Retirement And 401(k)s: What Everyone Should Know

During the past few years, many U.S.-based companies have changed the retirement outlook of the United States by straying away from traditional retirement pension plans and focusing on more profitable 401(k) plans. This trend has been growing consistently. Today, nearly one-fourth of the Fortune 1,000 companies have changed or are considering changing their pension plans to individual 401(k) plans.

To help consumers understand the basics of 401(k) plans, CreditGUARD of America has compiled the following do's and don'ts of 401(k) plans.

What You Should Do
If your employer offers a 401(k) plan and matches a percentage of your contribution, you should take advantage of this opportunity. An average employer matches 50 cents for a dollar and up to 6 percent of an employee's salary. What most employees do not understand is that the employer contribution match is basically free money.

The contributions you make towards your 401(k) come out of your paycheck before taxes. As a result, you do not pay income tax on the money you contribute. The 401(k) earnings or capital gains are also tax-deferred until you reach retirement age, allowing your investments to grow at a healthy rate.

If you are middle-aged and have not yet put aside enough savings towards your retirement, you should contribute the maximum amount allowed towards your 401(k). In 2006, the government increased the maximum contribution limit from $14,000 to $15,000 per year. For those who are 50 years or older, you may contribute an extra $5,000 per year towards retirement, known as "catch-up" contributions.

You should carefully review your employer's 401(k) plan and learn your rights as a participating employee. Under U.S. law, you are eligible to start contributing to a 401(k) plan after one year of employment with a company, provided one is offered. The U.S. Department of Labor provides information about 401(k) plans at www.dol.gov/ebsa/publications/wyskapr.html.

Finally, you should design your 401(k)
investment portfolio to meet your specific financial goals. Most 401(k)
plans offer employees various risk/return options ranging from
conservative to aggressive portfolios. For instance, an investor who
prefers a stable and uninterrupted flow of future returns can opt for a
conservative portfolio, compared to another investor who likes to take
on higher risk levels while raking in higher returns by investing in an
aggressive portfolio. Investors who prefer the middle ground can choose
a moderate, balanced or a growth portfolio.

What You Should Avoid
A 401(k) can be a great retirement tool
as long as you do not withdraw from it until you reach the age of 59
1/2. If you decide to withdraw money before that date, you must pay
income taxes on your withdrawals in addition to the 10 percent early
withdrawal penalty. Also, when you tap into your 401(k) funds early,
you sacrifice your future compound earnings, which will shrink your
nest egg.

Another good point to remember is that when you leave your current
job for whatever reason, you should follow proper precautions when
rolling over your 401(k) to another employer or to an Individual
Retirement Account (IRA). When leaving their jobs, most people request
their employer to cash out their 401(k)s and write out a check for
them. In such a situation, the employer is required by law to withhold
20 percent of the funds for tax purposes. However, if you request your
previous employer to arrange a direct rollover (money transferred from
your previous employer to your new employer) without going through your
bank account, the tax withholding can be avoided.

CreditGUARD of America is a nonprofit credit counseling agency that
assists consumers through debt counseling and financial education.
Please visit our website at www.creditguard.org or call (800) 867-0406 for a free consultation with a certified credit counselor.

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