Posted on: Thursday, March 3, 2005

AKAMAI MONEY
Free money comes in 401(k) plans

By Deborah Adamson

If you saw an unclaimed $20 bill on the street, you'd probably rush over to pick it up.

Yet many people do not join their company's 401(k) plan — and employers usually shell out a lot more than $20 in matches. In fact, you can get thousands of dollars annually for free.

"You're leaving free money on the table," said Chad Adams, a financial adviser with American Express Financial Advisors in Ala Moana.

Low-income earners get an extra bonus on top of 401(k) perks: a federal tax credit of up to $2,000 per taxpayer.

Still, 34 percent of employees who have access to a 401(k) plan do not join, according to a study released last month by Hewitt Associates. Among those who are in a plan, 77 percent are not contributing enough to get the full company match, the human resources services firm said.

So what is a 401(k)? Named after section 401(k) of the IRS Code, it is a type of retirement plan with tax advantages that's funded by the worker and usually by the company as well. The employee deposits part of a paycheck and the company matches the money up to a certain percentage. For example, companies may put in 50 cents for every $1 you put in up to 6 percent of your salary.

That company match, compounded over time, can mean a lot of extra cash.

Let's say you put $100 a month into a 401(k) earning an 8 percent annual return. After 20 years, you'll have over $59,000, Adams said. With a company match of 50 percent — another $50 a month in your pocket — your 401(k) savings would jump to about $89,000.

Since your money is taken out pretax, you're saving on taxes as well. If you're in the 25 percent tax bracket, you'll save an additional 25 percent on your contributions, said Robert Brokamp, editor of the "Rule Your Retirement" newsletter by Alexandria, Va.-based Motley Fool.

"You add those two together, it's like getting a 75 percent return," he said.

Finally, it's tax-deferred — meaning you're only taxed when you withdraw the money.

So if you leave $1,000 in a tax-deferred account, it will grow to $19,837 after 30 years at an average annual rate of return of 10 percent. If you leave the $1,000 in a taxable account and you're in the 27 percent tax bracket, after 30 years you'll only have $8,876, according to American Express.

That's why even if an employer doesn't match contributions, workers should still participate — you get pre-tax and tax-deferral benefits.

If you want to know how much you can afford to contribute, ask your human resources or payroll department to calculate your take-home pay after a 401(k) contribution. There's also a calculator at www.choosetosave.org/tools/fincalcs.htm.

Some 401(k) rules to remember: generally you cannot withdraw your money before you reach 59ý years of age without paying a 10 percent penalty plus income taxes, although there may be exceptions. When you reach 59ý, you skip the penalty but still have to pay taxes. If you need access to your money, many plans will let you borrow against your 401(k).

If you're low income, Adams said, you can take a tax credit of between 10 percent to 50 percent of your yearly contributions — up to $2,000 per person — if you put money in a 401(k), IRA or other retirement plans.

When you join a 401(k), you have to decide how your money will be invested. Usually, you have to choose among several stock or bond mutual funds, real estate investment trusts, company stock and a less volatile option such as a money market account.

But with dozens of choices, employees can get confused. "People get analysis paralysis," Brokamp said. "They look at all the choices and they say where should the money go?"

If you want to proceed slowly, he said, consider parking your money in a money market account while you do basic research.

When you're ready to plunge in, a rule of thumb is that the younger you are, the more money you should have in stocks. The older you are, the more you should have in bonds.

Danny Alvarez, an investment representative from Edward Jones in 'Aiea, provides a sample allocation: if you're in your 30s, consider investing 15 percent of your funds in bonds and 85 percent in stocks; in your 40s, look at putting 30 percent in bonds and 70 percent in stocks. In your 50s? At least 40 percent should be in bonds and the rest in stocks.

As for company stocks, it's generally wise to limit exposure to 10 percent of your portfolio, he said. While you hear stories of employees becoming millionaires through company shares — Microsoft is a commonly cited example — there are Enrons out there whose shares have lost value.

For more information, go to www.fool.com, click on "401K" on the left under "Personal Finance." Another site to check out is www.401K.org.

Reach Deborah Adamson at dadamson@honoluluadvertiser.com or 525-8088.