When Should You Consider a 401(k) Plan?
In 1981, tax laws established the 401(k) plan, a form of defined-contribution retirement plan. The government’s motivation was to encourage Americans to increase their private savings as a supplement to Social Security. For employers, the appeal was that defined-contribution plans are simpler to administer and less troublesome to fund than pension plans. For workers, the advantages include an immediate reduction in taxable income, a potential investment boost in the form of employer matching contributions, and the potential for higher earnings accumulation from tax deferrals on capital gains and income. No wonder, then, that defined-contribution plans are among the most recognized and prized benefits in the American workplace. Employers have learned that the range, quality, and performance of their plan’s investment choices matter, as do the ability to make frequent changes in investment choices, take out loans, and flexibility to tap plan assets when employees experience financial hardship. They have also learned that a generous employer-matching contribution is the single most valued feature for employees. But, is your employer-sponsored 401(k) always the best place for your money? The answer may not be an unequivocal yes. Here are five questions to answer when deciding whether and how much you should contribute: 1. Do you have an emergency fund? Typically, every household’s first priority is to establish an emergency fund equal to three to six months of earned income. While there are ways to access funds in your 401(k) plan (loans and hardship withdrawals), it is generally easier to use an emergency fund. 2. Are you properly insured? If you have dependents, life insurance is a much more cost-effective way to provide for their needs than a savings plan. 3. Does your employer match your contributions? An employer-matching contribution is the single most compelling reason to participate in a workplace defined-contribution plan. So, if your plan features a match, it’s generally a good idea to participate at least up to the maximum matching amount. That said, over the past few years, many employers have been forced to cut back or eliminate their ongoing matching contributions. If your plan doesn’t offer one, it’s not necessarily a reason to stay away from it. But it does mean you should research other ways to save for your retirement. 4. Does your plan offer enough diversification? Some plans offer very few investment choices. There may be nothing wrong with these choices, but limited choices may not offer the kind of diversification you need. You may need to open your own individual retirement account (IRA) to find the wider range of opportunities that will maximize your returns while controlling for risk. 5. Are the funds well managed? Not all funds perform equally well, and some charge more than others. While you shouldn’t blame a fund when the financial markets underperform, you should evaluate a fund’s performance relative to the markets in which it invests. Is your employer’s 401(k) the best place for your next retirement savings dollar? Only a thorough review of the plan and your needs can answer that question.
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This newsletter was prepared by Integrated Concepts Group, Inc. The opinions expressed in this newsletter are for general information only and are not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. The views expressed are those of the author and may not necessarily reflect those held by PlanMember Securities Corporation. Material presented is believed to be from a reliable sources and PSEC makes no representation as to it accuracy or completeness.