By David Pitt
The stock market seems to have turned a corner and mutual funds are growing again. For 401(k) investors there’s an opportunity to regain some lost ground, but they’ll need to make some decisions. How do you make the right choices without taking on too much risk again?
The economic downturn also has hit some workers particularly hard. A layoff forces a decision about what to do with a 401(k) that still resides at a former company. When does it make sense to roll it over into an IRA or some other retirement account?
Then, there’s the issue of whether it’s a good idea to plow all your money into one place or diversify among more than one account. Here are few questions and answers to ponder as you create a strategy for your retirement funds.
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Q: I no longer work for the company that holds my 401(k) account. What factors should I consider as I think about whether to just leave it there or roll it over into an IRA or some other account?
A: An Individual Retirement Account typically offers many more investment options. Your 401(k) probably has a very limited number of mutual funds to chose from. The more numerous choices available in an IRA can provide access to higher quality funds, and more opportunity to diversify your money. Drawbacks, however, are that you won’t be able to borrow the money in an IRA, while many 401(k) plans allow loans. Also, fees you’ll pay in an IRA quite often are higher. In many 401(k) such fees are waived or significantly lower.
Q: Should I put more money into my 401(k) or open a Roth IRA, which taxes the money when it’s deposited but would allow me to withdraw the money at retirement tax-free.
A: Many advisers would say you should contribute enough to your 401(k) to take advantage of any employer match. Let’s say your employer matches 50 percent of what you contribute up to 6 percent — a common deal offered these days. It would be wise to set aside at least 6 percent of your pay to take advantage of that free money from your employer.
If you want to set aside additional money for retirement once you have taken advantage of the company match, open a Roth IRA. You can put in up to $5,000 for 2009, or $6,000 if you are 50 or older. Keep in mind the Roth IRA does have an income ceiling. If you file a single tax return you can’t contribute if you make more than $116,000. For those married filing jointly it’s $169,000 and for married filing singly it’s $10,000.
One advantage of having both a Roth and your 401(k) is that you’ve diversified your retirement income. The 401(k) money you withdraw in retirement will be taxed but the Roth IRA money can be withdrawn tax-free.
Q: Is there any way to estimate how long it might take to regain the money I’ve lost in my 401(k) so I can think about when I might be able to retire?
A: There are three key factors that have significant impact on the time it may take to recover from the 30 percent to 40 percent losses most 401(k) investors experienced. They are: account balance at the end of 2008; the amount of contributions made by you and your employer; and your anticipated rate of return based on which funds you chose in your account.
The Employee Benefit Research Institute has studied 21 million 401(k) accounts to come up with some answers about how stock market losses affected retirement accounts and how workers can get some of the losses back.
Principal Financial Group Inc., a Des Moines, Iowa-based 401(k) provider, has taken the EBRI research and put together an online calculator that will help you analyze your situation.
Find it at www.principal.com/retirement/ind/recovery/index.htm.
In a research paper on the topic, Principal analysts offer the following example that gives you some idea of recovery time.
The average annual 401(k) worker and employer contribution is just under $5,000. Assuming that amount and an investment return of 4 percent a year, an account valued between $100,000 and $150,000 as of Dec. 31, 2008, could be rebuilt in just under 7 years.
Investing more aggressively, taking on more risk, and getting a return of 8 percent a year could rebuild that account in 4.6 years. Although no one will guarantee a 4 percent or 8 percent annual return for several years, this illustration gives you some idea about how you can — through the choices of stock and bond funds in your 401(k) — regain some of the lost money. But, to get closer to an 8 percent return, you’d have to invest in a rapid growth stock fund that could present higher risk if the markets were to tumble again. Only you can decide how the level of risk you’re willing to take. — AP