Posted on 05/19/2011 8:44:58 AM PDT by Kaslin
Dear Carrie: I was out of work for 14 months and had to dip into my retirement savings to make it. I am working again and want to "catch-up." What strategies would you suggest to help?
Also, since I can't put that money back in my 401(k), what sorts of accounts would be best to look at?
-- A Reader
Dear Reader:
Fourteen months is a long stretch of unemployment, and it's unfortunate -- but entirely understandable -- that you'd need to tap your retirement account to stay afloat. I'm glad to hear you're working again and elated to hear you want to get back on track with your retirement saving.
As your question acknowledges, you can't just put withdrawn money back into a 401(k), unless of course you borrowed from it. And unfortunately, as you learned, when you make what the IRS calls an "early distribution," you have to pay a penalty in addition to taxes.
So, your savings have undoubtedly taken a hit. But there are several ways you can get caught up; the following is a rundown:
NO. 1: MAXIMIZE YOUR CURRENT 401(K) CONTRIBUTION
Obviously, you want to take full advantage of the retirement plan at your new job, whether that's a 401(k), 403(b) or another plan. As you probably know, 401(k) and similar plans are just too good of a deal to pass up -- given the fact that contributions are generally made with pretax dollars, and investment gains and income are untaxed until you start withdrawing the money when you retire.
For 2011, you can contribute up to $16,500, plus an additional $5,500 if you're 50 or older -- well over the $5,000 you can put into an IRA ($6,000 if you're 50-plus). If your company offers a matching contribution, then your 401(k) plan is even more appealing. Saving more is the easiest (and most effective) way to help build wealth.
NO. 2: CONTRIBUTE TO AN IRA
If you haven't already, you can also open an IRA. However, since you participate in your company's 401(k) plan, you can only fully deduct your contributions to a traditional IRA if your adjusted gross income (AGI) is less than $56,000 (this deduction is phased out for single filers with AGIs between $56,000 and $66,000 and for those married, filing jointly with AGIs between $90,000 and $110,000.) Or you may be eligible to open and contribute to a Roth IRA, depending on your income.
NO. 3: INVEST IN A TRADITIONAL BROKERAGE ACCOUNT
There's no rule that says retirement assets must be held in a retirement account. You can always save and invest in a traditional brokerage account. Your investments aren't tax-deductible, of course, but there are no limits to how much you can save. And you can construct a tax-efficient portfolio to help reduce the drag of taxes on total returns. Talk to a good financial adviser for details.
In fact, some people relish the flexibility of a brokerage account because it offers essentially unlimited investment options and you'll never be forced to take a distribution.
NO. 4: INVEST MORE AGGRESSIVELY
Finally, and I say this with a degree of caution, you can consider investing more aggressively in an attempt to earn a higher return. Depending on your current holdings, your appetite for risk and your time frame, it may be appropriate for you to shift a part of your portfolio from bonds or cash into stocks. But this requires a thorough understanding of the risk you might be assuming, including the potential for negative returns and an appreciation of the importance of a long-term time horizon (say, five years or more). Also, realize that the potential return of a portfolio heavily weighted in stocks (say more than 60 percent or so) may well not justify the risk.
So if you decide to go this route, I suggest working with a trusted, objective financial adviser to create a portfolio that has the potential to generate some extra performance and still offers a high degree of diversification. I realize this may be a daunting prospect, especially given the recent recession, but it can be an option you'll want to consider.
CREATE A SAFETY NET
As a final note: I know you realize that dipping into your retirement plan is something to be done only in an emergency. So, I encourage you to do what you can to ensure you won't be in that position again -- by starting to build an emergency fund that is highly liquid (like a money market account or laddered CDs). Then add to it every month until you have at least six month's or even a year's worth of living expenses.
I hope you will never need to use it. But since life is unpredictable, it will be easier to weather another storm if you have a financial cushion!
Best of luck.
Good advice.
I actually wasn’t aware that a 401k had a max contribution limit like an IRA does.
Personally I’ve always believed 401ks are a rip off. The fees are so high they have to make a ton before you come out on top. And the guy “managing” it can shift money around constantly...win or lose, he gets paid.
I also don’t believe the money isactually there. That’s why you can’t withdraw it anytime you want. If all the holders withdrew at the same time they’d find out they don’t have as much money as they think they do.
When the company I worked for stopped matching J.P. Morgan/Chase sent letters out to everyone advising to keep pumping money in. Crooks.
Finally, I withdrew my money to buy a house. But my wife had to take out a “loan” to get hers. Both working for the same company with the same 401k through JPM/Chase. She had to make payments to pay it back. Now she left the company 3 months ago and still can’t get them to send her the money she’s paid them.
Rip offs? They are one of the best vehicles out there. You put in $1 and it only costs you maybe 70 cents depending on your marginal tax rate. You make over a 40% gain on day 1. Fees are nominal, almost neglible. Average is just over 1% generally but many offer index funds where the fee is even less. It’s one of the areas where the little guy gets a great deal. The money is absolutely there. It’s heavily regulated and insured. There are exceptions of course as there is with anything you do. You can’t get at it as easily as you would a bank account but that’s the intent and the trade off for the massive benefit you get. If you are lucky enough to get a match it’s even better. A $1 might get you $2 with a good match, only costing you 70 cents and you have almost a 200% return on day 1. Even if the market drops 50% the next day you are way ahead.
The OP said she “dipped” not borrowed.
Aren’t there certain times you can take money out without penalty, like 1st home purchase?
I believe you can also take money out at other times except you pay taxes on it immediately and a heavy penalty (20% ?) to the Feds for an early withdrawal.
I got the impression she did the early withdrawal w/penalty due to financial hardship. No repayment possible, unlike “borrowing” from your own account where the money has to be repaid to avoid the penalty & taxes.
You withdrew all of your 401-k? Assuming your under age 59 1/2 and depending on how much you had saved you probably paid quite a hefty sum in taxes and penalties.
I don't know what you're doing, or for whom you work, but you seem overly cynical. Fees are usually lower than anything you could get on your own, and they're highly regulated. You are discouraged to withdraw money and take loans, because they're not called 401(k) ATMs...they're called 401(k) savings' plans.
Also, fees are usually low in 401(k) plans because administration is fairly low. They don't have to worry about scenarios where everyone is "withdrawing funds at the same time;" people don't usually leave or retire at the same time. Rest assurred, when it comes to regular distributions, most 401k plans can handle them.
Finally, I don't see how you consider JP Morgan/Chase "crooks" for encouraging employees to maintain their contributions, even when employers stop their matches. Yes, I realize that continued contributions are good for the financial institution, but they're also good for the employee. Just because an employer temporarily stops matching, doesn't mean the vehicle is a poor investment.
No offense, but between you and your wife, you've done everything you should NOT have done with your finances: if you were planning to buy a house, you should've saved for that separately; if your wife was planning to leave the company, she shouldn't have taken the 401(k) loan--typically, if you can't pay back loans upon leaving a company, you're socked with an early withdrawl penalty.
Even though WF 401-k automatically ups your % holding you can override it via self-direct on how much you want withheld most likely. My employer doesn’t offer a match which sucks but I still contribute anyway. I wanted to roll my current and active 401-k into an IRA with another financial institute but its only allowed if I leave my present employment and then rollover the 401-k to an IRA. Wish my current 401-k plan was also a Roth but its not unfortunately.
Will 401Ks be such a hot idea when withdrawals are taxed at 50%?
You can “borrow” from a plan if you pay the money back. There is no penalty or tax hit if you borrow.
You “dip” in if you take an early withdrawal that you don’t pay back, which is what it sounds like the OP did. You pay taxes on the money you took (since they were invested with pre-tax money) as well as a penalty for early withdrawal. This is not good.
I was just trying to help you understand the way a 401k works.
You really don’t get it?
You need to talk to your plan administrator.
I’m outta here!
I was just pullin’ your leg. Thx ... :)
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