Wednesday, January 12, 2011

How well do you know your 401k?

Lets start with what is a 401k. Definitions on the web, in newspapers and in magazine articles are as simple or as complex as the prospective audience. Simply put, its a savings plan. I will stick with that simple definition and focus on aspects of 401k that may help you.

pretax dollars....401k allows you to save in pre-tax dollars, invest in pre-tax dollars and grow your money in pre-tax dollars. Ofcourse there is a limit that resets every year or so but a decent limit.

employee match....401k contributions are matched by a lot of employers for different contribution amounts and for different percentage matches. Some may match $ for $ upto 3%, some upto 3% for first 6% and so on. One way to look at it is getting an immediate ROI on your contribution. This feature by itself is worth making 401k your first savings account.

investment options....401k investment options vary by plans from safest (money markets) to riskiest (you investing in stocks with your own analysis) and everything in between. Depending on your comfort with risk and knowledge on the stock market, you could be at one end of the spectrum or all over meaning you can be 100% in money market or stocks or have 5% invested among 20 different mutual funds. My recommendation would be to read about the funds being offered, their investment strategy and past performance, evaluate what maps to your long term goals and make a decision. Some funds have a higher management fees versus the other so look out for that when making a choice.

contribution options....401k contributions again vary with plans and features being offered. Some allow a flat % each paycheck, some allow for a gradual increase in contributions over time. Some even allow different contribution % options depending on the source of income; salary, bonus etc. Depending on your own financial outlay and market perception, you could decide to start slow with gradual increases or alternately start aggressively with max contributions upfront. Note that employer matches will likewise adjust so find the right balance.

investment re-balance....401k plans offer this amazing feature that allows you to move your investment between the multiple investment options within your plan by simple % allocations to each. This is handy if your perception of the market has changed and want to adjust. Some plans even allow a forward looking re-balancing.

withdrawals....401k plans have withdrawal options. You have got to invest some time to get answers to the following questions. How much can I take out? What is the penalty, fees etc? How much time does it take and what are the qualification criteria? Lot of articles have been written about how taking money out from 401k is a bad idea. I agree with all of them but when you need the money and have exhausted all options, you got to do what you got to do. Having the knowledge ahead of time on how you can access the money will allow for a peaceful demeanor when making this tough decision.

Lastly....its your money so give it attention like any other investment. A 30-60 minute review once a quarter can go a long way in building up your savings with the investment options that map to your plans the best. Thats what this is all about, isn't it?

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1 comment:

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