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Many of us are covered by one or more types of defined contribution retirement plans, such as a 401(k), 403(b), 457, or any of a number of other plans. What many of these plans have in common is that they are referred to as Cash Or Deferred Arrangements (CODA), as designated by the IRS. These plans are also often referred to as Qualified Retirement Plans (QRPs). Each type of plan has certain characteristics that are a little different from other plans, but most of them have the common characteristic of deductibility from current income and deferred taxation on growth. (Note that this list of plans does not include IRAs. IRAs have certain characteristics that are completely different from QRPs, and vice-versa. Also, Designated Roth Contributions, such as Roth 401(k), has certain different attributes compared to the non-Roth variety we\u2019re discussing here.)<\/p>\n
1. Each dollar you defer is worth more than a dollar.<\/strong> It\u2019s true. As you defer money into your retirement account, each dollar that you defer could be worth as much as $1.65. How, you might ask?<\/p>\n Since you are not taxed on each dollar that has been deferred into the retirement account, your \u201ctake home\u201d pay only reduces by the amount that is left over after taxation. For example, if you\u2019re in the 25% income tax bracket, generally your income will only reduce by 75\u00a2 for every dollar that you defer into your retirement plan. Therefore, the 75\u00a2 that you\u2019ve effectively \u201cspent\u201d is worth 33% more ($1.00) in your retirement account.<\/p>\n If you happened to be in the highest, 39.6%, income tax bracket, this works out to a 65% increase in the value of each dollar deferred. This doesn\u2019t even take into account the potential for matching dollars from your employer!<\/p>\n 2. Matching \u2013 FREE MONEY.<\/strong> Well, it\u2019s not exactly free, you must defer some funds (but it\u2019s all still your money) in order to take advantage of it, but other than that, your employer is actually chomping at the bit to give you this money. The reasons can be far-reaching, but the point is that it\u2019s literally yours for the taking (and totally yours if you\u2019re vested in the plan). It should be noted that some companies do not match your funds at any level in a plan.<\/p>\n So, what should you do about this? If you aren\u2019t currently participating in your company\u2019s 401(k) or other deferred compensation plan and they match your funds, you are throwing money away by not participating in the deferral arrangement. Depending upon the options in your plan, you could be turning your back on as much as a 100% return on your investment \u2013 guaranteed! Everyone should take advantage of AT LEAST the matched portion of your deferred compensation plan. After that, it may make good sense to put money aside in a Roth IRA (up to the maximum annual amount), before adding more to your deferral to max out your 401(k).<\/p>\n 3. Don\u2019t Overload On Company Stock.<\/strong> Even (especially?) if you\u2019re in a company where the stock has experienced dramatic increases in recent history, you need to make sure that your overall exposure to any one company is limited. A rule of thumb that I use is: no more than 5% of your overall net worth should be invested in any one company. If you are inclined to have a larger stake in your company because you work there and enjoy the sense of ownership, I still wouldn\u2019t recommend putting any more than 10% in that stock. The figure is doubled for the company that you work in because, at least presumably, you are more in tune with the value of the company and internal events taking place and could make adjustments if an event were coming up that could seriously impact your holdings.<\/p>\n Of course, the reason behind this is to limit your exposure to the ebb and flow of a single company\u2019s stock price. For example, what if you held stock in one company that amounted to 30% of your overall net worth, and that stock took a major hit of a 25% price reduction? This one event would have the impact of yanking down your net worth balance by 7.5% \u2013 quite a serious impact, to say the least. The folks at Enron (and countless other companies) found out the hard way how much damage can be done by having too large of an exposure in a single company.<\/p>\n 4. Diversify, diversify, diversify.<\/strong> Most of us understand the concept of diversification, but how do you actually accomplish it?<\/p>\n In order to properly diversify, you need to review the available investment choices in your plan, and then use those choices to spread your investments among capitalization categories (large-cap and small-cap), as well as between value-oriented and growth oriented, as well as domestic companies and international companies. You should also consider what amount of fixed-income investment (bonds) makes the most sense in your portfolio.<\/p>\n Keep in mind, diversification doesn\u2019t simply mean you put an equal amount of money in each available choice of investment. Each person needs to consider this individually, in respect to their overall portfolio and risk tolerance. Your investment allocation should include assets held outside of the deferred compensation plan, such as other IRAs or taxable accounts. You need to make a decision as to what allocation makes the most sense for you and apply it across all of your accounts. If you\u2019re fairly young and have a lot of years to grow your funds (as well as recover from any downturns), you can probably take on a greater amount of risk. If you\u2019re nearing retirement, most likely your risk profile will be much less risky.<\/p>\n 5. Don\u2019t Take A Loan.<\/strong> No matter how tempting it is, taking a loan out from your qualified retirement plan in more cases than not, results with derailing your hard work in saving and building up your account. Not only are you strapped with having to pay back the funds to your account (with interest), but you have also given up whatever growth might occur within your account (since the funds are being used for another purpose).<\/p>\n Experience tells us that you would be much better off to temporarily suspend or reduce your contributions to your retirement plan in order to save up money for that purchase, instead of taking a loan from your retirement plan. It may take a little while longer, but you\u2019ll probably appreciate it a bit more as a result of your saving.<\/p>\nShare, tweet, print, email, like or pin this post:<\/h3>\n<\/div>\n<\/div>\n
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