Four Things Every Retirement Investor Should Know replacing How a 401k plan works

Charles Schwab & Company recently suggested the following four things every retirement investor should know.

1. Contribute the maximum you can

Make the most of a company retirement plan: Investing in a company 401(k) or other retirement program is a powerful savings tools. 401(k) deductions are pre-tax and, money can grow tax-deferred. Investors should contribute the maximum amount for the greatest benefit, or at the very least, set aside the percentage the employer matches. Matching dollars are also pre-tax, which can greatly increase growth potential over time.

Maximize opportunities with previous employers' plans: If a 401(k) is still with a former employer, investors may want to consider rolling over a 401(k) into an IRA for greater investment choice and control, and to help protect the retirement assets that have accumulated.

2. Be aware of risk

All investments contain some degree of risk, but there are ways to minimize it. The main types of risk that can affect a portfolio are:

When choosing investments, investors should structure portfolios to minimize risk. The following may lead to increased portfolio risk:

Two investment strategies that may help minimize your risk are diversification and dollar cost averaging.

3. Save beyond company retirement plans

Generally, most Americans will need 70 to 80 percent of their current income in order to sustain a comfortable lifestyle during their retirement years. Unfortunately, Social Security will not be enough for most. In addition to company retirement plans, the following retirement savings vehicles may help investors achieve financial independence in retirement:

4. Plan and re-evaluate a retirement investment strategy

Whether retirement is in five years or 20 years, investors should periodically re-evaluate retirement portfolio and assess progress toward retirement goals.

(1) Consult your tax advisor to determine if your situation allows higher contributions.
(2) Distributions made before age 59 1/2 may be subject to early withdrawal penalties.
(3) Withdrawals of earnings are subject to ordinary income tax.

Information provided in partnership with, LLC., LLC is not the author of the material unless specifically noted. We do not endorse and disclaims any and all responsibility or liability for the accuracy, content, completeness, legality, or reliability of the material. 
Copyright (c) 2005 by, LLC. All rights reserved. 

Don't Make A 401(k) Mistake - 10 Tips replacing Tax Savings Tips

Hewitt Associates has outlined their top 10 tips for employees to make the most of their 401(k) plans.

"For many employees, a 401(k) plan is their only source of retirement income so it's critical that this benefit is used to its full potential," says Lori Lucas, defined contribution consultant, Hewitt Associates. "It's disheartening to see employees make mistakes that could cost a lot in the long run, especially when it's time to retire."

Hewitt offers the following tips:

  1. Join the club. Participate in the plan.

    According to Hewitt's research, the majority of companies offer a 401(k) plan . Yet, participation rates average at about 77 percent . Hewitt's research shows that employees nearing retirement (age 50 - 59) had the highest participation (86 percent), while those furthest from retirement (age 20 - 29) had the lowest participation (59 percent). Join the plan and enjoy the tax benefits. Not only can contributions lower your tax income, but the money grows tax-free until you withdraw it at retirement.

  2. Don't leave money on the table. Take advantage of your company's match.

    Ninety-seven percent of employers provide some form of match or contribution to employees' 401(k) plans . In a Hewitt study of nearly 150,000 employees, more than half (59 percent) of employees eligible to receive an employer match did not contribute up to the maximum match threshold. Of those 401(k) participants failing to take advantage of the company match in the first year, 81 percent failed to take advantage of the match in the second year as well.

    "When employees do not take advantage of the company match -- especially when it is immediately vested -- participants are leaving free money on the table," said Lucas.

  3. Compounding is a good thing. Understand and appreciate its power.

    Examining nearly 500,000 eligible employees with salaries under $80,000, Hewitt found that nearly half (46 percent) of employees age 20 - 29 contributed zero. With a median account balance of $3,600, these participants could fall far short of their retirement goals if they failed to contribute additional money during their 20's.

    Take for example, an employee with a 401(k) balance of $3,600 at age 25 who fails to contribute until age 30 and after that contributes $5,000 per year. Assuming a 10 percent annual rate of return, that employee would be giving up $260,000 at retirement (age 60) versus if that same employee had contributed as little at $2,400 per year from age 25 to age 29 ($12,000 total).

    "While employees tend to contribute more to the plan as their salaries increase and they get closer to retirement, it's clear that young 401(k) investors especially do not realize what they are giving up when it comes to the power of compounding," said Lucas.

  4. Set your savings goal and don't be arbitrary when choosing your contribution rate.

    Hewitt's research indicates that 401(k) participants are drawn to round numbers such as 5 or 10 percent when choosing contribution rates. In the group of 500,000 eligible employees, Hewitt found that nearly one quarter (23 percent) chose these contribution levels.

    "Employees need to consider their needs and personal circumstances when choosing their contribution rate," said Lucas. "The fact that contribution levels tend to anchor at these random numbers suggests that employees are not necessarily matching their personal savings requirements with their choice of contribution level."

  5. New job? Don't cash out your 401(k).

    Hewitt's analysis of nearly 170,000 defined contribution plan distributions shows that 68 percent of 401(k) plan participants opt for lump sum cash payments when changing jobs . Less than one-third (26 percent) roll their balances into IRAs and only 6 percent move their money to their new employers' plans.

    No matter how small the balance is, it is important to keep the money tax-deferred. Not only will employees cashing out lose out due to tax implications, but they will not reap the benefits of potential savings over time.

  6. Lifestyle funds can be helpful -- if you use them appropriately.

    Although employers offering lifestyle funds intend them to serve as turnkey investment solutions, where 401(k) participants simply match up their time horizon and risk preferences with a single fund, Hewitt's research shows that few 401(k) participants use them this way. Instead, participants mix lifestyle funds with other funds, resulting in homogeneous portfolios, regardless of age and years left until retirement.

    "Participants need to realize that lifestyle funds are not 'just another fund option,' said Lucas. "If you choose to use a lifestyle fund, match the fund with your time horizon and stick to it. Otherwise, you might defeat its purpose and weaken its effectiveness."

  7. On autopilot? Don't let inertia drive your investments.

    Automatic enrollment -- the practice of automatically signing up employees to participate in a company's 401(k) plan unless they specifically choose not to -- is a successful method to increase participation rates. However, according to Hewitt's research , automatically enrolled participants tend to remain at conservative default elections, even after one year of participation in the plan.

    Employees should remember that default elections are a starting point and it's their job to adjust contribution levels and fund selections based on how much they need to save and how much risk they should assume.

  8. It's okay to take a loan. It's important to understand its impact.

    Increasingly, employers offer loan provisions in 401(k) plans. In fact, loan provisions in plans have grown from 67 percent in 1991 to 92 percent.

    Hewitt's study of nearly 400,000 plan participants shows that nearly 30 percent of participants had loans outstanding; with an average principal outstanding amount per participant of $6,900 (on average balances of $57,000). The research also shows that nearly 30 percent of 40 - 49 year-olds -- the highest percentage of all age groups -- had loans outstanding.

    "Borrowing against your 401(k) savings can be a relatively easy and inexpensive way to raise needed money," said Lucas. "However, 401(k) loans are not a no-brainer. They're typically due immediately when you leave the company, something to consider in shaky economic times."

    It's important to remember that when you borrow from your plan, your account is reduced by the amount of your loan. While the money isn't lost since you will pay it back with interest, you do lose out on whatever additional return the money might have earned had you left it in the account.

  9. Diversify. Take advantage of the funds at your disposal.

    Hewitt's research shows that that average 401(k) plan offers 11 investment options. Yet, Hewitt's study of 500,000 plan participants finds that 36 percent of participants allocate contributions to a single fund. Another 19 percent allocate contributions to only two funds.

    "By failing to take advantage of the funds available within a plan, participants may be cheating themselves out of diversification opportunities," said Lucas. "They may be assuming more risk than they need to for the level of return that they are likely to realize."

  10. Don't forget to rebalance.

    Further evidence that 401(k) plan participants tend to buy and hold is Hewitt's study of nearly 500,000 401(k) participants, which found that 28 participants made a trade. Older participants with higher salaries and longer service histories were more likely to make a trade than younger participants.

    "While it's commendable that participants are picking and sticking when it comes to their long-term retirement assets, if participants do not interact with their plan in a given year, it could be that they are allowing their asset allocation to get out of balance," said Lucas. "Over time, it's possible that because funds grow at different rates, a moderate portfolio could become more aggressive, leading to unexpected vulnerability when the market gets rough."

Information provided in partnership with, LLC., LLC is not the author of the material unless specifically noted. We do not endorse and disclaims any and all responsibility or liability for the accuracy, content, completeness, legality, or reliability of the material. 
Copyright (c) 2005 by, LLC. All rights reserved. 

FAQ's About Retirement Plan Distributions replacing leaving your assets in a company plan

Whether you are about to change careers or retire, you have made an important decision for your future-one that may be filled with exciting plans, hopes, and opportunities. As you prepare for this change, you have one more important decision to make: what you should do with the retirement investments that have been accumulating on your behalf.

You probably have many questions about your retirement plan distributions and the available alternatives. This article provides you with some answers and important information concerning taxes, retirement planning, and investments. When reviewing this information, remember that it is important to consider how new and existing tax laws may apply to your particular situation.

One law in particular may have a major impact on your decisions: the Unemployment Compensation Amendments Act of 1992. While its primary purpose is to generate revenue for unemployment benefits, this law made important changes in the way retirement plan assets are rolled over to an individual retirement account or another employer's plan. Specifically, employees have a "direct rollover" option, under which most types of plan distributions may be paid directly to the IRA or other eligible retirement plan of the employee's choice. In addition, the law discourages employees from having most types of plan distributions paid directly to them by imposing mandatory 20% withholding on these amounts.

The first part of this article examines the major issues concerning the Unemployment Compensation Amendments Act-and, more specifically, how this law and its 20% withholding requirement affect your plan distributions.


What are the main provisions of the Unemployment Compensation Amendments Act of 1992?

The law:

What distributions are affected?

The direct rollover and 20% withholding requirements generally apply to all eligible rollover distributions made after December 31, 1992. This includes any distribution made after 1992 as the result of an event that occurred prior to January 1, 1993 (such as an employee's separation from service before 1993) and any distributions made after 1992 that are a part of a series of payments begun before January 1, 1993.

What is meant by the "20% withholding requirement"?

When an eligible rollover distribution from your employer's plan is paid to you-rather than to the trustee of a traditional IRA or other eligible retirement plan as a direct rollover-the plan is required by law to withhold 20% of that amount. This amount is sent to the Internal Revenue Service as federal income tax withholding.

For instance, assume that your eligible rollover distribution is $10,000. Only $8,000 will be paid to you, because the plan must withhold $2,000 as income tax. However, when you prepare your federal income tax return for the year, you will report the full $10,000 as a payment from the plan. You will report the $2,000 as tax withheld, and it will be credited against any income tax you owe for the year. Note that you will owe ordinary income taxes on $10,000, less any amount you roll over within 60 days. A 10% federal excise tax may also apply.

What types of distributions are subject to the 20% withholding requirement?

Any distribution from a qualified retirement plan or a 403(b) arrangement that is eligible to be rolled over but is not paid directly to a traditional IRA or other eligible retirement plan is subject to 20% federal income tax withholding.

Are there any exceptions to the 20% withholding requirement?

Yes. The following types of distributions are not eligible for a tax-free rollover and therefore are exempt from the withholding requirement:

In addition, the IRS has ruled that eligible rollover distributions of less than $200 may be excluded at the payor's discretion from the direct rollover and 20% withholding requirements. Note, too, that distributions due to the death of the planholder are not subject to 20% withholding.

Are distributions from an IRA subject to 20% withholding?

No. The 20% withholding requirements do not apply to distributions from IRAs. However, if you receive a distribution from an IRA before you attain age 59-1/2, you may be subject to the 10% excise tax for early withdrawals.


What is a "direct" rollover? How does it differ from a "standard" rollover and an asset transfer?

A direct rollover is the payment of your plan distribution directly to a traditional IRA or other eligible retirement plan of your choice. Your direct rollover distribution check may-at your employer's discretion-be given to you or sent directly to the trustee of your new IRA or plan. In all instances, however, the direct rollover check must be made payable to the trustee of your new IRA or plan.

In a standard rollover, your plan distribution is paid to you (i.e., the check is made payable to you) and you make your own arrangements to roll over the assets to an IRA or other plan.

An asset transfer is the movement of retirement assets between similar plans. This differs from a direct rollover, which is the movement of retirement assets from a qualified plan or 403(b) arrangement to a traditional IRA or other eligible plan. With an asset transfer, no tax forms are generated by either the paying or the receiving custodian. Just as with a standard rollover, a direct rollover will be treated as a distribution and a subsequent rollover contribution. As a result, the paying custodian will report the distribution on IRS Form 1099-R. In the case of a rollover to an IRA, IRS Form 5498 is issued by the receiving institution; there is no corresponding tax form issued in the case of a rollover into a new qualified plan or 403(b)(7) plan.

What are the advantages of a direct rollover to a traditional IRA or other eligible plan?

First, you avoid the 20% federal income tax withholding requirement. Second, with a direct rollover of your distribution to a traditional IRA, you defer paying any current-year taxes on your plan distribution. What's more, when you make an IRA rollover, any earnings on your retirement assets will continue to grow on a tax-deferred basis, just as they did in your employer's plan. Thus, by making a direct rollover to a traditional IRA, you are provided a double tax benefit:


How can I initiate a direct rollover from my current retirement plan to a traditional IRA or another eligible retirement plan?

As a first step, it is up to you to select the traditional IRA or other eligible retirement plan to which your direct rollover will be paid. You should then check with the sponsor of your chosen traditional IRA or plan to find out how the direct rollover payment should be made, and what special forms must be completed. Also, if you intend to have your direct rollover paid to another eligible retirement plan, you should confirm that the plan does, in fact, accept direct rollovers. It is important, too, that you ask your benefits office for copies of its direct rollover procedures and forms.

Can I delay my decision?

If you are not yet ready to choose a recipient financial institution for your direct rollover, you may elect to have your plan distribution (less the 20% withholding requirement) paid to you. Any portion of the distribution that you do not roll over to a traditional IRA or an eligible retirement plan within 60 days will be taxable to you as ordinary income in the year of receipt. And, in general, if you are under age 59-1/2, you may also be subject to a 10% federal excise tax. Therefore, if you are not ready to make a decision, you should check to see whether you are permitted to keep your assets in your employer's plan for the time being.

What happens if I roll over my distribution within the 60-day rollover period?

To roll over the entire amount of the distribution, you can make up the 20% that was withheld with other money. The amount withheld will then be credited against any income tax owed.

If you elect not to make up the 20% that was withheld and roll over only the amount you actually received (the total distribution less the 20% withheld), the portion withheld will be treated as a taxable distribution to you. In general, if you are under age 59-1/2, you may also be subject to a 10% additional federal excise tax on this amount, in addition to ordinary income taxes.

Can I split my distribution (i.e., roll over a portion to a traditional IRA or an eligible retirement plan and keep the remainder as a taxable distribution)?

Yes. According to the rules, you may split an eligible rollover distribution by having a portion paid as a direct rollover to a traditional IRA or eligible retirement plan and receiving the remaining portion as a taxable distribution (which is then subject to 20% withholding). Your employer, however, is not required to permit a split if the amount that is paid as a direct rollover is $500 or less.

Can I roll over my distribution to more than one traditional IRA or eligible retirement plan?

While you have the option of selecting any traditional IRA or eligible retirement plan to receive your direct rollover, your employer is not required to allow you to split up your rollover among two or more retirement arrangements.

Can I roll over my distribution to an existing traditional IRA?

Yes. However, if you wish to preserve your right to roll over your distribution into the eligible retirement plan of a future employer, you should maintain a separate IRA (known as a "conduit" IRA) for these assets. The IRS insists that, under these circumstances, you do not mix these assets with an existing IRA or add future contributions.

If you do not intend to transfer your plan distribution to a new employer's plan, even at a later date, you may commingle these assets with any other traditional IRAs you currently have (provided that these existing IRAs have also not originated from an employer plan or that you have no intention of transferring them to a future employer's plan). The major benefit of commingling IRAs whenever possible is that you can consolidate your holdings and thereby reduce the number of IRA custodial fees you pay each year.

Can I roll over company stock certificates or property, such as real estate or limited partnerships, that I receive from an employer-sponsored plan?

Company stock and property are treated differently. First, you must determine if your company stock or property is eligible to roll over. Your plan administrator can assist you if you are unsure. The portions of the distribution that are eligible may be directly rolled over to a traditional IRA to avoid the 20% federal income tax withholding.

If you choose to take a distribution, and the distribution consists only of company stock, it will not be subject to the 20% federal income tax withholding. This applies whether or not you roll over the assets to a traditional IRA within 60 days.

Eligible distributions containing property in addition to company stock will be subject to the 20% withholding requirements. If there is not sufficient cash included in the distribution to satisfy the withholding obligation, the plan administrator must either sell the property or obtain cash from you in an amount sufficient to cover the withholding.

If you want to roll over the company stock you hold in your retirement plan, you must establish a self-directed traditional IRA. This is an IRA held in a brokerage account.


Am I subject to any other penalties?

Generally, distributions or withdrawals you receive from your employer's plan prior to age 59-1/2 for reasons other than your disability will be subject to an additional federal excise tax of 10%. This 10% excise tax is applied to the taxable amount of your distribution and is in addition to the ordinary income tax you pay on your distribution. The 10% excise tax will not apply, however, to:

For tax purposes, how do I report a direct rollover?

You simply report the IRA rollover of your distribution on your individual income tax return-Form 1040. Specifically, you report on your return the taxable amount of your plan distribution as reported to you on the Form 1099-R you received by January 31 in the year following your distribution. Then you report as ordinary income any amount of the distribution you did not roll over to the IRA. In the case of a standard rollover, if you rolled over the entire taxable amount of your distribution, you should report the 20% withheld as tax withheld and it will be credited against any income tax you owe for the year.

Where can I find more information about direct rollovers and plan distributions?

Before your plan distribution is paid, your benefits office will provide a written explanation of the special tax rules of which you should be aware.

You will also find information about the tax treatment of payments from qualified plans in IRS Publication 575, Pension and Annuity Income, and IRS Publication 590, Individual Retirement Arrangements. Both are available from your local IRS office or by calling 1-800-TAX-FORM.


If you choose a direct rollover:

If you choose to have your plan distribution paid to you:

For a more detailed explanation of the required minimum distribution rules, refer to IRS Publication 590.


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