What Is A 401K Plan?
A 401K plan is a retirement savings account with deferred income taxes on both earnings and saved money. 401k plans generally are available for employees of private-sector companies, though some self-employed individuals can start their own 401-k savings plan. While the ability to avoid taxes until withdrawal of 401k funds makes these investment plans ideal for retirement savings, the drawback is that substantial penalties are in place for those who need to withdraw funds before they are 59.5 years old or during the time the person remains employed by the company holding the 401k plan.
Typically, 401k savings are invested in “mutual funds”, which include some combination of stocks, bonds and money market investments. The employee stipulates a certain amount of each paycheck that will go to the 401k fund. Often, one of the employer benefits of a 401(k) plan stipulates the employer will match the money the employee places in the 401k fund. This allows employees to get double-pay for the money they place into their retirement savings account, and it is recommended that people in such a plan maximize this benefit by maxing out their 401k allocated. “Maxing out” suggests that an employer has a maximum limit an employee can place in their 401k funds every paycheck. If there is such a limit, a person should place the maximum limit in the 401 savings, if their home budget allows for this.
Introduction Of 401K Plans
The introduction of 401K Plans began in 1978, due to a new provision in the U.S. tax code. The term “401k” refers to that section of the tax code, in fact, and had no meaning prior to the changes of 1978. There were further changes in 1986, which meant that government jobs generally didn’t allow 401k plans. Other countries have 401k plans, though they might or might not call them by another name.
Why Are 401Ks Loosing Money?
If you’re wondering “Why are 401Ks loosing money?” its because 401k plans are heavily invested in the stock market, so when the New York Stock Exchange hits a bad time, like right now, people’s 401k retirement funds take a big hit. Given that the stock market is hovering at just over 7,000 points right now, its lowest level since 1997, people have seen their 401k plans lose close to half their value in the plummeting stocks.
Because a 401k plan is a long-term investment plan, temporary adjustments in the stock market are less of a concern, because the historical trend of the stock market is to go up, despite periods of short-term economic downturn. This historical trend involves too many factors to include here, but involve everything from inflation of the dollar, increasing flows of foreign cash into the stock market, growth in profits from simple factors like population growth (and therefore the growth in the number of consumers) and technological innovation. Those who are decades away from retirement should not be too concerned about losses in their 401k plans, because these losses are likely to turn around if the person is patient and leaves their money in the 401k plans. If you have decades until retirement, do not even consider withdrawing your 401k investments right now, because you’ll be getting out of the market at the wrong time and facing a large money penalty for doing so.
Lost 401k investment money is a concern for investors who are nearing retirement age, because they have less time to allow the natural market process recover their lost assets. If you have 5 years or more until retirement, keep your funds in the 401k plan. The stock market should correct itself in the next five years, and much of your savings should return. All that investment money is still out there; it’s just being saved instead of invested. So when the NYSE looks like a safe investment again, people will stop making 2-3% interest on savings accounts and try to make perhaps double that interest on investments. When that happens, the stock market will start to go up again and you can ride the wave.
Those who plan on retiring in less than five years have tougher decisions. They may not see the entire value of their 401(k) plan return. Of course, getting out now means you’ll be paying big taxes on your remaining retirement funds at a time you might not be able to afford to do so. Talk to a financial advisor before taking the drastic action of gutting your 401k plan, because even though the stock market is scary right now, you don’t want to compound your losses by panicking. Make a calm, reasoned decision with the best economic advice you can get before withdrawing your 401k retirement funds.
This entry was posted on Friday, January 25th, 2013 at 5:55 am and is filed under Personal Finance. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.