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What's So Great About 401(k)
and 403(b) Plans?
If you were to invest $1,000 when
you were 25 years old, your investment would grow to be worth $30,912
when you turn 60, assuming a 10% rate of return. If you waited
until you were 50 to make a similar investment, it would only grow to
$2,853 by your 60th birthday. The moral to this example is
simple. Start saving for your retirement as early as possible.
It's Up to You
How people save for retirement has
changed dramatically over the years. In years past, many
workers counted on their employers to contribute to a pension plan on
their behalf. For many retirees, the combination of a decent
pension benefit and a monthly social security check has made for a
Those days, unfortunately, are
over. With employees changing jobs more than ever, companies
looking to cut costs wherever they can, and social security a big
question mark for young professionals, the burden for saving for your
retirement now falls squarely on your shoulders.
401(k) and 403(b) Plans
While some companies still offer
traditional pension plans, the retirement savings plan offered by
your employer is most likely either a 401(k) plan or 403(b)
plan. Named after its corresponding section in the IRS tax
code, both these plans provide you with a systematic and tax
advantaged way to save for your retirement. Depending on the
type of entity your employer is, you will generally have access to
one of these retirement savings plans, not both. Most companies
offer 401(k) plans, while non-profit universities and hospitals offer
Here's how these plans work.
As an employee, you're allowed to elect to have a percentage of your
salary withheld each pay period. For 2001, the maximum annual
salary deferral is the lesser of 15% of your salary or $10,500,
subject to certain other limitations. You then direct how your
salary deferrals will be invested within your own 401(k) or 403(b)
account. Most plans offer a wide variety of quality mutual
funds to choose from.
Two Great Tax Breaks
Participating in these plans
provides you with two substantial tax breaks. First, amounts
withheld from your salary reduce your taxable earnings. If you're in
the 31% tax bracket, and contribute $10,000 to the 401(k) or 403(b)
plan during the year, you'll save $3,100 in federal income taxes that
year. It would only cost you $6,900 in after-tax dollars to
have $10,000 invested in mutual funds within your retirement savings account.
The second tax benefit is that
money invested within your 401(k) or 403(b) account grows tax
deferred. While each year you pay taxes on the investment
earnings of your non-retirement accounts, no taxes are paid on the
earnings of the investments within your retirement savings account
until such time that you withdraw money from the plan.
To illustrate the power of
tax-deferred investing over your working years, let's assume that you
have the choice of contributing $10,000 to a 401(k) or 403(b) plan
each year for 25 years, or you can take the $10,000 as a bonus, pay
the applicable taxes, and then invest whatever's left. If you
choose the pre-tax route, your account will grow to be worth more
than $1,000,000 after 25 years, assuming a 10% rate of return.
If you choose to pay taxes along the way, your investment portfolio
won't even grow to $500,000 over the same period of time.
Even though you shoulder much of
the burden of saving for your own retirement, many employers do help
their employees save for retirement through "matching
contributions". For example, if your employer matches 50%
on the first 6% you contribute, they'll add 3% of your salary into
your retirement savings account each year, provided you contribute at
least 6% of your salary to the plan. Find out whether your
employer offers a matching contribution, and if they do, make sure
you're contributing enough into the plan to take full advantage of
your employer's match.
Annual Maximum Contributions
Are On The Rise
The Economic Growth and Tax Relief
Reconciliation Act of 2001 was passed by Congress on May 26, 2001,
and signed into law by President Bush on June 7, 2001. As part of the
new law, employee contribution limits to 401(k) and 403(b) plans will
increase gradually from the current maximum of $10,500 to $15,000.
The limit will be $11,000 in 2002; and will increase by $1,000 each
year until it reaches $15,000 in 2006.
Remember, every week that goes by
that you haven't contributed as much as possible to your 401(k) or
403(b) plan at work is a missed opportunity for saving for your retirement.
Life, Disability and
Long-Term Care Insurance
Ask an insurance salesperson how much life and disability insurance
you need, and they'll probably tell you, "A lot!" The
problem is, they're usually not very far from the truth.
Very few people are wealthy enough to be without disability insurance
and life insurance. Even if you have some coverage through an
employer sponsored plan, you should still evaluate whether you need
to purchase additional coverage on your own.
Long-term disability insurance: Disability insurance
protects against lost income in the event you become disabled.
Most people in their working years should have at least a minimum
amount of long-term disability insurance.
Life insurance: Married couples with children, or
consisting of only one working spouse, will probably need to purchase
life insurance on both spouses. Married couples consisting of
two working spouses with no children, and unmarried individuals with
no children and very few debts, may not need life insurance right
now. However, it's usually a good idea to purchase life
insurance while you're sure that you're insurable.
How Much Life Insurance Do You Need?
When you're trying to figure out how much life insurance you need,
keep in mind that your life insurance provides liquidity to:
Pay off your debts, such as mortgages and equity loans, auto
loans, student loans, credit cards, and other personal loans.
Pay for your final expenses, such as funeral expenses, unpaid
medical bills and estate taxes.
Set up an emergency fund for your family and/or your business
Set aside money that will be earmarked for your children's
educations and your surviving spouse's retirement.
Provide a nest egg to provide income to the surviving spouse
to ensure that your family can maintain its current standard of living.
While you're looking at your life insurance situation, don't forget
to review who you've named as beneficiary on each of your policies.
How Much Disability Insurance Do You Need?
The questions should really be how much disability insurance can you
get? As an incentive for people to get back to work as soon as
possible after becoming disabled, most disability income policies
will only cover up to 60 to 70 percent of salary.
What About Long-Term Care Insurance?
Generally, people wait until they
are between the age of 50 and 60 before purchasing long-term care
insurance. Most young health care professionals, therefore, are
too young to consider purchasing this insurance.
However, have your parents
purchased long-term care insurance yet? Remember, if your
parents need to pay for in home care or nursing home care, how long
do you think their savings will last?
FALL IS A GREAT TIME OF THE YEAR FOR
If you're married, and you and your spouse need
some guidance, check out
(Brought to You By Your Friends at MDTAXES.COM)
CALENDAR FOR THE MONTH OF SEPTEMBER, 2001
Saving and Investing
For 2000, the standard deduction for a single individual is $4,400
and for a married couple is $7,350. A person will benefit by
itemizing once allowable deductions exceed the applicable standard
deduction. Itemized deductions include state and local income taxes,
real estate taxes, mortgage interest, charitable contributions, and
unreimbursed employee business expenses. For 2001, the standard deduction has been increased to
$4,550 for a single individual and $7,600 for a married couple.
- For 2000, the personal exemption is $2,800. Individuals
will claim a personal deduction for themselves, their spouse, and
their dependents. The personal exemption has been increased to
$2,900 for 2001.
- The maximum earnings subject to social security taxes
has been increased to $80,400 in 2001 from $76,200 in 2000.
- The standard mileage rate has been increased to
$.345 per mile as of January 1, 2001 from $.325 per mile
- The maximum annual contribution to a 401(k) plan or
a 403(b) plan remains at $10,500 for 2001, and has been
increased to $11,000 for 2002.
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