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My Employer is Eliminating 401(k) Matches

retirement Companies are responding aggressively to the bad economic news. Layoffs, hiring freezes, and salary freezes have been some of the most common actions so far.

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Now, more and more employers are looking at eliminating the matching of 401(k) contributions. According to a survey by Watson Wyatt, the global human resources and financial services firm, things are changing quickly. In October, 2% of firms said they had already cut back on these matches and 4% said they planned to. Two months later, in December, 3% had already made the cut and 7% said they intended to.

And these are large companies. Established brands that we all know. Motorola, FedEx, Kodak, and Starbucks just to name a few.

They’re usually using the word “suspend” rather than “eliminate” when they announce these cuts. But it raises a question:

If my employer stops matching my contribution to my
401(k), should I still keep making contributions myself?

It forces us to save

This is perhaps the biggest reason to keep making contributions. Financial planners have said for years that we should pay ourselves first. Investing it before we get it, as we do with our 401(k), is the best way to make sure that happens.

Most people report that they don’t really miss the money. It’s like the taxes that are deducted from our paychecks – the government knows most of us won’t miss the money if we don’t see it.

Of course, there are ways to set up an automatic deduction from our checking or savings account for investments outside of a 401(k). That’s really close to having it deducted from our paycheck, but it’s not quite the same. That little variation can make a bigg difference for some people. You have to judge that for yourself.

Higher limits

The next best option to a 401(k) for most people would be an IRA because contributions may also be deductible. You should check with your financial advisor about the specifics of your situation.

Because you invest before paying taxes, it’s as if the government is making part of the contribution for you. For example, if you made a $1,000 contribution to one of these retirement plans and you’re in the 25% tax bracket, you would pay $250 less in taxes. So, in essence, you’re only out of pocket $750.

With either plan, you don’t pay taxes on the money you earn on your investments until you pull it out. Deductible and deferred – that’s a pretty powerful combination.

Where the 401(k) gains favor is that it has higher maximum limits – your contributions to your 401(k) can total up to $16,500 in 2009 ($22,000 if you’re over 50). You can’t contribute more than $5,000 to an IRA in most cases.

If my employer cuts or eliminates my 401(k) match, are there
reasons to fund my retirement through another vehicle?

A lot of 401(k) plans offer fairly limited investment options and you may pay lower fees in a plan that’s not a 401(k). 

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The bigger issue

It’s not like we don’t already have a sense of it. But recent months have reinforced this paradigm. We can’t count on anyone or anything for any part of our financial future. We must take full control of our own finances. We have to build our own safety nets to make sure we are financially secure.

How much will you have at retirement?

It really boils down to three factors:

  • how much we invest
  • how much we earn on our investment (after all fees and taxes)
  • how long it is invested

From these three factors, we see that we have three options if we don’t want to retire on less money:

1st – We can try to earn more on the money we invest.
That involves taking more risk and we don’t have much appetite for that right now. So this probably isn’t going to fly with most of us.

2nd – We can postpone our retirement.
This buys us more time. People who are really close to retirement right now may not have much of a choice. They may have to do this. But if you still have some time on your side, there may be a better way.

3rd – We can increase our contributions.
Look at your budget and see if there is any way you can make up for the investment your company was making.

If your employer reinstates matching contributions, you can stop contributing at the increased rate and enjoy the extra money in your budget … or …

… you can keep making your higher contributions to give your retirement a kick!

To all our readers in Australia, happy Australia Day! And we hope our friends in India enjoy Republic Day!

And thank you so much for spending time with us today. Join us next time when we discuss extreme multi-tasking. Until then, here’s to your bigg success!

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(Image in today's post by woodsy)

I Need Money! Should I Borrow from my Retirement Plan?

balancingWe’ve been talking about money decisions in tough times and how it may affect your 401(k). We started by looking at cashing out a 401(k), which is the absolute last resort.

Next, we looked at cutting back on 401(k) contributions. This is a much better option than cashing out, but you should try to contribute up to the limit of your employer’s matching contribution. That’s found money so you’ll be thankful you did.

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Now, we want to look at borrowing from your 401(k). The best advice we can give you on this is … don’t listen to us! Seriously, we can only talk about this in a general sense. So before you make a decision, talk with your professional financial advisor about the specifics of your situation. Then you can do what’s best for you with confidence.

There may be a better solution

Before you borrow from your 401(k), consider whether a home equity line-of-credit might be a better solution. You may already have one you can tap into. If not, consider applying for this type of loan instead of borrowing from your 401(k).

These loans are not as easy to get as they were a couple of years ago. You also won’t get as much of a line as you might have then because house values in many areas.

How much can you borrow?

If you decide a home equity line-of-credit isn’t your best bet, you can tap your 401(k) up to two times each year for money. It’s your money, so there’s you don’t need to be approved for the loan. You can borrow up to half of the vested portion of your portfolio, with a $50,000 limit.

Pay back is purgatory!

A loan from your 401(k) is a relatively inexpensive source of money. However, you’ll be paying the loan back with after-tax dollars (i.e the interest isn’t deductible). Compare that to a home equity line-of-credit, which is deductible in most cases.

In the eyes of the government, you and your 401(k) are two separate “entities”. So even though you think you’re borrowing from yourself, you’re not – you’re borrowing from your 401(k) so you have to pay it back within five years with an exception for first time homeowners who may have a longer payback term.

You can do that with each paycheck or you can do it in installments. You have to make a payment at least once every quarter. For example, if you borrowed $10,000, you would have 20 quarters to pay back the loan so you would have to pay $500 every quarter plus interest.

Of course, while you’re paying back the loan, you’ll have less money to spend every paycheck or every quarter, depending on which way you choose to pay back the loan. If things are tight now, what will they be like with even less free cash flow?

The other thing to consider about paying back your loan is that the dollars that were taken out of your portfolio are only earning whatever interest rate you’re paying. If that rate is less than what you could have earned if you kept it invested in your portfolio, you’re losing money you would have had at retirement.

No pay back is hell!

So it may be tempting to “borrow” the money and then not pay it back. In the government’s eyes, that’s the same as cashing out. So you’ll have to pay income taxes and, if you’re under 59½, you’ll also pay a 10 percent penalty. 

Analyzing the scenarios

The Center for American Progress Action Fund recently analyzed a number of scenarios [pdf]. Let’s look at the two extremes:

IF you take out a loan, pay it back with interest, and continue making your regular contributions, THEN there is almost no effect on your expected portfolio at retirement. In fact, in all the scenarios they considered under these conditions, there is less than a one percent difference in the end portfolio. Not so bad, huh?

But that ignores the fact that we’re borrowing money because we need it now. So we’re likely to cut back on our 401(k), if not stop making contributions altogether. That’s the double whammy.

IF you do that (i.e. the double whammy), THEN you can expect your savings at retirement to be as much as 22 percent less. 

What if …

Before you borrow, ask yourself some questions. For example, what if your company cuts back and you lose your job? Let’s spin it in a positive direction, what if you get a great job offer? You want to consider these scenarios as well before deciding if you want to borrow now.

Bottom line

Look for other ways to cut back on your spending. Even a little bit here and there can make a bigg difference. Consider temporarily cutting back on your contributions, but don’t dip below your employer’s match if you can possibly avoid it. Borrow if you must, but don’t cash out unless there is just no other alternative.

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