Max Out On Your 401 - k - retirement savings plans

Kiplinger's Personal Finance Magazine, May, 1999 by Mary Beth Franklin

Despite the setback, Lee made one important move that many workers fail to make. When he left his previous job, he took the $6,000 in his 401(k) plan and added it to the rest of his retirement savings in an IRA. Had Lee cashed out his 401(k) when he left--as more than half of all job switchers do--he would have lost almost half of it to federal and state income taxes and a 10% penalty for early withdrawal. Even worse, he would have sacrificed all the future earning power of that money, which is now working hard for him in his IRA.

When you change jobs, have your 401(k) balance transferred directly into a rollover IRA. That dodges the 20% tax withholding required if you take the money yourself, even if you plan to make a tax-free rollover into an IRA.

SORT OUT YOUR GOALS

After seven years of pushing their separate 401(k)s to the max, Martin and Patricia Aguirre of Chandler, Ariz., have accumulated more than $200,000. Now the thirty-something couple wonders if there is such a thing as going overboard with a retirement plan, particularly with three young children and college expenses in their future. After all, in 30 years their retirement savings would be worth about $4.5 million--assuming no further additions and annual earnings of 11%.

Unfortunately, the answer to the "can we stop saving?" question is no. Time is your best ally. It is better to contribute as much as you can as early as you can because you don't know what the future may hold: unemployment, disability or even the decision by one parent to stay home with the kids--which the Aguirres are considering. And, of course, inflation will dilute the purchasing power of their savings. Thirty years of 3% inflation would make that $4.5 million worth about $1.9 million today. A pile of dough, yes, but not enough to finance a comfortable 30-to 40-year retirement in the 21st century. Remember, every dime coming out of the 401(k) will be taxable in the Aguirres' top tax bracket. (And who knows what that will be in 2029?)

For now, Martin, a business-services manager with Motorola, plans to continue adding about $10,000 a year to his 401(k) plan, taking full advantage of his employer's match on up to 3% of his salary. He divides the assets in his 401(k) account (now worth about $160,000) among three of his plan's four options: 60% in a stock index fund, 30% in a balanced fund and 10% in company stock. Patricia, an underwriter for State Farm Insurance, contributes about 10% of her salary to her 401(k), which now totals about $45,000, divided between a stock fund and a balanced fund. Outside their 401(k)s, the Aguirres also contribute to two mutual fired accounts earmarked for their children's education.

Saving for college and retirement at the same time is a challenge many people face. For them, college tuition and retirement planning are on a collision course.

Consequently, you may find yourself unable to sock away the maximum amount in your 401(k) plan. Try at least to deter enough to claim the full employer match if your plan offers one. You don't want to pass up free money, even if it means you'll ultimately have to tap your 401(k) to pay for college. (For the scoop on 401(k) loans, see the box on page 70.)