|
|
YOUR EMPLOYER is probably making you rich.
How? Well, if you have a 401(k) plan at the office and you're participating, with employer matching, then you should have a very comfortable retirement - one that you'd be hard-pressed to match without the tax-deferred compounding a 401(k)offers.
The numbers speak for themselves. (See chart.) If you had saved a mere $100 a month in a 401(k) plan for the past 20 years — and your company had matched it at a rate of 50% — you'd be sitting on $184,000 right now (assuming your investments did at least as well as the S&P 500 index). With a Roth IRA, you'd have just $147,287. A large-cap portfolio? Try $108,259. Even a highflying hedge-fund manager would have had to nearly double the performance of the stock market over those 20 years to match the returns possible in an average 401(k).
This section features interactive tools and guidance that will help you make the most of your 401(k). But step No. 1 is simple: Max out. Put as much into your plan as your employer will match each year. Think of it this way: What other investment gives you the equivalent of a 25% or 50% return on the first day?
If you still have money you want to save after filling up your 401(k), our research shows that you should follow this pattern:
- Roth IRAs: After you've maxed out the company match, turn to a Roth IRA — if you qualify. (Your adjusted gross income must be less than $95,000 or less than $150,000 if you're married.) That's a better option than putting it in the 401(k) without the match. It's true that you won't get a tax deduction on Roth investments this year, but the eventual tax-free status of your Roth returns outweighs any immediate gain you'd get from a tax deduction. (See our Which IRA Is Right for You? for more on Roth accounts.)
- Unmatched 401(k): Keep putting your excess savings into the Roth until you've used up the $3,000 that you're allowed to contribute each year. (If you'll be age 50 or older by the end of the year, you can contribute an extra $500 annually.) Then, if you want to save even more than that, make whatever unmatched contributions you are allowed to your 401(k). The government currently caps contributions at $12,000, although the limit is $14,000 for those age 50 or older.
- Regular IRA: If you can't open a Roth IRA because of your income level, max out both the matched and unmatched portions of your 401(k). Then consider a nondeductible IRA. Here also, the annual limit is $3,000 ($3,500 if you'll be age 50 or older by year-end), but anyone can open one. And the benefits are still significant: After 20 years, the tax-deferred compounding will give you 5% to 15% more to spend during retirement than the same investment would in a taxable account.
- Taxable Investments: When you've exhausted all these options, a taxable investment is the next best thing. The key to choosing taxable investments for your retirement savings, however, is to keep your expenses down and get the most benefit from the 20% capital gains break. That means holding your stocks for more than 12 months — longer, if possible — and choosing mutual funds with a low annual turnover (the rate at which the fund manager buys and sells holdings). Since the law requires that gains from selling stocks be distributed to mutual fund investors, the higher the turnover rate, the greater the amount of your return each year that will be subject to taxation — and that amount may be taxed at higher rates.
- Variable Annuities: Forget them. Their exceptionally high expenses often counteract the tax-deferred aspects of these contracts. Variable annuities make sense only for a fixed-income asset such as bonds or cash, and only if you are saving for at least 12 years. In that case, the gains from compounding your interest free of income tax eventually outweigh the drag created by higher fees. The exact number of years necessary to come out ahead depends on your tax bracket and the income yield of your investments.
Once you've got your savings placed in your 401(k) and other accounts, of course, you then have to choose the most appropriate investments. Our Picking Investments section will walk you through the issues involved.
|
|
 |
|
|
|
|
|
