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Answers
to Some Common Questions
Okay.
Now you’ve got the point: You don’t want to miss out on the benefits
of saving in a retirement plan when you’re young. This next section
will answer a few questions you want to ask before you get started.
The
Facts on 401(k)s
Q:
Am I eligible for a 401(k)?
A:
Ask your employer. You may be required to work for your employer
for a year or reach age 21 before you can contribute.
Q:
One of my 401(k) investment options is stock in my company. Should
I bite?
A:
Probably not. When you work for a company, you already have a
huge "investment"
in it. If the business runs into difficult times, you are at risk
twice: Not only could you lose your job, but you could also see
your retirement portfolio plummet. What’s more, many employers
match employee contributions with shares of company stock, so
you may already be heavily invested in your firm.
Q:
My company plan allows me to invest in a guaranteed investment
contract. What’s that?
A:
Guaranteed investment contracts (GICs), sometimes called stable
value funds, are investments that are similar to CDs (certificates
of deposit) but are guaranteed by a bank or insurance company
instead of the federal government. They are usually offered in
401(k) plans. GICs are considered relatively safe investments.
They have rates of return that are generally one or two percentage
points higher than those of money market funds. Though I recommend
putting most of your long-term savings in higher-yield investments
like stock, GICs can be used to balance your portfolio.
A
growing number of mutual
fund companies are marketing stable value funds as a good
investment option for IRAs
as well. Though these funds are also relatively safe and have
slightly higher returns than money
funds, they often come with relatively high expenses,
and may hit you with a 2% or 3% fee if you withdraw them or roll
them over before you retire. Until the market for stable value
funds forces these expenses down, I’d stick with low-expense money
funds and bond
funds.
Q:
What happens if I change jobs?
A:
If you move to a new company, you can transfer your 401(k) money
into an IRA or into your new employer's plan if your new boss
allows it. But you must be aware of a few annoying rules. It’s
important that you tell your old employer that you want a direct
rollover into your new company’s 401(k) or into an IRA. Although
the rules say the plan can pay out or "distribute" the 401(k)
money directly to you, there are several reasons to avoid this
method. If you are paid the money directly, the plan must withhold
20% of the amount you are due and send it to the IRS. You are
then responsible for replacing that 20% from your other savings
when you make the transfer into your new plan. If you can’t come
up with the money in 60 days, you will have to pay tax on that
20%, plus a penalty. (I told you these rules are annoying.)
Another
option you have if your account is over $5,000 is to leave your
401(k) money with your old company. Once you leave a company,
you’re no longer eligible to contribute to its 401(k), but your
account will continue to grow if your investments do well. If
you like the investment options at your old company’s 401(k) better
than the ones in your new company’s plan, this may be a good option
for you.
No
matter what you do, resist the temptation to simply cash in your
401(k). You will have to pay tax on the money, plus the 10% penalty.
Q:
What happens if I have an outstanding loan against my 401(k),
and I quit or I’m fired?
A:
This is a situation you should try to avoid. Most companies will
ask you to pay the entire loan back in one lump sum when you leave
the firm. If you can’t, the amount you owe may be treated as money
withdrawn (instead of borrowed) from the plan, and you may therefore
owe taxes plus the 10% penalty.
Q:
They tell me I’m vested. What does that mean?
A:
To be vested is to have a nonforfeitable right to the money your
employer contributed to your retirement plan on your behalf. Most
company retirement plans require you to work for the firm for
a certain number of years before you become fully vested, meaning
you can get 100% of the money your employer contributed for you.
Typically it takes about five years. Some companies have a gradual
vesting policy. With a gradual schedule you might be 20% vested
after two years at a company, 40% after three years, and so on.
Once you become vested, however, it doesn’t mean you may withdraw
your money without paying the 10% penalty and taxes on your earnings.
If you’re not vested and you need to get your money when you leave
the firm, you can withdraw the money you contributed (plus earnings
on those contributions), but you can’t keep any of the money your
employer contributed for you (or the earnings on those employer
contributions). If you’re partially vested, you’ll get to keep
a portion of the money your employer contributed for you, plus
earnings. Knowing your company’s vesting schedule can help you
time a career move. Keep in mind that some companies consider
a year of service to be less than a full calendar year (for instance,
five months and a day). That’s why you should consult your company’s
employee benefits or human resources department to find out the
exact date you’ll be vested.
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