Five ways to avoid sabotaging your 401(k) plan

If you're like most workers, you're in the same position with respect to your retirement savings plan. Sure, it would be nice to have a traditional pension that delivers a monthly check until the day you die, but hardly anyone has one of those anymore. Instead, most of us have a 401(k) plan, which requires more maintenance than a traditional pension.

Unfortunately, a lot of us neglect our 401(k)s, or make decisions that could erode the value of our plans. How to preserve your savings:

1. Don't treat your 401(k) like a benevolent banker.

In 2010, nearly 28% of plan participants had an outstanding 401(k) loan, a record high, according to Aon Hewitt, a consulting firm. That's not surprising: Current interest rates on 401(k) loans are typically below 5%, you can get one without a credit check, and when you repay the loan, you pay interest to yourself.

But there are drawbacks to these loans, too. If you leave your job, you'll have to repay the entire balance, usually within 60 days, says Pamela Hess, director of retirement research for Aon Hewitt. Otherwise, the IRS will treat the loan as a distribution, which means you'll owe income taxes on the entire amount, plus an early withdrawal penalty if you're under 59½. This happens quite frequently: Aon Hewitt estimates that nearly 70% of plan participants who leave their jobs with outstanding 401(k) loans end up defaulting.

Convinced you won't lose your job any time soon? Borrowing from your 401(k) could still jeopardize your retirement if you stop contributing to your plan while you're repaying the loan. Workers who stop contributing for five years — the typical maximum term for a 401(k) loan — could reduce their retirement income by 10% to 13%, according to an analysis by the Employee Benefit Research Institute. The reduction nearly doubles for workers who take out two loans, EBRI says.

2. Carefully consider the pros and cons of rolling over a former employer's 401(k) plan to an individual retirement account.

A survey by Fidelity Investments found that only 30% of participants in Fidelity 401(k) plans moved their money out of their plans within four months when they changed jobs.

The Basic Roth 401K Rules | 401k Contribution Limit

Roth 401K is one of the attractive benefits that a company can offer to their employees. If you have this opportunity, it is a good way of saving for your retirement with the assistance of your employer’s matching/profit sharing contribution.

The main difference between the traditional 401K and Roth 401K is the way they are taxed. The traditional type is pre-taxed, while Roth 401K is deducted after tax. The after-effects of the taxation for Roth 401K is much better since the funds you’ll withdraw are tax-free.

The very basic, and often self-explanatory, Roth 401K rules can be divided into 4 main categories:

Contribution limits

The IRS have already announced that the current year’s contribution limits remain the same. Although a yearly increase in the contribution limits is usually anticipated, this year’s decision is based on the low inflation rate and low cost of living allowance. So as part of the Roth 401K rules, for this year the contribution limits are as follows:

- $16,500 for employees 49 years old and below

- $16,500 plus $5,500 catch-up contribution for employees who are 50 years old and above

Distributions

The contributions for Roth 401K are deducted after taxation and the distributions are basically tax-free. However, the IRS only allows minimum yearly withdrawals when you reach 70.5 years old. The amount is calculated by dividing the year-end account value by life expectancy as per IRS publication 590, appendix C. You can avoid this mandatory distribution by rolling over your Roth 401K balance into Roth IRA that has no minimum distribution requirement.

Employer contributions

Employers’ contributions to their employees’ Roth 401K plans are just voluntary options since they are not required by the IRS to do so. If an employer chooses to contribute, it should be paid into the pre-taxed portion of the traditional 401K plan instead of the Roth 401K.

Withdrawal penalties

There is a 10% withdrawal penalty if the funds are withdrawn before the age of 59.5 years old. Roth accounts also apply the same penalty for those who will take distributions within the 5-year establishment of the account. The earnings from that distribution will also be subject to an income tax.

You may learn more about the Roth 401K rules by checking the IRS website and by reading online/offline finance-based publications.

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