Most 401k investors rely on their month or year end 401k balance statements to see the financial position of their retirement plans. Most of them however do not understand the rules and regulations specified in the 401k document (you can request a copy of this document from your 401k administrator). Here are 5 things that you MUST know about your 401k plan in order to avoid committing bad investment moves:
i) Employer Sponsored Match? You Might NOT Get It!
Many employers that you work for have what’s called a vesting schedule where you must put in a certain # of years of work before you are eligible for the employer sponsored match 401k contributions. For most employers, this # is 3 years. Therefore, if you quit working with your current employer in less than 3 years, you are eligible for 0 employer sponsored match 401k contributions. Why? Because that’s just the way it is! Back in 2001, this # of vesting years (also known as “three year cliff”) was 5 years!
Check with your employer as to the vesting schedule policies. Some employers now allow immediate vesting where you are eligible for employer sponsored 401k match contributions as soon as you start working for that company.
ii) If you take out a 401k Loan and leave your Employer, you will have to repay it back immediately!
The above title is as simple as it gets. If you borrow a 401k loan from your employer and heaven forbid are laid off, fired or quit your job, you will have to pay back this loan immediately! What if you cannot pay back this loan immediately? You will be faced with a 10% early withdrawal penalty fee plus the local state taxes. Therefore, think deep before you borrow from your own 401k plan.
iii) 401k Balance Less than $5000?
If you quit your current employer while your 401k balance is less than $5000, you should roll it over to an IRA or your new employer’s 401k administered plan. This is because the old employer will not allow you to keep a balance of less than $5000 in his 401k plan. If you quit your employer with a balance of less than $5000, here are the steps to follow:
- Instruct your employer to make out a check to your 401k or IRA custodian for a 401k rollover.
- Or instruct your employer to make out a check directly payable to you. However, if you choose this option, your employer will withhold a 20% federal tax and remit it to the government. Furthermore, you will also face a 10% early withdrawal penalty fee if you choose this option. Therefore, we suggest you choose option #1.
iv) Sales Fees? 12b-1 Fees?
If you work for a small firm, you could be getting charged all kinds of fees. Some of these include:
- 401k Record Keeping fees
- Mutual fund sales charges
- 12b-1 fees
- Investment Transaction fees.
If you are faced with many of these charges, you should tell your employer to switch to a no-load 401k administrator such as Fidelity Investments or VanGuard.
v) Don’t Buy Variable Annuities!
Some 401k plans will encourage you to invest in variable annuities offered by insurance companies, because of their tax-advantages. You should NOT really settle for this, because investing in a 401k plan already means you are in a tax-advantaged situation (tax deferral until the age of 65 or when you retire). You should instead invest in 401k plans that invest in mutual funds such as the no-load mutual funds provided by Fidelity Investments or VanGuard.
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