401(k) Do's and Don'ts

I accidentally looked at a third quarter statement for one of my retirement accounts last week. Its value had dropped just 11 percent. If you'd told me a year ago that I'd be OK with a loss in value of "just 11 percent" on any investment, I'd have called you crazy.

But crazy is what the market has been. And crazy is how many folks have been acting regarding their investments.

Now, however, it looks like we might be in for a break. There are some indications that global markets are stabilizing a bit as investors digest steps taken to deal with the credit crisis.

Don't Mess With Taxes readers apparently were ahead of the chill curve. Last week, we asked, How are you dealing with the stock market meltdown?

A whopping 80 percent of respondents indicated they were staying their investment course. Here's the breakdown:

44% said: I have a regular investment program and I'm sticking with it
24% said: I'm buying bargains.
12% said: I'm leaving current holdings alone, but not investing new money.
  9% said: I bailed out and put my money into FDIC-insured instruments.
  9% said: I'm ignoring it, hoping the market will eventually work itself out.
  2% said: I'm taking other approaches.

401(k) tips: My investment account that lost just 11 percent of its value is one that began as a 401(k). These tax-advantaged workplace retirement plans are major components of many individual investment portfolios.

So it seemed appropriate, to borrow a word that Fed Chief Ben Bernanke used in discussing another round of rebates, to look at some 401(k) do's and don'ts.

Do participate
For most workers, 401(k)s are their primary retirement savings vehicle. Unfortunately, most workers aren't making the most of these plans. In fact, some studies show that as many as one-quarter of eligible workers choose not to participate in their company's 401(k) plan.

I know that sometimes it feels like you need every last dollar of your pay. But seriously consider putting at least a minimal amount into a 401(k). Your contribution comes out of your pay before taxes are deducted, so that's a bit of a saving upfront. And you might be surprised as to how quickly you can adjust to that "missing" amount, which actually is making more money in the long-term for you.

Do contribute enough to get a match
Many companies match their employees' contributions up to a certain amount. A typical match is 50 cents on your dollar up to 6 percent, giving you an added 3 percent of money to grow tax-deferred. That's an immediate 50 percent return. So as soon as you can, up your contribution level so that you get the maximum match from your boss.

Do your homework before signing up
Even when employees do participate in their company 401(k)s, too often they invest in a way that doesn't make sense. For example, a young employee who can afford to take some risks because she has a longer investment time line, might invest too conservatively. Meanwhile, an older worker has put his retirement money at too much risk by selecting a plan with volatile stocks.

Before selecting your 401(k) option, assess your other investments and how this will fit in with your overall strategy. Carefully examine the various options available. And talk with your plan administrator if you have questions about the company's offerings. Some companies now offer added guidance, thanks to the Pension Protection Act of 2006, which enables plan sponsors to offer investment advice to employees.

Don't over invest in your employer
Remember Enron? Thousands of that company's workers thought that their employer's stock was their best retirement bet. It's usually not, even when a company is in good shape. You need to stay diversified; you're already getting a paycheck, so look at other options for your 401(k). Even when the company stock is a great investment, you don't want your portfolio (or life) dominated by one stock.

Don't borrow from your plan
Your 401(k) is a retirement savings vehicle, not a revolving credit account. So don't borrow from your account unless it's a dire emergency. True, you'll pay yourself back, but by taking some money out, you lose the earnings it would have produced and you'll likely never recover them. Plus, if you leave your job while you're still paying back your 401(k) loan, you could be asked to settle the loan as soon as you leave. If you don't repay it, the loan balance will be treated as a distribution, which leads us to our next tip.

Don't take early distributions
In most cases, if you take funds from your 401(k) plan before you are 59½, you must pay a penalty of 10 percent additional tax on the withdrawal.

Do roll it over
Early, and costly, distributions commonly occur when folks change jobs. They take their 401(k)s with them, which is a good idea, but they do so the wrong way. Don't have your former employer give you the account funds. Instead, have your 401(k) rolled directly into a plan at your new job. This trustee-to-trustee transfer will keep you from facing potential tax penalties.

What if your new employer doesn't have a 401(k) program? Don't worry. You can roll your old 401(k) into an IRA.

Comments

[Vincent B]

The greatest thing about a 401K is the tax deferrment. Even if the vehicle you choose only averages a small return, it's better than investing on the outside because you get to invest the whole dollar you were paid rather than only 75 cents (assumes 25% effective tax rate). That's leverage! Always delay and avoid paying taxes as long as possible...the second largest expense of your life if you're a homeowner.

[Andrea]

I've lost significantly more than that, which some people might find odd since I'm in the investment business and have done a pretty good job of calling the market moves (within a small group of friends - not publicly), but really, I just don't pay much attention. The one thing I did do a couple of weeks ago was raise my pre-tax contribution from the match-max to 12%. That's quite a jump, I know, and that money won't be going to pay down debt, but frankly, I just don't care right now. The payoff for buying stocks at this price is hopefully worth more than the piddling 3% I'm paying on my credit card debt.

[Kay]

You're right that the down market offers a chance to get more shares at value prices.
But time is also a factor. The concern for many account holders is that their plans lost a lot of money and they are nearing retirement. Most analysts say it will take 10 or more years for most assets to get back to where they were before the meltdown. If you're 50 or so and hoping to retire early, that means plans you made based on your investments' continued growth pre-crash will have to be rethought, since you'll not have as much money as you planned. Sure, the market is never a sure thing, but I doubt anyone made plans taking into account that their funds would have a big chunk of such lower earnings.

[Manarin]

Couple of additional thoughts:

If you are putting money into your 401k, why does it bother you that your account has taken a double digit decline? Now you are buying more shares of your future wealth at discount prices?

It's like going to the mall for the sale of lifetime but instead of buying things that will depreciate in value, you are buying assets that will go up in value over time.