Most people have questions about their 401k retirement plan. They often wonder exactly what a 401k is, how a 401k works, or how to revive the dwindling balance. A 401k plan is complex but relatively easy to understand so don't panic.
What is a 401k?
A 401k is an employer sponsored retirement plan. Employees can contribute a portion of their income into the plan on a pre-tax basis. The maximum amount of the contribution is limited by the federal government and the plan itself. An employer can elect to contribute tax-deferred matching funds into the employee's account. This type of plan is called a defined contribution plan since the employee decides the percentage of their income to contribute. Once the employee retires, their distribution will depend on the amount the plan has grown. Because of this, the employee should choose the investments carefully. Once the employee starts taking distributions, the withdrawals are taxed. If money is withdrawn before reaching age 59 1/2, there is also an early withdrawal penalty.
How does a 401k work?
If a company offers a 401k retirement plan, the employee usually has the option to select the investment funds from a list of funds provided in the 401k plan. The employee contribution will automatically be deducted from the employee's pay check before taxes. Each employee can contribute up to a certain percentage of their pay into a 401k and some employers will match a percentage of the contributions. The contributions along with any matching funds are then invested into the employee's selected funds. Some employers permit employees to take loans from their 401k plan and there are certain hardship withdrawals that are permitted. 401k plans also can have a vesting period where an employee must be employed for a defined number of years before they own all of the money in their account. The employee contributions are vested immediately but the company matching funds don't belong to the employee until they meet the vesting requirements.
What can be done to repair a declining balance?
The first thing to do for a declining balance in a 401k is to look closely at the investment mix. Investing too heavily in company stock can cause problems if the company should run into financial trouble. Contributions should be adjusted to make the most of the contribution limits and, if at all possible, the maximum tax-deferred contribution should be made. If this isn't possible, at the very least, an employee should contribute enough to get the company's matching funds.
What are some recommendations for balancing a 401k portfolio?
Balancing a portfolio is important to be sure investments are on track with the retirement game plan. If a person wonders whether or not to rebalance, they should discuss their goals, risk tolerance, and other concerns with a financial advisor to be sure rebalancing is necessary. Age and how close a person is to retirement will dictate whether a portfolio will consist of investments for growth, income, or a combination of both. In addition to age, the risk tolerance and the overall retirement goals should be considered. If the decision to rebalance a portfolio is made, an employee should be sure to question whether or not there could be a redemption charge and if there is, how much this redemption charge will be.