How will a retirement plan help you save with a 401(k)?
You will pay less in taxes for each dollar you contribute to your plan as your money is deducted directly from your salary before taxes are taken out. Your contributions reduce your taxable income and can reduce the taxes you may owe. In addition, tax deferral accelerates your savings due to your money growing tax-free until you withdraw it. The money you do not pay in taxes can continue earning interest through the years.
What are the possibilities of the newer Roth 401(k)?
The new Roth 401(k) option, with its after-tax contributions and tax-free qualified distributions is modeled in part on the Roth IRA, which has become a popular way to save for retirement. Although individuals with higher incomes are prohibited from opening a Roth IRA. The new Roth 401(k) option allows all employees to make use of its tax-free possibilities, regardless of income. The Roth 401(k) requires no minimum distributions and ultimately be passed to heirs free from federal income taxes.
Who is most likely to prefer the rewards of the Roth 401(k) option?
Workers with high assets, who are seeking to manage their taxes in retirement can benefit from the Roth 401(k)’s tax-free qualified distributions. In addition, young workers with lower incomes today, who can expect their income levels to rise and to pay taxes at higher rates in retirement can benefit by paying taxes now and then will not pay federal taxes on qualified distributions in retirement. Employees who have already accumulated substantial retirement savings and are seeking to manage or lower their distribution levels in retirement, can opt to roll the Roth 401(k) into a Roth IRA, which has no required minimum distributions.
Asset Allocation vs. Market Timing
Asset allocation, or how you divide your money among the different types of investments, is an important factor in reaching your retirement goals. Experts have found that your asset allocation accounts for over 90% of your long-term returns. Additionally, having the proper asset allocation can help you manage market volatility, the ups and downs of the market.
Why asset allocation critical?
Asset classes are categories of investments, grouped according to their objectives and what they invest in. Many types of investments react differently to the same market conditions. For example, when stock prices are up, bond prices are often down and visa versa. By spreading your money among the various asset classes, you reduce the risk that poor performance in any one asset class will affect your entire retirement portfolio. In addition, it is also important to diversify, or divide your investments within the asset classes because it is better to spread your savings among funds that invest in different segments of the market.
What rate of return should I target?
You might think that you should just target the highest rate of return. However, the higher the target rate, the greater the chance of short-term losses and fluctuations on your investments value. That is why it is important to find the balance that is right for you.
How do I choose my asset allocation strategy?
Different types of investments have returned different percentages over time.
- Stocks are shares of ownership in a company. Over the past 25 years, stocks have returned an average annual return of about 14%.
- Bonds represent the loan money to a company or government. Bonds have returned an average annual return of about 9% over the past 25 years.
- Cash equivalents seek to maintain the value of your investments. Over the past 25 years, they have returned an average annual return of 7%.
What is your risk tolerance?
The basic rule of thumb is “the higher the rate of return you target, the more heavily you will need to invest in stocks.” Historically, stocks have delivered higher long-term returns than any other investment vehicle. However, stocks have also been the most volatile, which means that they fluctuate in value the most rapidly. Annual returns have ranged as high as 38% and as low as -22% over the past 25 years. Your risk tolerance is your ability to ride the ups and downs of the stock market and benefit from its long-term growth.
How many years should I invest?
The more years you have to invest until retirement, the higher returns you may want to target. Earning a little more each year can add up to a lot after many years.
Why should I enroll today?
For some people, retirement may seem a lifetime away, but do not be tempted to put off savings because each year it becomes more and more difficult to make up for lost time. The key is to start as early as possible.
What should I expect from Social Security when I retire?
To find out what you will receive from Social Security when you retire or call (800) 772-1213 to request an estimate.
Review Understanding 401(k) Nondiscrimination Testing (provided by Transamerica).
If you are changing jobs or retiring and need to decide what to do with your 401(k), Transamerica Testing can assist in answering the questions you may have regarding your current retirement options.
IRS 401(k) Checklist
Is your company’s 401(k) plan in compliance? To find out, please review the IRS Checklist (supporting details to each question follow the first page of the checklist).
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