Tuesday, November 3, 2009

Get Ready For Open Season - Part 2

Saving Money Tip #204 - Get Ready For Open Season – Part 2. In this series we are discussing getting prepared for the open season enrollment that usually occur in places of employment this time of year. In Part 1 of this series, we discussed health care options. Today we will discuss the 401(k). For those who are not too familiar with the 401(k), it is a vehicle offered by many companies so that their employees will put money away for retirement. In days long gone, most companies offered what was called a pension or a defined benefit plan. After an employee put in a certain number of years of service, he would be eligible to receive a certain amount of money (defined benefit) when he reached retirement age. The more years of service the employee put in, the higher his benefit would be. A generation ago, many people did not have to worry about saving for retirement because their company often did it for them and guaranteed that they would receive a set amount of money at retirement age. Employees didn’t have to worry about how the stock market was doing or what the ups and downs for the economy were, they knew they were getting x number of dollars at a certain age with which to retire on.

Sadly, those days are mostly long over. Most companies have done away with the traditional pension plan, and instead, today, offer the 401(k) plan. The 401(k) plan puts the responsibility of saving for retirement on the employee. If you don’t contribute to a 401(k) or do other savings on your own, you will not have money to retire (other than Social Security from the government). A 401(k) is considered a defined contribution plan because there is no guaranteed benefit, the system is based on contributions. By law for 2009, a person cannot contribute more than $16,500 annually to a 401(k) – a bit more if you are over 50. (A company, however, can restrict that contribution even further. They may say you can only put in up to 15% of your salary or you can put in a maximum of $10,000 per year. There are some laws the company has to follow regarding how much can you put in.) Most companies will offer some type of match as an incentive for you to make contributions. It might be a dollar for dollar match on the first 3% of your salary that you put in. Or it might be a 25% match for everything you put in. Most companies have one or maybe two investment firms that they use to handle their employees’ 401(k) investments.

When you receive your 401(k) information consider it carefully. Unless you want to be working well into your 70’s or however long you live, you really want to put money away for retirement no matter your age now. The earlier you start to invest, the more your money will accumulate. And 401(k) plans make it easy to invest. Money that you contribute to the plan comes out pre-tax just from your paycheck just like health insurance co-payments through your company do. This will lessen your tax burden at tax time. You will not be required to pay tax on these contributions until you are of retirement age or take the money out. This allows you to have more money up front for investing. In addition, any money that the company matches you is “free” money. If they offer a dollar for dollar match on the first 3% of contributions, and you turn it down, you are essentially turning down a 3% salary raise.

Don’t make the mistake of some people I know and not invest because you don’t understand what a 401(k) plan is, because you don’t trust it, or because retirement is a long time off. Once you start making the contributions you will adjust to your salary that you do receive, so that you won’t even miss the money that much. But at year-end, and especially after a few years go by, you will be amazed at how much you have saved.

Make sure you look over your investment choices carefully before making decisions. Most companies offer an a la carte selection with stock mutual funds, bond mutual funds, some money market accounts, and possibly some company stock. If retirement is more than 20 years away, you can afford to have your money in higher risk investments like stock mutual funds, but if you are not comfortable with that level of investing yet, then go ahead and put some of it in a money market account, or put only a smaller portion of it in some stock mutual funds. Some people like to be conservative with their contributions and use their company match for the riskier investments. Overall, I like a balanced approach with a mix of investment types, but for new investors, you need to do what is comfortable for you.

Many companies will offer some investment seminars so you can learn more about risk, or you can read through some other blog posts I have done on retirement topics here and here. I have also discussed it in other places in my blog - look in the retirement category. But one piece of advice I strongly give is whatever you do, invest in your 401(k), at a minimum up to the company’s match. Unless you are drowning in debt and are thousands and thousands of dollars in the hole, there is no reason not to be contributing, and even then I might contribute up to the company match.

In Real Life (IRL) –
I have mentioned many times on this blog that when I was first introduced to the 401(k) at my workplace, it held little interest for me. After all, I was 22 and retirement was very far off. But an older co-worker who was close to retirement age urged me to at least contribute up to the company match which was dollar for dollar on the first 3%. So that is what I did the first year I was eligible. After that first year, I was advised by my dad to up my contributions to the full amount I was allowed, which was 13% of my salary. And I did that, too. I will be frank with some dollar figures here. I started that job making under $20,000. I became eligible to invest in the 401(k) after one year of service. I worked at that company for 9 years, and left the company making approximately $37,000. So I saved between 3% and 13% of my salary of between $20,000 and $37,000 for 8 years. My company upped the match to 4% at some point in there. I have not done a thing with the money I put into that company’s 401(k) since I left the company 11 years ago. When I checked that account at the end of last quarter I was $18 shy of $75,000 in that account.

So by putting between $600 per year to $4800 per year into an account for 8 years and having the company match some of that money I have built up a savings for retirement of $75,000. Not bad for a quick decision at open enrollment time. Had I not done this, the hundreds of dollars I would have gotten each year minus taxes that I would have paid on it could have easily gotten eaten up in entertainment, eating out, and frivolous spending. Instead, I started a nice little nest egg for retirement.

Your company is not going to be saving for your retirement anymore, so why not start doing it for yourself this enrollment season? At the very least, put in at least as much as the company will match, and if you are able and willing, put in the maximum your company will allow.

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