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Retirement

Retirement is probably the most significant investment challenge you will face. This section outlines the different retirement plans and related terminology.

401 k A 401k plan is one type of retirement savings plan that is offered by employers as a benefit. With this plan, you contribute a portion of your salary pretax which in turn reduces your taxes. In some instances, your employer may match or contribute funds on your behalf to add to your retirement savings. All contributions made are yours. All contributions are taken out before your taxes are calculated which reduces your gross salary and taxes you pay. Another advantage is this plan is portable. All the funds are yours and therefore can be taken with you when you leave your current employment. The money can also be rolled into another plan with your new employer with no tax penalty. While this money is yours and yield tax savings, the government also has regulations which restrict access to the funds if under the age of 59 ½. Some plans will allow you to borrow against the money saved but there will be a tax penalty applied when you file your taxes.

A Roth 401k plan allows after-tax contributions where the earnings will be tax free if you don’t take them out until after age 59 ½ and you were in the plan for at least 5 years.

How is your money protected? The money in a 401k account is protected from any creditors and from your employer. This money is not considered an asset of the company and therefore your employer can never access the money. The Employee Retirement Income Security Act (ERISA) also requires that the people who operate the plan to act prudently in your interest. However, there is no law that protects from losses that occur due to plan investment performance. It is also not protected from IRS or other government agencies from garnishment to pay back taxes or divorce and child support settlement agreements.

Individual Retirement account This type of account is opened directly at a bank or mutual fund company by an individual. There are no payroll deductions, but you can set up automatic withdrawal from your bank account. The earnings are tax deferred, but contributions may or may not be tax deductible. Your employer has nothing to do with this account so all contributions must be made by you. All amounts rolled over to an IRA are protected from creditors and all contributions up to 1 million are also protected. Like a 401k the IRS has limits to how much you can contribute annually. For 2015, 2016, and 2017, your total contributions cannot be more than 5500 (6500 if you’re 50 or older) or your taxable compensation for the year, if your compensation was less than this dollar limit.

A direct rollover is the payment of your prior employer's 401(k) plan distribution directly to an Individual Retirement Account (IRA) or other eligible retirement plan of your choice. If you don’t roll over your entire account balance, you will be subject to the 20 percent federal income tax or the 10 percent early withdrawal penalty for individuals under age 59½.

Profit Sharing Plan A type of retirement program offered by employers to share the profits with their employees. A percentage of the annual profits are contributed to the plan on your behalf. The amount depends on a company’s profitability but is not guaranteed to occur. With this plan on the employer contributes to the plan.

Related Terminology

Tax Deferred Investing When investing in your employer’s retirement plan, your earnings grow tax deferred until you withdraw the money. The balance in the plan will grow much faster than a traditional savings account as the money is continually reinvested without being taxed.

What is Vesting? Vesting is the term used to determine how much of your 401(k) funds you can take with you when you leave your company. Employee contributions are immediately vested but your employer may set up a vesting schedule which indicates when and how much of the employer contributions you can take with you when you leave the company. Many companies range from three to seven years in order for you to be fully vested in your 401(k). Some may have you be vested in a percentage that increases each year until you reach the maximum amount.

Asset Allocation You will need to consider how to best allocate or invest your 401k contributions so that you will reach your financial retirement goals. How your assets are allocated is more important than how one specific fund performs. Stocks have a higher potential than money market investments or bonds but you take on more risk. Young individuals should allocate the majority of contributions to stocks. Should the plan lose money they have a longer time period to gain is back. Individuals close to retirement should consider less risky investments into bonds and money market funds. By diversifying your asset allocation, you lower the risk of your account.

Risk Tolerance Your employer does not determine how your money will be invested. Individuals make their own decisions on how much to invest and what asset allocation strategy to use. How you invest your money is directly related to your risk tolerance. The longer time you have to invest your money, the more flexibility you’ll have in choosing investment funds.

Higher Risk = Higher Potential Reward and Lower Risk = Lower Potential Reward It's important to educate yourself and be knowledgeable about the risk / reward trade-off. There’s always a certain amount of risk that must be taken to reach your retirement goals. You want to make sure you are at least earning more than the inflation each year. It’s always good idea to review your investments periodically and make changes are needed.

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