Hewitt Associates, the global management consulting and outsourcing firm specializing in human resources solutions, offers ten tips to help employees make intelligent decisions about how to get the most from their company-sponsored 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 at Hewitt.
For those people who will rely exclusively on their 401(k) to supply retirement income, as well as for anyone else who wants to be a savvy investor, these tips will help employees better understand their plans and the options available to them.
- Participate in the plan. This may seem like a no-brainer, but about one-quarter of eligible employees don't participate in their company 401(k) plans. Remember that contributions lower your taxes and the earnings are withdrawn tax-free at retirement.
- Take advantage of matching funds. According to a Hewitt study, 97 percent of employers provide some sort of match or other contribution to employee 401(k) plans. The study also found that 59 percent of employees do not contribute enough to take advantage of such matching programs.
- Understand the power of compounding earnings. Employers need to take the time to explain to employees how compounding works. Young workers are most likely to not take advantage of 401(k) plans, but it is these same workers who will benefit the most from compounded earnings.
- Set goals and don't be arbitrary when choosing a contribution rate. Plan participants need to plan their retirement needs and develop a formula by which they can contribute an appropriate amount to meet those needs.
- Don't cash out plan when changing jobs. Survey results found that 68 percent of 401(k) plan participants take the money and run when changing jobs, cashing out their retirement plans and not reinvesting the money in a similar plan. Only 26 percent roll their balances into an IRA, and only six percent move money into a plan with their new employer.
- Lifestyle funds are not always an appropriate choice. Fund groups designed to provide different amounts of risk for people at different points in their lives can be worthwhile, but the plans should be considered in conjunction with retirement funds from all sources.
- Don't let inertia stand in the way of investment choices.Employees should understand that default investment selections need to be monitored and adjusted as the economy changes. Retirement goals may change also. Employees should examine their investments regularly and determine the right combination for their goals.
- Participants need to understand the 401(k) loan process. Nearly a third of a group of 400,000 surveyed 401(k) plan participants have outstanding loans, with an average principal of $6,900. Although it's easy and relatively inexpensive to borrow against a 401(k), employees need to know that their loan will become due in full should they leave their job. Also, they need to understand the impact of the loss of compounded earnings on the loaned money and weigh that against the cost of borrowing the money from a variety of sources.
- Diversify. Although the average 401(k) plan offers 11 investment options, 36 percent of participants allocate all money to one fund, 19 percent allocate all money to only two funds. Participants need to understand the variety of investment options available to them. They need to monitor the performance of those investments and assess the risk involved, keeping in mind that the risk can change as investments mature.
- Rebalance invested funds. Older plan participants are more likely to make trades and change the investment mix than younger participants. Asset allocations can get out of balance as funds grow at different rates. Participants need to appreciate the importance of rebalancing investment choices from time to time.
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