Investors come in every shape and size, as well as risk tolerance. That last quality can really vary depending on whom you’re discussing the subject of investing. So let’s approach today’s rant in a way that should appeal to you whether you’re ultra-conservative or a daredevil risk taker.
One of the things to do during this holiday season after you’ve completed your shopping, should be to plan out your finances for next year. Most people I know put more thought and time into planning for their vacation than they do for their retirement. I’m guessing the majority of IG readers hold down a job somewhere so the first place to look at planning are your company’s offering of retirement plans. And I’m also guessing that most of us will not be able to say we spent a larger portion of our life taking vacations vs. being in retirement.
Retirement Plans Are Not Built Equally!
Complaints about one’s own retirement plan from disgruntled friends and family are common. My reaction is to ask them how much time they spent studying the features of their company’s offering? Too many people have the misconception that all plans are built equally. Throw that out right now! Ask for your company’s retirement plan prospectus and scrutinize it. Don’t say it’s boring, because you’re just giving yourself an excuse to fail. And if you can’t accomplish such a simple task, you really have no one but YOURSELF to blame for your future.
What are some differences? For starters, most retirement plans vary in their funds / investments offering. You need to familiarize yourself about any type of company match / profit-sharing matches that may come your way. Some companies may have weird limits on how much can be deducted per paycheck. If you’re the type that is looking for flexibility beyond the normal mutual funds offered, you might be lucky enough to have an employer that offers a self-directed brokerage option in your plans; giving you the reigns on your investment selections.
Where’s The Free Money?
Most employers offer some sort of a match based on your participating contributions. What are you doing to maximize that match? This is essentially free money for you and it’s not uncommon to see companies match 50% or even 100% of you contribution up to a certain limit. Let’s say you maximize a 50% match. Even if all you’re doing is nothing but putting into a money-market fund (for the ultra-conservative), you’re still getting a 50% return on your money. I say 50% because that’s money you would not have gotten had you not participated. If you are a risk-taker, you now have more money to play with, so I hope you do have a good investment selection in your plan. At the very least, you should be able to fall back on some index funds. Start making a budget now, to ensure you’re able to pick up those matches through payroll deductions next year.
I’m not gonna ask you to jump into the pool without knowing how deep it might be. A major concern for not maximizing your contributions to the company match have to do with any vesting restrictions. I hope that you have a generous employer who believes in 100% vesting right from the start, but more likely you’ll be put on a graded / cliff vesting schedule. This is a valid concern for young professionals entering the work force. You might be considering jumping ship a few years down the road. In fact, down the road you might decide whether to jump ship based on how well your current and your potential new employer’s retirement plans are. Ask questions about vesting restrictions and find out those answers!
A New Ally – The Pension Protection Act of 2006 (PPA)
But a big reason why maximizing company match should be a major consideration for 2007 is because of a less publicized feature of the PPA. Under old rules, it did not make sense if your company matches were forced to be put into a investment such as company stock. The PPA has compelled retirement plans to quickly comply with changes, so that employees can immediately diversify their company matches out of employer stock. Regarding vesting, the PPA has also sped up the schedule as matches must now become vested 100% after three years of service or over a six-year vesting schedule at 20% each year, beginning in the second year. There is more consistency now that rules are put in place so that employers can no longer enjoy their own interpretation of those features.
To Roth Or Not To Roth?
Many retirement plans have started to allow Roth 401k contributions. Roth contributions are after-tax contributions that use up your contribution limits like normal pre-tax deferrals. The advantage is that qualified withdrawals are tax-free for both your invested principal and any investment gains. I have a rule of thumb when it comes to whether Roth contributions should be used. Over the long run, the taxation differences between Roth / Non-Roth contribution work out to be very minimal provided your tax-brackets remain stable. The advantages can be more significant if your tax brackets will be different from the time you’re contributing to the time you’re withdrawing the monies.
Generally, if you are going to potentially withdraw at a higher tax bracket than your contributions (such as a young professional withdrawing money for home purchase or kids’ college tution), you’re better off with Roth contributions. If you are in your mid-40s where arguably your tax brackets are near their peak, normal contributions make more sense because they help you current tax situation; provided that you are withdrawing the money for retirement purposes at a lower tax-bracket.
Saving For A Rainy Day
It’s never advisable to dip into your retirement cookie jar but the fact of the matter is sometimes you do need to invoke some usage of your retirement plan. BE VERY FAMILIAR with the rules and restrictions surrounding retirement plan loans or withdrawals. You might not need it but you should know it. For those reader who are interested in maximizing their retirement plan limits beyond just getting the company match. Do realize that contribution limits are increasing in 2007; though not by as much as the last 3 years.
2006 Normal deferral limit – $15,000
2006 Catch-up deferral limit – $5,000 (for participants over 50 years of age)
2007 Normal Deferral Limit – $15,500
2006 Catch-up deferral limit – $5,000 (unchanged)
For my fellow Canadians, some of the points covered here are still relevant. You can check out this page for Retirement Savings Plans (RSPs) contribution restrictions.
One Last Motivation
If you have not considered contributing or even maximizing your company match in the past, want know what will get those juices flowing? Calculate how much match you have missed out on from previous years, and calculate how much you will be missing out in the future. But don’t dwell too much on the past, action gets results, and it’s time to take action!