A 401(k) plan can be an excellent financial vehicle for saving for retirement. You can enjoy the benefits of matching contributions from your employer; the ability to contribute pre-tax dollars, which lowers your taxable income for the year; and gain earnings that accumulate on a tax-deferred basis. However, there are things you should know to help you maximize your return and avoid costly mistakes that could derail your plans for a comfortable retirement.
Vesting refers to the amount of your company's matching 401(k) contributions that you actually own. Depending on the rules of your company, it could take anywhere from three to five years before you are fully vested. If you leave before then, you could forfeit some or all of the accumulated funds that were part of a company match.
Loan Repayment Issues
One benefit of a 401(k) is that you can borrow from it at a relatively low interest rate under certain conditions. However, if you leave the company before repaying the loan in full, you will be required to make immediate repayment of the outstanding balance. If you can't, you'll be hit with a 10 percent early withdrawal penalty and have to pay taxes on the amount for the current tax year.
If you use your 401(k) to invest in mutual funds, it's possible that you are paying a sales charge, known as a "load." You may not even realize it unless you've read the fund's prospectus because the load is simply deducted from your contribution amount. This could eat into your contribution by as much as 4 percent. Check to see whether your 401(k) offers a no-load fund investment option, which would eliminate the additional sales charge.
Investment Options Are Not Set in Stone
Your company may offer a limited number of investment options for your 401(k), which can reduce your chances of maximizing your return. Be aware that your company can add more options on an annual basis, so be sure to contact your benefits administrator or HR representative about the possibility of offering more choices.
Diversification Is Key
Proper diversification of your 401(k) investment dollars between stocks, bonds and cash can help you minimize risk and get the highest return in the long run. A good strategy is to have your financial adviser evaluate your plan on an annual basis so you can make any necessary adjustments.
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