Originally created as a means to supplement company sponsored pension plans, defined contribution plans, such as the 401(k) plan, have become one of the most important tools available to help today's employees save for a secure and comfortable retirement. Named for the section of the IRS tax code that governs their existence, 401(k) plans offer employees a convenient way to save for their futures, while simultaneously offering other important benefits.
Why participate? Your 401(k) may become your primary source of retirement income.
Unfortunately for many, gone are the days when employees could count on a company sponsored pension plan and Social Security to satisfy their retirement income needs. Indeed, over the past couple of decades, there has been shift away from defined benefit pension plans in favor of defined contribution plans. More than ever, the responsibility has shifted from the employer to the employee to help ensure that they will have adequate income in retirement.
While traditionally a core source of retirement income, most would agree that the future of Social Security is in doubt. Even if the program survives, it's highly unlikely that the monthly benefits provided would cover all of one's retirement income needs. Obviously, with guaranteed pension plans largely a thing of the past, and uncertainty surrounding Social Security, your 401(k) plan may become your most important source of income in retirement, so we believe it's important to plan and save wisely.
An easy, tax-advantaged way to save.
As the old saying goes, if you want to build wealth, you have to "pay yourself first." When participating in a company-sponsored 401(k) plan, it's easy to follow this mantra since participants save through systematic contributions that are deducted from their pay before they ever receive their paychecks. Since participants never receive the money, in all likelihood, it's money they'll never miss.
To participate, employees elect to have a set percentage of their pay deducted and contributed to the plan each pay period. Since deductions are made pre-tax, participating not only helps employees save for the future, but it also helps to lower their current taxable incomes. Additionally, contributions and earnings grow on a tax-deferred basis and are not taxable until withdrawn from the plan. Over time, the deferral of taxes and the compounding of investment earnings can substantially add to participants' wealth.
Matching contributions: It's "free" money.
As an incentive to encourage employee participation, many employers offer matching contributions. Deposits made by the employer to the accounts of participating employees, matching contributions may be dollar for dollar, or they may be a percentage of the participant's contribution up to a certain limit. Unlike profit sharing plans whereby employers make discretionary, non-elective contributions for their employees regardless of their participation, under the matching contribution formula, employees must contribute to the plan to qualify for the match. Furthermore, employees should ensure that they are contributing enough to their plans in order to receive the full employer match. Anything less and they may be leaving "free" money on the table.
Employees gain access to a diversified menu of investment options.
In addition to ease of participation, company sponsored 401(k) plans typically offer a broad and diverse menu of investment options that enables employees to create a diversified portfolio that matches their unique time horizon and risk tolerance. While some plans offer individual funds options, others feature a choice of broadly diversified, professionally constructed portfolios designed to suit the needs of different types of investors.
You may be able to borrow your own money.
While not universally available in all plans, some offer participants the ability to borrow the funds in their plan accounts. While the ability to borrow your funds may sound attractive, there are pros and cons to doing so. For example, when borrowing from their 401(k) plans, participants can re-pay the loan at a fixed rate of interest that may be lower than rates available on traditional loans. Additionally, borrowers are able to conveniently re-pay themselves - principal plus interest - through payroll deductions.
The downside? The money borrowed from the plan loses the earning potential that it would have otherwise enjoyed had it remained fully invested. Additionally, if the participant terminates employment with his or her company, he or she will likely have to re-pay the loan in full in order to avoid it being treated as a withdrawal. If treated as such, the outstanding balance would be subject to taxation as well as a possible 10% early withdrawal penalty if the participant had not yet reached 59 ½ years of age.
Plan sponsors must act in your best interests.
According to the Employee Retirement Income Security Act (ERISA) of 1974, plan sponsors must adhere to a fiduciary standard meaning they are duty-bound to act in the best interests of the participants with respect to plan information, investment options available, full and fair fee disclosure, as well as regular educational opportunities for employees. Given these standards, participants can have peace of mind knowing that their sponsor should be managing the plan to the highest ethical standards, with their best interests in mind.
Given the benefits of saving through a company sponsored retirement plan, we would suggest that if you're not currently participating in your company's plan, contact your plan administrator for information on enrolling. If you're already enrolled, consider increasing your monthly contributions to help build a bigger nest egg for your future. For tax year 2014, participants are eligible to contribute up to $17,500 to their plans, and those aged 50 or older are eligible to make an additional catch-up contribution of $5,500. 1
While participating in your 401(k) plan is, we believe, a giant step forward in planning for your financial future, it may be but one piece of your complete financial picture. Throughout their lifetimes, most individuals will face a variety of planning and asset management needs that may include saving for a college education or minimizing taxes, as well as strategies for income generation in retirement, or planning for the transfer of one's wealth.
Please contact us if you have questions, or if we can be of assistance with any of your financial planning needs.
Symmetry Partners, LLC and "Broker-dealer" are unaffiliated.
Content written by Symmetry Partners, LLC. Our firm utilizes Symmetry Partners, LLC for investment management services. Symmetry Partners, LLC, is an investment adviser registered with the Securities and Exchange Commission. The firm only transacts business in states where it is properly registered, or excluded or exempted from registration requirements. All data is from sources believed to be reliable, but cannot be guaranteed or warranted. No current or prospective client should assume that future performance of any specific investment, investment strategy, product or non-related investment content made reference to directly or indirectly in this article will be profitable. As with any investment strategy, there is a possibility of profitability as well as loss. Symmetry follows a passive investment strategy that involves limited ongoing buying and selling actions. Passive investors will purchase investments with the intention of long-term appreciation and limited maintenance. Passively managed portfolios are designed to closely track their respective benchmark index rather than seek out performance. As a result, the portfolio may hold securities regardless of the current or projected performance of a specific security or particular industry or market sector. Maintaining investments in securities regardless of market conditions or the performance of a specific security could cause the portfolio to lose value if the market as a whole falls. Please note that you should not assume that any discussion or information contained in this article serves as the receipt of, or as a substitute for, personalized investment advice from Symmetry Partners or your advisor.
Asset allocation does not protect against loss of principal due to market fluctuations. It is a method used to help manage investment risk.
Diversification does not protect against loss of principal.
Please be advised that Symmetry Partners, LLC does not provide tax or legal advice and nothing either stated or implied here should be inferred as providing such advice. The information is provided for educational purposes only. Please be advised that Symmetry Partners is merely relaying this information and has no control if some of the timelines are amended.