock. All gains on the stock are then taxed at long-term
capital gain rates when you sell it. So the stock is no longer
tax deferred, but the income tax rates are lower based on the
current tax laws. This is a complicated strategy and needs to be
reviewed carefully to see if it is a viable option for you.
Lastly, name your beneficiaries and keep these updated. Thus,
your heirs will receive the best tax advantages to the money you
are leaving behind.
Participating and managing your company sponsored retirement plan
does not have to be complicated or overwhelming. Always consider
the options carefully when investing your money. Do not panic
during market fluctuations and always keep in mind, these are
FPA member Scott M. Kahan, CFP®, is president and founder
of Financial Asset Management Corp. in New York City.
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