This turbulent economy has taken its toll on everybody. No one is left unscathed – from Warren Buffet to Google all the way down to your personal 401(k). Many companies are struggling to stay afloat, and, just like the rest of us, are making necessary changes to keep their heads above water. Almost everybody is trimming the fat off their budgets, including businesses.
Since June 2008, more than 80 companies have eliminated or reduced their matching contributions to employee 401(k) plans, according to the Pension Rights Center. That list keeps growing as President Barack Obama throws the kitchen sink at our desolate economy in hopes of reviving our stock market from its financial coma.
So what do you do if your employer cut its company match? Here are some points to consider before you sell every investment under the sun and stuff your money in a piggybank:
Take a deep breath and try to relax. Your 401(k) is a retirement plan specifically designed for, well, your retirement. It is a long term investment so there is no reason to put yourself through the gut-wrenching process of following the day-to-day struggles of the stock market. It is very easy to get wrapped up in today’s media as they constantly fill our minds with Armageddon-like thoughts. Remember, it’s their job to create hype and turn nothing into something.
Keep contributing to your 401(k). The annual contribution limit for 2009 is $16,500 and an additional $5,500 for employees over 50 years old. Take advantage of it. 401(k) plans still offer a valuable means to save on a tax-deferred basis, meaning you are not taxed when you put the money into the account, but you pay taxes when you withdraw the funds. As we all know, it takes money to make money. So the larger your untaxed balance, the more it can grow. Also, because you don’t pay taxes on your 401(k) contributions, it lowers your taxable income when you file your taxes, thus saving you money.
Start contributing to a traditional Individual Retirement Account (IRA). Without the company match, there is really no great benefit to a 401(k) when compared to an IRA. Practically anyone can open and contribute to a traditional IRA. The only requirements are that you must have taxable compensation and be under age 70½. It is important to realize that an IRA is not an investment itself, but rather a tax-advantaged vehicle where you can hold some of your investments. You need to decide how to invest your IRA dollars based on your own risk tolerance and investment philosophy. How fast your IRA dollars grow is largely a function of the investments that you choose.
A traditional IRA basically functions the same as a 401(k), but there are several key differences. Your employer offers 401(k) plans and, they may be limited to very few investment choices. In an IRA, you can invest in various investments – mutual funds, individual stocks, bonds, CD’s, annuities, etc. – depending on the financial institution where you open the account. The only downside is the contribution levels are much lower – you can only contribute up to the lesser of $5,000 ($6,000 if age 50 or older) or 100 percent of your taxable compensation.
If you’re strapped for cash, borrow against your 401(k). While it may be tempting, avoid withdrawing from your retirement accounts before you are 59½ years old. They are not bank accounts. You will get hit with a 10% early withdrawal penalty plus your current income tax rate. So if you need some cash, borrowing money from your 401(k) may be the cheapest source of funds you can find. Typically, the interest charged on such a loan will be less than an unsecured bank loan. When you pay the money back, you’re really paying the money to yourself. Also, loans from your 401(k) are not reported to the credit-reporting agencies. However, lenders will count the loan as debt if you are applying for a mortgage. Not all retirement plans allow participants to take loans so check with your plan administrator to see if you qualify.
Stay Positive. Once the economy turns around, companies will start to have confidence in their bottom line and may begin matching your 401(k) contributions again. Until that happens, use these tips to shed light in today’s dark investment world.
John D. Coury is a financial advisor with Waddell & Reed Inc. in Hartford, CT. Send additional comments or questions for John D. Coury to editor@thehartfordguardian.com.
