Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: MONDAY, April 9, 1990 TAG: 9004070017
SECTION: BUSINESS PAGE: A9 EDITION: METRO
SOURCE: MAG POFF BUSINESS WRITER
DATELINE: LENGTH: Medium
And then they have a 401(k) tax-deferred plan at work they seldom think about.
Virtually everyone who's eligible should contribute to a 401(k), especially if the employer matches your dollars. Your employer's percentage is actually a boost in salary.
Just because the plans are subject to restrictions, however, doesn't excuse you from managing the account just as you do your mutual funds and bank CDs.
The plans allow you to set aside a percentage of income determined by your employer up to a limit of 10 percent.
You don't pay taxes on the contributions until you withdraw your savings, usually at retirement. The earnings are sheltered as well.
Tax-deferment makes a considerable difference.
J.K. Lasser's Personal Investment Annual projects that a $6,000 annual contribution earning 8 percent will grow to $242,356 in 25 years assuming a 28 percent tax bracket.
The same money in a tax-deferred account will produce $473,726 at retirement.
So the plan makes sense for everyone who has already socked away three to six months' salary for emergencies.
A 401(k) cannot be your first investment unless you have resolved to build up your cash cushion at the same time.
Because it's intended for retirement, money inside a 401(k) isn't easy to reach.
Taxes are due on the share of money that you take out of a plan under any circumstances.
You can take the money without an additional 10 percent penalty when you turn 59 1/2 or become disabled.
If you leave the company, you can avoid the 10 percent penalty only if you roll over the money into a separate IRA account within 60 days.
You can tap into the money in case of hardship, a situation that may be defined in various ways by different company plans, but you almost always have to pay the penalty.
In his 1990 Money Guide, Fortune Editor Marshall Loeb said only the employee contribution can be taken in a hardship situation.
The 10 percent penalty is waived, he said, only if the hardship is tax-deductible medical costs. That's an amount exceeding 7 1/2 percent of gross income.
Many companies allow you to borrow your money from the plan, however.
You must pay a market rate of interest, but that money will be flowing into your own account too as you pay back the loan.
Andrew Hudick, a fee-only financial planner with Elliott & Associates in Roanoke, said the difficult decision is how to allocate the money rather than whether to participate.
Most plans in this area offer four funding choices, he said.
These are a stock mutual fund, bond mutual fund, guaranteed income fund and a company stock fund.
Hudick said a Wall Street Journal study has determined that 83 percent of company matching contributions are allocated to the purchase of company stock.
Most people, Hudick said, should use their personal contributions to buy other investments.
He pointed out that an employee's future is already tied to the success of the company.
The prudent course, Hudick said, is to diversify beyond the same company.
"Often when reviewing the mutual fund choices [whether stock or bond] you will find that the choices available to you perform below the industry average," Hudick said.
"This makes them a poor investment choice for your funds, and often leaves you with the guaranteed income fund as your best option."
Many participants should make the maximum 401(k) contribution under the terms of their plan, he said. The federal ceiling is $7,979 this year.
He said they should allocate their entire personal contribution to the guaranteed income fund while the matching company contribution buys company stock.
Meanwhile, Hudick said, money saved outside the plan should go into a portfolio of stocks or stock mutual funds.
He said that course would offer the most flexibility in terms of investment selection while preserving benefits of the 401(k) plan.
If a plan is "guaranteed" by an insurance company, Hudick warned, employees should make sure the insurance company has a high rating and a low percentage of junk bond exposure.
"Manage your 401(k) money as though it were a part of your other investment portfolio. It is."
Hudick also said that anyone taking money from a plan should consult an adviser on the tax ramifications of handling the money.
That's especially important for people who are retiring or leaving the company.
by CNB