{"id":383,"date":"2012-02-26T18:29:34","date_gmt":"2012-02-26T18:29:34","guid":{"rendered":"https:\/\/eagleoneresources.com\/?p=383"},"modified":"2012-02-26T18:30:15","modified_gmt":"2012-02-26T18:30:15","slug":"planning-for-retirement-part-4-401ks","status":"publish","type":"post","link":"https:\/\/eagleoneresources.com\/?p=383","title":{"rendered":"Planning For Retirement – Part 4 … 401(k)’s"},"content":{"rendered":"
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In Part 1 of this series, we briefly discussed how retirement planning had changed from the days when Joe went to work for The Big Company.\u00a0 Back then, the company provided a pension plan that paid Joe a retirement income based on how many years he’d worked for the company and how much he made while he worked there.\u00a0 Today, his grandson, Joe3 works for a company that offers a 401(k) plan rather than a pension.\u00a0 But, how does the 401(k) work?<\/p>\n

A 401(k) plan has much in common with an IRA.\u00a0 Like an IRA, the 401(k) allows Joe3 to reduce his taxable income by contributing money into the plan.\u00a0 Joe3 directs his employer to deduct a specific amount of money from each paycheck.\u00a0 These untaxed funds are invested in accordance with instructions that Joe3 provided when he authorized the deductions.\u00a0 The growth of the investments is not taxed until such time as Joe3 takes money out of the account.<\/p>\n

Because this is intended to serve as his retirement plan, Joe3 is expected to leave the money in the account until he is at least 591<\/sup>\/2<\/sub> years old.\u00a0 If he withdraws money from the account before that age, he will pay ordinary income taxes on the money withdrawn; and<\/span><\/em>, he will pay a 10% penalty for the premature withdrawal.<\/p>\n

One of the real advantages of the 401(k) plan is the ability to contribute far more to the plan than is permitted for an IRA.\u00a0 While the maximum contribution to the IRA in 2012 is $5,000, an individual can contribute up to $17,000 into the 401(k).<\/p>\n

Another advantage is that this plan allows an individual to reduce his or her taxable income regardless of annual income.<\/p>\n

Moreover, because the 401(k) plan entails regular, consistent, investments, the individual is able to take advantage of the concept of “Dollar Cost Averaging”.\u00a0 Dollar Cost Averaging simply means that the purchaser buys more shares when prices are low and fewer shares when prices are high.\u00a0 Consider this example.\u00a0 Joe3 has decided to invest $100 each month in stock issued by the XYZ Company.<\/p>\n\n\n\n\n\n\n\n
Month<\/span><\/td>\nPrice Per Share<\/span><\/td>\nTotal Shares Purchased<\/span><\/td>\n<\/tr>\n
January<\/td>\n$10.00<\/td>\n10<\/td>\n<\/tr>\n
February<\/td>\n$5.00<\/td>\n20<\/td>\n<\/tr>\n
March<\/td>\n$20.00<\/td>\n5<\/td>\n<\/tr>\n
Total<\/td>\n$300.00<\/td>\n35<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

As can be seen, Joe3 has invested a total of $300.\u00a0 If he decided that he wanted to sell all of his shared in the XYZ Company, how much would he have to sell them for in order to make money; $5, $10, $20, or something else?\u00a0 If we divide his $300 investment by the 35 shares he owns, we can see that he paid an average of $8.57 per share; thus, he’ll make money if he sells the entire investment for more than $8.57 per share.\u00a0 Of course, this does not include any fees that he may have to pay when selling the shares.<\/p>\n

Now, let’s extend this concept into Joe3’s 401(k) program.\u00a0 If Joe earns $500 per week and directs his employer to deduct 10% ($50) from each check and place that money into his 401(k).\u00a0 When prices are high for Joe3’s chosen investment, he will buy fewer shares at the high price. \u00a0When prices are low for Joe3’s investment of choice, he’ll get more shares.\u00a0 At his retirement, Joe3 will have amassed a significant retirement account that he can convert into a regular monthly income to support him in his golden years.<\/p>\n

One final potential<\/span><\/em> advantage should be recognized here.\u00a0 Some companies provide some type of matching contribution to an employee’s 401(k) contribution.\u00a0 Joe3’s company contributes $0.50 (fifty cents) for every dollar that Joe3 puts into his 401(k).\u00a0 This represents an immediate 50% return on his investment so longs as Joe3 remains with the company long enough to “vest” that matching contribution.<\/p>\n

Companies have a choice in vesting schedules; specifically, that matching contribution becomes the employee’s money when one of two schedules has been met.<\/p>\n

    \n
  • “Cliff Vesting” – the entire matching contribution becomes the employee’s property after 2 years of employment.<\/li>\n
  • “Stair-Step Vesting” – the matching contribution becomes the employee’s money in increments; i.e.,\n
      \n
    • 20% of the matching contribution belongs to the employee after 2 years of employment;<\/li>\n
    • 40% of the matching contribution belongs to the employee after 3 years of employment;<\/li>\n
    • 60% of the matching contribution belongs to the employee after 4 years of employment;<\/li>\n
    • 80% of the matching contribution belongs to the employee after 5 years of employment; and,<\/li>\n
    • 100% after 6 years of employment.<\/li>\n<\/ul>\n<\/li>\n<\/ul>\n

      Some employers measure the beginning of the vesting period from the initial date of employment while others measure it from the date on which the matching contribution was made by the company.\u00a0 Of course, the employee’s contributions to the plan always belong to the employee and cannot be taken away (which is not to say that the value is always the same … the value can increase or decrease based on the performance of the investment that the employee has chosen).<\/p>\n

      Just like the IRA, Joe3 must begin withdrawing money from his 401(k) by the time he turns 701<\/sup>\/2<\/sub>.\u00a0 Failure to make the minimum annual withdrawals will result in the assessment of tax penalties.<\/p>\n

      401(k) plans offer employees a great way to plan for retirement through the use of payroll deductions (if you don’t see the money, you don’t miss the money) and growth within a tax sheltered environment.\u00a0 If your employer offers this type of retirement plan, check it out … someday you’ll be very glad you took advantage of the opportunity to plan for your future retired life.<\/p>\n

      NEXT UP … 403(b)<\/p>\n","protected":false},"excerpt":{"rendered":"

      In Part 1 of this series, we briefly discussed how retirement planning had changed from the days when Joe went to work for The Big Company.\u00a0 Back then, the company provided a pension plan that paid Joe a retirement income based on how many years he’d worked for the company and how much he made […]<\/p>\n","protected":false},"author":6,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_s2mail":"","footnotes":""},"categories":[44,13,35,49,23],"tags":[],"class_list":["post-383","post","type-post","status-publish","format-standard","hentry","category-financial-planning","category-money-management","category-personal-finances-2","category-retirement-planning","category-saving-money"],"_links":{"self":[{"href":"https:\/\/eagleoneresources.com\/index.php?rest_route=\/wp\/v2\/posts\/383","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/eagleoneresources.com\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/eagleoneresources.com\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/eagleoneresources.com\/index.php?rest_route=\/wp\/v2\/users\/6"}],"replies":[{"embeddable":true,"href":"https:\/\/eagleoneresources.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=383"}],"version-history":[{"count":2,"href":"https:\/\/eagleoneresources.com\/index.php?rest_route=\/wp\/v2\/posts\/383\/revisions"}],"predecessor-version":[{"id":385,"href":"https:\/\/eagleoneresources.com\/index.php?rest_route=\/wp\/v2\/posts\/383\/revisions\/385"}],"wp:attachment":[{"href":"https:\/\/eagleoneresources.com\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=383"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/eagleoneresources.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=383"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/eagleoneresources.com\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=383"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}