Wednesday, March 26, 2014

Unscrambling Your Retirement Nest Egg

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At Investing Daily, we’ve grown increasingly concerned with the national trend toward underfunded retirement plans. For the next few weeks, we'll send you a complimentary series of focused briefs to get you thinking about new ways to maximize performance both inside and outside of a structured 401k or similar plan. We hope you'll find these briefs useful.

This is the fourth installment in a five-part series.

As part of our continuing effort to better serve loyal readers, we’ve answered the latest batch of "frequently asked questions" regarding 401k plans. The questions below run the gamut in sophistication and were posed by novice and seasoned investors alike. Chances are, at least a few of these topics have perplexed you as well.

What are the limits to 401k contributions?

This question is trickier than it seems. You can't just determine the limit and then assume the ceiling is fixed. As with anything that involves the government, the rules continually change and you need to monitor them.

The maximum pretax contribution dollar amount is established by the IRS and annually adjusted for inflation. The pretax contribution limit for 2014 is $17,500.

How much should I contribute?

We advise the maximum, but that's easier stated than done. Not everyone can afford it. Strive for at least 15-20 percent of your income during your earning years.

If your company is generous enough to offer a matching contribution, you should kick in enough to make the most of that match. For example, if your company matches $1.00 up to 10 percent of your contributions, you should contribute at least 10 percent.

Are there different ways in which employers offer a matching contribution?

Yes, your employer can choose among several methods for determining the percentage that it contributes. The most common are a fixed percentage of what you put into the plan; a! predetermined percentage of your pay; and a discretionary percentage that's subject to change according to how your company is performing.

To reiterate: Make it a point to contribute at least the minimum amount required to trigger your company's full match. Otherwise, you're refusing free money!

I'm self-employed. What are my 401k options?

Many people don’t realize that you don’t need to run a large full-time business to benefit from a self-employed retirement plan. Even if you moonlight, work part time, or freelance, self-employed retirement plans offer enormous tax benefits.

In fact, if your cash flow can handle it, you might be able to put 100 percent of your net profit as a self-employed person into a 401k plan—and deduct the money, too. Here’s a look at your options:

Simplified Employee Pension (SEP) Plan.

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 If your income from self-employment is relatively small, or if you’re newly self-employed, a SEP is your best bet.

The biggest enticement of a SEP is as its name implies: it’s simple. The IRS treats a SEP just as if it were an Individual Retirement Account (IRA), which means the paperwork to set up a SEP is minimal and, mercifully, the IRS imposes no requirements for annual tax reporting.

Annual contributions to a SEP are discretionary; if you’re hurting for cash one year and need to cut back, you’re free to do so. Moreover, SEP contribution limits are relatively high: 25 percent of net income, up to $52,000 for 2014, which is ample for most people. (The amount is subject to annual cost-of-living adjustments for later years.) Also, another convenience is that you can set up and fund a SEP after the end of the tax year.

Self-employed 401k

Also known as a solo 401k, this alternative involves more paperwork and must be established by December 31. T! his plan ! is limited to self-employed business owners with no employees other than a spouse. The major benefit: you can put in considerably more money every year than with a SEP.

Self-employed individuals and small business owners that have adopted a solo 401k plan for the 2014 taxable year will be able to make tax-deferral employee and employer contributions of up to $52,000. Those over the age of 50 have a limit this year of up to $57,500.

Annual contributions are discretionary and you can borrow from the plan.


Can I temporarily cease contributions if I can’t afford it, but start up again later?

It depends on your employer. Some allow it; some don't. However, most plans give you the latitude to stop contributing for a while. Check the rules with your HR department.

What are "hardship" withdrawals?

We advise against hardship withdrawals. Your best bet is to bite the bullet and find another source of money for whatever need has arisen. You should treat your 401k as sacrosanct. That's why it was troubling that during the Great Recession, many 401k savers tapped their accounts simply to make ends meet, further exacerbating the retirement crisis that faces America.

But again, that's easy to state and harder to do. Maybe your financial back is against the wall and you have no recourse but to crack your 401k piggy bank. If that's the case, the IRS allows the following reasons for a hardship distribution:

Medical expenses incurred by you, your spouse, children, dependents, beneficiaries beyond what is covered by insurance;Payment of funeral or burial expenses for your spouse, children, dependents, parents, or beneficiaries;Purchase of primary residence;Payment of tuition for post-secondary education for you or your spouse, childr! en, depen! dents or beneficiaries for the next semester or scholastic period;Prevention of eviction from your primary residence or foreclosure of the mortgage on your primary residence; andPayment of repair to your primary residence that qualifies for the casualty deduction of Internal Revenue Code Section 165.Check with your HR department for further details.

What are the rules regarding loans from 401k plans?

We advise against taking out a loan against your 401k. But if you urgently need money, this option is available to you, depending upon your employer's rules.

Companies are free to offer loans as part of a 401k plan, but nothing compels them to do so. Your Summary Plan Description or HR department can make this clear for you. Typically, you must repay the loan within five years.

You're allowed to borrow up to 50 percent of your vested account balance to a maximum of $50,000. Plans often establish a minimum amount and restrict the number of loans you can take at any one time. Repayment is usually n the form of installments automatically deducted from your paycheck.

If you leave your job, any unpaid portion of the loan will be calculated as income and be subject to taxation and, if you're under the age 59 1/2, a penalty.

John Persinos is editorial director of the investment advisories Personal Finance and 401k Millionaire, as well as their parent website Investing Daily. Follow John on Twitter.

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