More and more employers are offering defined contribution 401(k) retirement plans to their employees. This popularity may be attributed to the fact that 401(k) plans are generally less costly for employers to maintain than traditional defined benefit pension plans.
A 401(k) allows participating employees to elect to defer a percentage-typically between 1% and 15% ¾of their pay each month into the plan, up to a 2002 maximum of $11,000 on a pre-tax basis. This percentage amount may be adjusted within these limits each year and many employers match employee salary deferrals in some way. In addition, employer contributions, along with those of the employee, are placed in a special retirement account for the employee where they have the potential to grow on a tax-deferred basis until retirement. Plan participants choose how they want to allocate their assets among the investment choices offered by their plans. Employees´ contributions are always their own, and employer matching funds become vested (owned by the employee) after remaining in the plan for a specific number of years.
Some of the advantages of contributing to your company´s 401(k) plan include:
- Easy and convenient payroll deductions.Contributing to any savings plan before you actually receive the money is one of the most painless ways to invest. When you join a 401(k), you decide (up to a specified maximum) how much will be withheld from your paycheck and contributed to your plan account each pay period.
- Pre-tax savings. Your 401(k) contributions are made on a before-tax basis. By contributing to the plan, you are reducing your federal taxable income.
- Tax-deferred savings. Your pre-tax contributions, any employer contributions and any earnings on these contributions can grow on a tax-deferred basis. This means you don´t pay taxes on the money in your account until it is withdrawn, usually beginning at retirement, and then at ordinary income tax rates. The compounding effect of tax-deferred growth can be a powerful way to build a retirement fund for your future. Note, however, that withdrawals before age 59 1/2 may incur a 10% penalty.
- A choice of investment strategies. Most 401(k) plans offer at least three types of investment choices-conservative, moderate and aggressive. Many professional financial advisors believe that a conservative approach to retirement planning may not provide sufficient funds over the long term. That´s why many financial advisors recommend a moderate or more aggressive investment strategy when you are young, with a gradual shift to a more conservative strategy as you move closer to retirement. Of course, any investment strategy depends not only on the number of years to retirement, but also on your individual goals and risk tolerance. One solution may be to diversify among a number of investments in a variety of risk categories in order to create a portfolio that best suits your individual circumstances.
If you would like to learn more, please contact Jason Wyatt, Associate Vice President, Retirement Planning Specialist, Morgan Stanley at
jason.wyatt[at]morganstanley.com.
This article does not constitute tax or legal advice. Consult your tax or legal advisors before making any tax- or legally-related investment decisions. This article is published for general informational purposes and is not an offer or solicitation to sell or buy any securities or commodities. Any particular investment should be analyzed based on its terms and risks as they relate to your circumstances and objectives.
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