Profit Sharing and
Savings Plans
• Profit Sharing Plans
• 401K Plans
• Individual Retirement Accounts
• Common Misconceptions about 401Ks
The 401K Plan
• A 401(k) plan is a qualified plan with a cash-or-deferred arrangement
(CODA)
• CODAs are permitted with profit sharing plans, including stock bonus
plans and ESOPs.
• Prior to the establishment of 401(k) plans, employees did not have
the option of deferring compensation into a retirement plan on a
pretax basis
• Retirement plans were funded almost entirely by employers
• Some companies offered “thrift” plans, which allow employee
contributions of after-tax dollars, not pretax dollars as with 401(k)
plans
• A salary reduction agreement is one type of cash or deferred
election, and allows a participating employee to contribute future
compensation into a 401(k) plan
The 401K Plan
• You often hear individuals refer to their “401(k) plan,” but in reality
401(k) provisions must be combined with either:
• A profit sharing plan (including stock bonus plans and ESOPs), or
• A “SIMPLE” plan.
• Currently, these are the only two plans that offer 401(k) provisions
• In a nutshell, a profit sharing 401(k) plan is characterized by:
• The ability of employees to make voluntary contributions of pretax
dollars up to a certain amount ($18,500 in 2018, plus $6,000 catch-up if
over age 50).
• These are, in effect, deferrals of compensation that are not taxed until
they are distributed from the plan.
The 401K Profit Sharing Plan
• Individual accounts for participants, who usually are responsible for
making investment decisions regarding the assets in those accounts
• Matching contributions from employers (called 401(m) contributions);
employers can match employee contributions in whole or in part
• These matching contributions are tax deductible for the employer to the
extent that they do not exceed certain limits (25% of participating
employees’ payroll)
• Plan loans and opportunities for hardship withdrawals
• A plan may be established as part of a profit sharing plan so that
non-401(k) profit sharing contributions may be made to participants’
accounts
The 401K Profit Sharing Plan
1. Employer discretionary contributions
• This is your “traditional” profit sharing part of the plan, and it is
entirely funded by employer contributions
• The employer is in effect “sharing profits” with its employees, and
allocating a certain amount to each employee
• There is often a vesting schedule associated with this section of the
plan
The 401K Profit Sharing Plan
2. Employee elective deferrals
• This is the 401(k) part of the plan, allowed because of the 401(k)
provisions
• It is in this part of the plan that the employee is able to defer some of
her compensation, pretax
• Employees are always 100% vested in what they have deferred, since
it is part of their compensation and they have elected to have it go
into the plan rather than currently receiving it
The 401K Profit Sharing Plan
3. Employer matching or non elective contributions
• This is also in the 401(k) part of the plan, and comes into play when
the employer decides to either match a portion of the employee’s
elective deferral or decides to make a non elective contribution on
behalf of all employees in the plan, whether they make a deferral or
not
• The vast majority of employers prefer the matching contribution
since it encourages employees to save for their retirement
• The matching or nonelective contributions may or may not have a
vesting schedule, but they often do not if the employer wants to have
a “safe harbor” plan in order to pass nondiscrimination tests.
The 401K - Eligible Employers
• All organizations, with the exception of state and local governments,
can currently establish 401(k) plans
• Those include:
• Sole proprietors. The sole proprietor, or self-employed person, is
treated as his own employee.
• Partners. If the self-employed individual is a partner, he is treated as an
employee of the partnership.
• Special rules apply to a partnership’s profit sharing plan if it includes a CODA.
• Corporations. Regular (or C), S, and limited liability corporations (LLCs)
are eligible.
• Tax-exempt organizations
• Indian tribal governments
The 401K - Eligible Employers
• State and Local Governments, as well as non-profits, may establish
403(b) plans, which are very similar to 401(k) plans
• Although state and local governments may not establish new 401(k)
plans, they may continue to administer grandfathered 401(k) plans
established under prior law
The 401K - Eligible Employees
• A 401(k) plan must allow plan participation to any employee who
• Has completed one year of service and has worked a minimum of
1,000 hours
• Is at least 21 years old.
• These are the basic ERISA eligibility requirements, referred to as “21
and 1.”
• A 401(k) plan may require employees to work for up to one year before
they can make elective contributions (usually called “deferrals”), but
many plans may allow elective deferrals upon employment or within
several months of employment.
• Even if the employer allows deferrals prior to one year of service,
oftentimes employer matches or non elective contributions will not
begin until the employee has completed at least one year of service
The 401K - Eligible Employees
The 401K - Limits on Contributions
• Section 401(k) plans are subject to the same “annual additions”
limits that apply to other defined contribution plans
• Additions to a participant’s account cannot exceed the lesser of
$55,000 or 100% of compensation (maximum for 2018).
• Additions Include all contributions, including
• Elective contributions (but not catch-up contributions);
• Matching contributions (401(m))
• Employer non elective contributions
• After-tax employee mandatory and voluntary contributions
• Employer contributions to another defined contribution plan the
employer may have, including money purchase plans, ESOPs, and
profit sharing plans
The 401K - Limits on Contributions
• Additions Include all contributions, including
• Forfeitures allocated to a participant’s account from terminated
participants
• Amounts allocated to a Section 401(h) individual medical account,
which is part of a qualified pension plan maintained by the employer
• Employer contributions for a key employee allocated to a separate
account under a welfare benefit plan for postretirement medical
benefits.
• Note that the $55,000 annual limit does not include the age
50 catch-up of $6,000
The 401K - Elective Deferrals
• Eligible employees may make an election to defer a portion of their
compensation prior to actually earning the money that is going to be
deferred.
• If the employee makes a deferred election, then elective deferrals will
come out of the employee’s pay and will be applied to her 401(k)
balance instead of being received as cash.
• The Internal Revenue Code limits the level of pretax contributions to
a maximum of $18,500 per year in 2018
• Subject to the previous limitations, elective deferrals are excluded
from the employee’s gross income for the year in which they are
made and are not subject to income taxation until distributed.
• However, deferrals still remain subject to FICA (Social Security and
Medicare) and FUTA (federal unemployment) taxes
• Note that FUTA is paid by the employer, not the employee.
The 401K - Elective Deferrals
Catch-up contributions
• Catch-up contributions are additional elective deferrals (up to $6,000
in 2018) that may be made by individuals who are at least age 50 by
the end of the plan or calendar year
• Catch-up contributions are unique because they are not subject to
certain limitations, including:
• The IRC Section 402(g) limitation on elective deferrals (see prior
discussion)
• The IRC Section 415(c) annual additions limitation of $55,000 (2018)
Maximum Elective Deferrals (2018)
Year
Elective Deferral Limit for
Individuals under Age 50
Elective Deferral Limit for Individuals
Age 50 and Older (includes catch-up
contribution)
2018
$18,500
$24,500 ($18,500 + $6,000)
The 401K - Non Deductible Contributions
• Some 401(k) plans may allow employees to make additional
contributions on an after-tax or nondeductible basis.
• Also, 401(k) plans may re-characterize elective deferrals as
nondeductible employee contributions to satisfy the 401(k) ADP test.
• Plan documents will specify whether this option is available to
participants
• Nondeductible, or after-tax, employee contributions are subject to a
nondiscrimination requirement known as the actual contribution
percentage (ACP) test
• They must be monitored on an ongoing basis to ensure that highly
compensated employees do not contribute such significant
nondeductible amounts that the plan falls out of compliance.
• This is often the case unless the company has a “safe harbor” 401(k)
plan
The 401K - Employer Contributions
• Employers can deduct 401(k) profit sharing plan contributions of up
to 25% of the participating employees’ payroll
• “Payroll” includes the elective deferrals and catch-up contributions
of those employees
• For purposes of calculating the 25% deduction limit, employer
contributions are defined as non elective contributions, matching
contributions, and discretionary profit sharing contributions only
• Employee elective deferrals and catch-up contributions are not
considered to be employer contributions for this purpose
• This is an advantage for an employer that wants to maximize
deductible contributions to a 401(k) plan
• Plus, it works in favor of employee-participants who want to maximize
their plan contributions
The 401K - Employer Contributions
Matching contributions
• Matching contributions are employer contributions made in
proportion to a participant’s elective deferrals or, less typically, a
participant’s after-tax voluntary contributions
• An employer may elect a formula for making matching contributions
to a 401(k) plan on behalf of employees making elective deferrals
• Plan documents state the formula by which matching contributions, if
any, are determined
• For example, the formula may have an employer make a qualified
matching contribution that is equal to 50% of a participant’s deferral
into the plan of up to 6% of the participant’s pay
• Typically, matching contributions are 100% vested at all times
• However, some 401(k) plans make these contributions subject to a
graded vesting schedule
The 401K – Self Employed Plans
• While 401(k) provisions are generally tied to profit sharing plans they
may also take the form of a solo (or Keogh) 401(k), a 401(k) stock
ownership plan (KSOP), or Roth 401(k)
Solo 401(k) Plans (Keogh)
• A self-employed individual can make deductible employer
contributions and elective deferrals to a 401(k) profit sharing Keogh
plan
• A self-employed individual can maximize his contributions to a
defined contribution Keogh plan
• Let’s consider the advantages of a solo 401(k) profit sharing Keogh
plan for Shawn.
Schedule C net profit (business profit)
Less income tax deduction allowed (1/2 selfemployment tax)
Net earnings from self-employment
Multiply by .2
(maximum amount allowable for owner)
Owner’s contribution =
$100,000.00
(7,064.78)
$92,935.23
x .2
$18,587.00
In summary, Shawn can make an $18,587 deductible employer contribution and
an $18,500 elective deferral (deductible as an ordinary and necessary business
expense) to his solo 401(k) profit sharing plan for 2018, a total of $36,587. A
shortcut that will allow you to estimate the Keogh contribution is to multiply the
net profit by 18.59% (for a 20% contribution) or 12.12% (for a 15%
contribution). Note: The further you go above the wage base, the less accurate
this method becomes.
If Shawn is age 50 or older, he can make an additional $6,000 (2018 limit)
catch-up contribution to a 401(k) Keogh profit sharing plan, for a total
contribution of $42,587.
Sole proprietors or partners, such as Shawn, will find it easier if they commit to
making elective contributions during the plan year. Of course, this will require
Individual Retirement Accounts (IRAs)
• The individual retirement account (IRA) was first introduced in 1974,
and there are now two general types of IRA accounts
• Traditional IRAs (typically funded with pretax dollars)
• The Roth IRA account (always funded with after-tax dollars).
• In addition, there are also two employer-sponsored retirement plans
that involve setting up IRA accounts for each of the eligible
employees:
• The simplified employee pension (SEP-IRA) plan and
• The SIMPLE IRA plan
• IRA accounts are not considered to be qualified plans, but rather
simply “tax advantaged” plans
• Since they are “individual” plans they are not subject to ERISA
requirements and have their own rules and requirements
Qualified and Nonqualified Plans, and IRAs
Qualified Plans
Nonqualified Plans
Pension Plans
Profit Sharing
Plans (DC)
Tax-Advantaged
Plans
Other
Nonqualified
Plans
Defined benefit (DB)
Profit sharing
Traditional IRA
Section 457 plans
Cash balance (DB)
Thrift plan
Roth IRA
Stock bonus
SIMPLE IRA
ISO
Money Purchase (DC)
ESOP (LESOP)
SEP
ESPP
Target Benefit (DC)
Age weighted
(SARSEP)
NQSO
Cross-tested
(comparability)
403(b) (TSA)
Deferred
compensation
plans
401(k) plan
SIMPLE 401(k)
IRAs
• An IRA is a trust or custodial account set up for the exclusive benefit
of its owner and/or his named beneficiaries
• IRAs were introduced as a means of supplementing retirement
income after Congress realized that personal savings, payments from
employer-sponsored plans, and Social Security benefits were
insufficient to meet the financial needs of many Americans at
retirement
• Over the years, IRAs have grown in popularity, and Congress has
expanded the types of IRAs available and the contribution limits,
making it possible for more people to enjoy their benefits
• IRAs are not qualified plans and are not covered by the Employee
Retirement Income Security Act (ERISA)
IRAs
• However, they are subject to a number of restrictions designed to
preserve the assets for retirement by impeding unencumbered
access to an IRA’s assets.
• The owner may not, for example, borrow from his IRA, and most
withdrawals made before the owner reaches age 59½ are penalized
IRAs - Statutory Requirements
• To comply with the Internal Revenue Code (IRC), every IRA plan must
adhere to the following requirements:
• An individual (taxpayer) must have compensation (earned income or
alimony) and be under age 70½ to be eligible to establish a non-Roth
IRA
• However, an individual who has compensation (earned income or
alimony) and is under or over age 70½ is eligible to establish a Roth
IRA
• It must be established for the exclusive benefit of an individual (IRAs
cannot be established as joint accounts) and the individual’s
beneficiaries
• It must be established as a custodial account or a trust set up in the
United States
• Documents must be set in writing
IRAs - Statutory Requirements
• Contributions (other than rollovers) must be made in cash
• For example, the IRA owner cannot take shares of stock from her safe deposit
box, use them to fund the IRA, and then take a deduction for the value of those
shares
• Contributions for 2018 cannot exceed 100% of an individual’s earned
income up to $5,500 a year per individual (or $11,000 for a married
couple filing a joint return, both of whom are under age 50)
• Individuals who are at least age 50 by the end of the year may also
make an additional $1,000 catch-up contribution (discussed below) for
2018
• Note: Rollovers are not considered “contributions” and can exceed
$5,500 per year.
IRAs - Statutory Requirements
• IRA contributions for a given tax year must be made by the income tax
filing deadline for that year, which is April 15th. Extensions are not
included.
• Individuals are immediately and fully vested in their contributions; IRA
owners always have full control of their accounts and the assets in
them
• Funds cannot be invested in life insurance policies or in collectibles—
with the exception of certain coins and bullion and shares of a publicly
traded, stock-exchange-listed investment trust invested in gold or silver
bullion (e.g. GLD).
• Prohibited transactions between an IRA and its owner will result in the
penalties and income taxation of the entire fair market value of an IRA.
• Loans to an IRA owner or a “disqualified person” (certain related
parties such as family members) are prohibited transactions.
IRAs - Statutory Requirements
• The use of an IRA by its owner as security for a loan is a prohibited
transaction.
• Assets cannot be commingled with other property
• Distribution of IRA accumulations must begin by April 1 of the year
following the year in which the owner reaches age 70½
• If an excess contribution is made to an IRA, then a 6% penalty tax
will apply
• If the excess contribution is withdrawn, no penalty will apply if the
withdrawal is made by the tax return filing due date (including
extensions) and if the withdrawal includes any income earned on the
excess contribution.
IRAs - Traditional vs Roth IRAs
• There are currently two types of IRAs: traditional and Roth IRAs
• Traditional IRAs may be tax deductible or nondeductible
• In a tax deductible IRA, contributions are deductible from current
income and earnings are tax- deferred until they are distributed and
taxed as ordinary income
• In a nondeductible IRA, contributions are made on an after-tax basis
and earnings accrue tax-deferred
• Upon distribution, all earnings are fully taxable as ordinary income;
however, distributions of after-tax contributions are nontaxable
• In contrast, contributions to a Roth IRA are always nondeductible
(after tax) and earnings accrue tax-deferred
• However, distributions that are considered “qualified” are tax-free.
Traditional IRAs - Contributions
• In 2018, individuals who are under age 70½ and have earned income
can contribute to an IRA
• Contributions are limited to the lesser of $5,500 or earned income
• In addition, individuals who have attained age 50 before the end of the
tax year are eligible to contribute an additional $1,000, bringing the
annual total contribution to $6,500
• Earned income, according to the IRC definition, includes the
following:
• Salaries, fees, bonuses, and commissions an individual receives as a
result of services performed (W-2 income)
• Schedule C (Self-Employment) net income
• K-1 income from a partnership (if the partner is a material participant)
• Taxable alimony
Traditional IRAs - Contributions
• Earned income does not include the following:
• Unemployment compensation
• Passive income, such as interest, dividends, and pension distributions
• Capital gains
• Deferred compensation (until it is taxed)
• Amounts received as a pension or annuity
• Social Security income
• Workers’ compensation
• Income from the sale of property; or
• Rental property income, unless this income is derived from a personal
service business
Traditional IRAs - Contributions
Traditional IRAs - Contributions
Traditional IRAs - Deductibility
• The ability to deduct contributions made to a traditional IRA depends
on two factors:
• The individual’s status as an “active participant” in a qualified or other
retirement plan, and
• The individual’s adjusted gross income (AGI)
• An active participant is an employee who during the plan year either
received a contribution or accrued a benefit under one of the
following plan types:
• Qualified plans,
• Certain government plans (NOT including Section 457 plans)
• Tax-sheltered annuity plans (TSAs) (also known as Section 403(b)
plans)
• A simplified employee pension (SEP), or
• A savings incentive match plan for employees (SIMPLE) IRA
Traditional IRAs - Deductibility
Filing
Status
Active
Participant?
Below $63,000
$63,000–$73,000
Above $73,000
Yes
Full deduction
Partial deduction
No deduction
No
Full deduction
Full deduction
Full deduction
Below
$101,000
$101,000–
$121,000
Above $121,000
Yes—both
active
Full deduction
Partial deduction
No deduction
No—both not
active
Full deduction
Full deduction
Full deduction
Single
Married
(Filing
Jointly)
Spousal
IRA (Filing
Jointly)
Income (AGI) Relative to Phaseout Ranges
One spouse yes, the other no:
Active spouse
Below
$101,000 full
deduction
$101,000–
$121,000 partial
deduction
Above $121,000
no deduction
Nonactive
spouse
Below
$189,000 full
deduction
$189,000–
$199,000 partial
deduction
Above $199,000
no deduction
Traditional IRAs – Taxation of Distributions
• Taxable distributions from IRAs are always treated as ordinary
income. (There is no preferential treatment with respect to gains.)
• The extent to which a distribution is subject to tax depends on
whether the IRA was funded with pretax (deductible) or after-tax
(nondeductible) contributions
• At distribution, a fully deductible IRA has a cost basis of $0 because
contributions were made with pretax money, and investment earnings
have accrued tax-deferred.
• Therefore, the full amount of any distribution will be taxable as
ordinary income
Traditional IRAs – Taxation of Distributions
• Contributions to a nondeductible IRA, as the name implies, cannot be
deducted from taxable income; in other words, contributions are
made on an after-tax basis
• Therefore, nondeductible IRAs have a cost basis
• When the account owner begins taking distributions, ordinary
income tax is owed only on the account earnings
• The cost basis is not subject to taxation upon distribution
Traditional IRAs - Required Minimum Distribution
• Generally, it is advantageous to prolong the period of tax-deferred
investment earnings for as long as possible
• However, the period of tax deferral is limited by the minimum
distribution requirements of IRC Section 401(a)(9)
• An IRA owner may begin penalty-free withdrawals from IRAs upon
reaching age 59½, but there is no requirement that withdrawals must
be made until the required beginning date (RBD)
• Withdrawals must begin by April 1 of the year following the year in
which the owner turns age 70½—this date is the required beginning
date
Traditional IRAs - Required Minimum Distribution
• Of particular note, this required beginning date applies to IRA
accumulations whether or not the IRA owner has retired
• As with qualified plans and 403(b) plans, distribution shortfalls are
subject to a 50% penalty tax.
• For example, if the required minimum distribution is $2,000 and no
distribution is taken, then the penalty tax would be $1,000
Roth IRAs
• Roth IRAs were created by the Taxpayer Relief Act of 1997
• In contrast to traditional IRAs, no deduction is available for
contributions to Roth IRAs—all contributions are made with after-tax
dollars
• However, Roth IRAs offer a unique opportunity for tax-free distributions
for both the owner and the beneficiary
• Eligibility for making a Roth IRA contribution is subject only to the
earned income requirement and the annual income limitations
• Neither active status nor age is relevant for determining Roth
eligibility
• Unlike traditional IRAs, Roth IRAs do not require an individual to
determine the “deductibility” of a contribution—remember, all
contributions are after tax
Roth IRAs
• For Roth IRAs you are determining “eligibility,” and this is based
solely on income.
• In 2018, individuals filing as single taxpayers with modified adjusted
gross income up to $135,000 and married joint filers with modified
adjusted gross income up to $199,000 are eligible to contribute to a
Roth IRA
• Unlike traditional IRAs, individuals can continue to contribute to a
Roth IRA after age 70½, as long as they have earned income.
• In addition, Roth IRA owners are not subject to mandatory required
minimum distribution rules.
• Beneficiary recipients of Roth IRAs are subject to required minimum
distribution rules.
Roth IRAs
• Roth IRA Modified AGI Phaseouts (2018)
• Modified AGI is AGI less any allowable adjustments, such as
• Retirement-plan contributions
• Student loan interest and
• Health insurance premiums paid by self-employed individuals
From
To
Single
$120,000
$135,000
Married filing jointly
$189,000
$199,000
Married filing separately
$0
$10,000
Roth IRAs - Distributions
• If distributions from a Roth are deemed “qualified,” they are tax-free
• Distributions that do not meet the definition of a “qualified”
distribution may be subject to income tax and the 10% early
withdrawal penalty
• To be considered a “qualified distribution,” two requirements must
be met:
• The owner must meet the five-year holding period requirement, and
• The distribution must satisfy one of the following four requirements
•
•
•
•
Must be made on or after the date the owner attains age 59½
Must be made to a beneficiary or after the death of the owner
Must be made to the owner because of the owner’s disability, or
Made for first time home buyers expenses of $10,000
Roth IRAs - Distributions
• A distribution meets the “five-year” holding period requirement if it is
made after five years have passed since the first contribution was
made to a Roth IRA
• This same holding period requirement will apply to future
contributions made to any Roth IRA.
• In other words, the five-year holding period begins in the year of the
first Roth IRA contribution and this same holding period will apply to all
future contributions, whether made to the same or different Roth IRAs
Roth IRAs - Conversions
• Unique to the Roth IRA is the ability to accept tax-deferred asset
funds from a traditional IRA or employer-sponsored retirement plan,
such as a 401(k), 403(b), or governmental 457(b)
• Such a conversion can be done without regard to income eligibility
limits
• When converting pretax dollars to a Roth IRA, the converted amount
is taxable as ordinary income in the year of conversion, but future
growth will be tax-free
• Pretax dollars are subject to ordinary income tax at the time of
conversion but are not subject to the 10% early withdrawal penalty,
even if under age 59½.
• If, however, a withdrawal of converted funds is made from the Roth
IRA prior to five years having elapsed since the conversion, such a
withdrawal would be subject to the 10% penalty
Roth IRAs - Conversions
• One of the biggest benefits of a Roth IRA conversion is that there is a
window to undo, or “recharacterize,” the conversion
• A recharacterization may make sense if:
• The investments have fallen in value since the time of the conversion
• There isn’t the cash necessary to pay taxes on the converted amount,
or
• Expectations about the future tax rate have changed
• The time limit for recharacterizing is the due date, including
extensions, of the tax return for the year in which the conversion was
done
• Over more than 30 years as a 401(k) plan consultant, I have worked
with some of the most prestigious companies in the world including
Apple, AT&T, IBM, John Deere, Northern Trust and Northwestern
Mutual
• And, I am always surprised by the simple -- but significant -misconceptions many people have about their 401(k) plans.
Significant Misconceptions
1. I only need to contribute up to the maximum company match
• Many plan participants believe their employer is sending them a
message on how much to contribute
• As a result, they only contribute up to the maximum matched
contribution percentage
• In most plans that works out to be only 6% in employee contributions
• However, many studies indicate that participants need to add at least
15% each year to their 401(k) accounts
Significant Misconceptions
2. It is OK to take a participant loan
• I have had many participants tell me, "If this were a bad thing why
would the company let me do it?"
• Account leakage via defaulted loans is one of the reasons some of us
are not able to save enough for retirement
• Many people, when they change jobs, elect to default on outstanding
401(k) plan loans because they don't have the cash lying around to
pay the loans back
• In addition, taking a 401(k) loan is a horrible investment strategy.
Generally, if you can take a loan from somewhere else, you should do
it
Significant Misconceptions
3. Rolling a 401(k) account into an IRA is a good idea
• There are many investment advisors working hard to convince
everyone this is a good thing to do.
• However, higher fees, lack of free investment advice, use of highercost investment options, lack of availability of stable value and
guaranteed fund investment options, and many other factors make
this a bad idea for most of us
• The Department of Labor agrees, as shown in its recent auto
portability proposal
• If you can, roll your prior 401(k) account balances, and your IRA
accounts, into your existing employer's 401(k) plan
• It is a much more cost-effective option
Significant Misconceptions
4. My 401(k) account is a good way to save for college, a first home, etc.
• When 401(k) plans were first rolled out to employees decades ago, human
resources staff helped persuade skeptical employees to contribute by
saying the plans could be used for saving for many different things
• They shouldn't be
• It is a bad idea to use a 401(k) plan to save for an initial down payment on a
home or to finance a home purchase
• Similarly, a 401(k) plan is not the best place to save for a child's education - 529 plans work much better
• In addition, your 401(k) plan is not the best place to save for a new car, boat
or that deluxe vacation
• If you wish to enjoy any sort of quality of life in retirement, use your 401(k)
retirement plan to save only for retirement.
Significant Misconceptions
5. I should stop making 401(k) contributions when the stock market goes
down
• I have had many participants say to me:
• "Bob, why should I invest my money in the stock market when it is going
down. I'm just going to lose money!”
• When the market is falling or has decreased significantly in value, stocks
are on sale. It is the best time to be investing in the market!
• Stick with your contribution plan in all types of markets. Stopping and
starting contributions is not a good way to accumulate the balance you are
going to need to retire.
• The biggest challenge participants who stop contributing face is when to
resume their contributions
• Most wait until the stock market recovers
• As a result, they end up buying when the cost of stocks is high -- not a
good investment strategy.
Significant Misconceptions
6. Actively trading my 401(k) account will help me maximize my
account balance
• Studies have consistently demonstrated that trying to time the
market (this includes following newsletters or a trader's advice) is
rarely a winning strategy
• Consistently adhering to an asset allocation strategy that is
appropriate to your age and ability to bear risk is the best approach.
• No one can predict what the market will do in the future
• Please don't believe that you or anyone else can
• Don't try to "trade" your account
• Everyone I have known who did this traded their account down to
nothing
Significant Misconceptions
7. Indexing is always superior to active management
• Although index investing ensures a low-cost portfolio, it doesn't
guarantee superior performance or proper diversification
• Access to commodity, real estate and international funds is often
sacrificed by many pure indexing strategies
• A blend of active and passive investments often proves to be the best
investment strategy for most of us.
Significant Misconceptions
8. Target date funds are not good investments
• Most experts who say that target date funds are not good
investments are not comparing them to most participants' allocations
prior to investing in target date funds
• Many of us, before investing in target date funds, may have invested
in only one fund or a few funds that were inappropriate risk-wise for
our age
• Studies show that the average number of funds used by 401(k)
participants is between three and four
• That generally is not enough to ensure proper diversification
• Target date funds offer proper age-based diversification
Significant Misconceptions
9. Money market funds are good investments
• These funds have been guaranteed money losers for a number of
years because they have not kept pace with inflation.
• Unless you are five years or less away from retirement or have
difficulty taking on even a small amount of risk, these funds are
below-average investments
• Try to invest in stable value or guaranteed fund investment options
instead.
Significant Misconceptions
10. I can contribute less because I will make my investments work
harder
• Many participants have said to me, "Bob, I don't have to contribute as
much as others because I am going to make my investments do more
of the work.”
• Most participants feel that the majority of their final account balance
will come from earnings in their 401(k) account
• However, studies show that the major determinant of how much
participants end up with at retirement is how much they contribute
rather than how much they earn.
Significant Misconceptions
11. A million-dollar 401(k) plan balance is enough to retire on
• It should be enough, but for many of us, it won't be
• A lot of us hope to do things in retirement that we only dream about
during our working years
• Others will experience unexpected health care costs that can quickly
deplete their savings
• Quite a few of us will live much longer than we ever thought
• As a result, many experts feel that a million-dollar 401(k) plan balance
won't be enough
• I hope these suggestions help you become a better 401(k)
plan investor
Case Study - Savings
•
You are a newly hired analyst at a top company
•
Your starting salary is $80,000 year
•
You are attempting to save about 10% of your income
•
You have the following options for savings and investment.
1. A Company 401K Plan that matches the first 6% Pretax Contributions at a 50%
Match rate
2. Your own Individual Retirement Account (IRA) with a balance of $5,500.
3. Your own Roth IRA with a balance of $1,250.
4. Your brokerage account with a balance of $2,500
Based on information in the course, how much would you save each
year and in which savings options would you put the money?
Purchase answer to see full
attachment