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A Common Mistake With Retirement Planning
Most articles about 401(k) plans, traditional
IRAs and Roth IRAs focus on rules and regulations. Contribution
limitations and income tax issues usually take precedent.
Unfortunately, little attention is given
to the matter of control. This refers to one's ability
to personally manage the asset on an active and ongoing
basis.
For example, when you join a 401(k)
plan you are restricted as to the investment choices.
Your plan sponsor makes that decision as part of their
fiduciary responsibility.
In the past, this was a big concern
because plan participants (i.e. the employees who enroll
in their company's 401(k) plan) were often given terrible
choices.
Sometimes, this was the result of ignorance
on the part of the plan sponsor. However, with some
publicly held companies it was the desire to encourage
employees to invest in the stock of their own company.
Today, federal regulation mandates better
investment choices. This means a plan participant is
able to choose from a greater variety of investment
styles, as well as a cash account that typically replicates
a money market fund.
But, this is still insufficient. The
ability to design the most appropriate investment plan
continues to be severely limited in 401(k) plans when
compared to the freedom of choice in IRAs.
It is important to review briefly what
has happened over the last 20 years with retirement
plans.
Not long ago, it was common for a company
to provide employees with a defined benefit plan. This
type of plan design guaranteed a stream of income based
on length of service and average wages. The income began
at what was then considered the normal retirement age
of 65.
For many workers, the defined benefit
plan, together with social security, ensured a sense
of security for their future lifestyle. Obviously, times
have changed considerably.
Today very few companies will assume
the defined benefit plan liability. In fact, companies
have shifted the responsibility for retirement savings
to the employee by adopting 401(k) plans.
Some companies will match a portion
of the employee's 401(k) contribution up to a maximum
amount or percentage. But this doesn't come close to
replenishing the void caused by the terminated defined
benefit provision.
What is more, the investment opportunities
in typical 401(k) plans are expensive due to excessive
management fees and brokerage commissions. Even the
so-called no load separate accounts have administrative
costs that significantly reduce the net return for the
average investor.
Most plan participants are oblivious
to the costs associated with the administration of their
plan. Also, they do not pay enough attention to the
allocation of their investment.
A self-directed IRA hosted by a low
cost online brokerage firm provides an opportunity to
reduce substantially the ongoing costs related to retirement
planning.
In addition, the IRA owner can invest
in a wide variety of individual stocks, bonds and commodities
to create a highly diversified portfolio. The 401(k)
participant must take the total package of a bundled
investment to include issues that can jeopardize the
total return.
This is not to say 401(k) participation
should be avoided. Not at all. But it should be coordinated
closely with a IRA to enhance the overall strategy for
long-term growth.
It's apparent that Congress must continue
to provide expanded retirement planning opportunities
for the individual employee. The rules will constantly
change, but the writing is very much on the wall.
Companies will no longer provide guaranteed
future benefits. Factors which contribute to this include
the pressure of worldwide competition, the deterioration
of union power, the ever increasing cost of health insurance
and the peripatetic nature of the workforce.
Therefore, the individual employee needs
to understand how to create a balance between the restrictions
found in the 401(k) plan and the significant freedom
of choice of the IRA.
Both instruments permit the postponement
of income tax. Whether the investment principal is pre-tax
401(k) or tax deductible IRA is irrelevant. At some
point the tax piper must be paid.
The strength of both systems is in the
tax deferment because, in most instances, this will
be a long period of time. In fact, many people choose
not to withdraw any money at all from retirement accounts
until they are forced to by federal regulation.
As stated earlier, rules change frequently.
Therefore, it is important to know what restrictions
are in place before making any investment choice. But
the basic premise doesn't change.
Analyze both the 401(k) plan together
with your ability to open a IRA. If your employer offers
a matching provision, commit a portion of your pretax
dollars to guarantee no less than the matching amount.
Anything over and above this figure
should be allocated to a self-directed low cost brokerage
IRA. This gives you the opportunity to enhance your
total retirement investment.
If your income exceeds the limitation
for deducting the cost of your IRA, do not let this
to be the sole reason not to open the IRA. Your freedom
of choice and long-term tax deferment can far outweigh
your lack of deductibility.
In the final analysis, most people make
financial decisions based on their level of comfort.
Indeed, this frequently leads to less than desirable
results.
1howto.com
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