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Investing in your 401(k)

Making the most for retirement

One of the best ways to save for retirement is through an employer-based 401(k) plan. According to the Department of Labor, these have become more popular than more traditional pension plans, but only two-thirds of the people that have plans available participate in them. They are extremely popular, but do require that employees shoulder more of the burden of saving.

A 401(k) plan is set up by the employer as a simple and convenient way to build up savings and get significant tax benefits while on the job. The plan takes its name from the section of the Internal Revenue Code that contains the rules for using the retirement savings plan (Section 401, paragraph (k)).

According to "Finance 101: Your 401(k) Investment Primer," from mpowercafe.com, "It is a tax-advantaged retirement savings account into which you (and sometimes your employer) make pretax contributions. You use the money you contribute to the 401(k) to purchase different investments that are offered by the plan."

When an employee joins a 401(k), he agrees to contribute part of his salary to the plan. The money contributed is deducted from the employee's paycheck before income taxes are taken out, so the employee ends up paying less tax up front. Also, employees don't pay taxes on what they contribute (or on any interest earned) until money is withdrawn at retirement. This allows employees to enjoy the benefit of compounding interest, which helps the savings quickly multiply.

However, money cannot be withdrawn from the plan before the employee turns 59 years old, with several rare exceptions, without paying a 10 percent early withdrawal penalty.

Some employers offer to match a certain amount of the employee's contributions. This means that for each dollar the employee contributes, up to a set amount, the employer also will make a contribution (10 cents, 50 cents, a dollar; it varies with employers). Check with your company about what amount, if any, they will match. Also see if your company allows you to be "vested" immediately or only after a certain number of years of work. While the money you put into a 401(k) always belongs to you, some companies don't allow you to access their contributions to your fund until you are vested. That could mean losing the company's contributions if you change jobs before that you have worked for the company for a long enough period of time.

Each company's 401(k) plan has different rules. The best place to locate information specific to your plan is in a document known as the "summary plan description," which can be obtained from your human resources department.

According to mpowercafe.com's "401k ABCs," There is a maximum amount of money an employee can contribute during a calendar year to the 401(k) plan. For 2003, the maximum pre-tax contribution is $12,000. This ceiling will increase by $1,000 each year until 2006, when it reaches $15,000. If your plan allows for after-tax contributions, they are not included in this limit. There is no federally imposed minimum contribution to a 401(k), but many plans require participants to contribute at least 1 to 2 percent of their salary.

Most plans offer a variety of choices for investing the money in your 401(k). It is up to each person to decide how to invest their money, using choices provided by the employer. Generally, these choices are stock, bond and money market mutual funds. As with any investments, you can be aggressive or conservative. The website 123s-of-401ks.com recommends researching the investment options offered in your 401(k) plan and selecting a mix that would give you the highest probability of reaching your retirement goal at the lowest risk.

The closer you are to retirement, the more conservative you should be with your investments. Younger investors can invest in riskier, but potentially more rewarding investments. The key to reducing your overall risk is to diversify your investments.

Here are some general guidelines to follow for balancing your 401(k) investments based on an article in Money magazine:

Aggressive: This is for those with 35 or more years until retirement.
50 percent - large cap stocks
15 percent - mid cap stocks
10 percent - bonds
10 percent - small cap stocks
10 percent - international stocks

Moderate: This is for those with 20 years until retirement:
35 percent - large cap stocks
35 percent - bonds
10 percent - mid cap stocks
10 percent - small cap stocks
10 percent - international stocks

Conservative: This is for those within 10 years of retirement:
40 percent - bonds
30 percent - large cap stocks
10 percent - mid cap stocks
10 percent - international stocks
10 percent - cash

Sources: 123s-of-401ks.com, mpowercafe.com, Money magazine, "Savings Fitness: A Guide to Your Money and Your Financial Future," from the U.S. Department of Labor Retirement Savings Education Campaign



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