|
Cents and Sensibility Guy Steele |
Keep investing in your
401(k) in any marketQuestion: I've held off putting money into my 401(k) until the market rebounds. Is this a good strategy?
Answer: It's not easy to keep contributing to your 401(k) when the market is down. After all, it's discouraging to see the balance drop on an account that's designed to provide money for retirement. Nonetheless, stopping or decreasing your 401(k) contributions could prove even more costly in the long run.
Even if you made the right moves and built a diversified 401(k) portfolio, it probably lost about 13 percent of its value in 2002, according to a study by the Vanguard mutual fund company. However, over the first three years of the current bear market, from 2000 through 2002, the study showed that the picture wasn't quite as gloomy; the median participant's 401(k) declined 6.3 percent per year
Furthermore, thanks to the sluggish economy, some companies have suspended those 401(k) matching contributions that are linked to profits, according to the Profit Sharing/401(k) Council of America.
These converging forces may have caused you to think about taking a "timeout" from your 401(k). And yet, that would almost certainly be a mistake.
Why? Because if you're a member of the "baby boom" generation, or if you're even younger, you'll likely spend two to three decades in a healthy, active retirement -- so you'll clearly need substantial financial resources. Along with Social Security and your personal investments, your 401(k) can be a big part of your retirement savings. And there's no way you'll help your 401(k) grow by not contributing.
Also, by not putting in money to your plan, you'll lose out on pre-tax contributions and the potential for tax-deferred growth.
Let's see how these tax features can help you.
First, you generally use pre-tax dollars to fund your 401(k). So, if you're in the 25 percent tax bracket, and you put in $10,000 to your 401(k) in one year, your contributions will really only cost you $7,500. That's an immediate 25 percent savings in taxes.
Next, your 401(k) earnings grow on a tax-deferred basis. Over time, tax deferral can make an enormous difference in your total accumulation. Suppose that you put in $10,000 to your 401(k) for 30 years, and your hypothetical average rate of return is 7 percent. When the 30 years are up, you will have amassed slightly over $1 million. (This calculation is merely an illustration; it does not represent any investments currently available.)
On the other hand, if you put that same $10,000 per year into a taxable investment that earned a hypothetical 7 percent, you will have only $730,000 at the end of 30 years, assuming you paid the federal tax rate of 25 percent. (If state income taxes are assessed, this figure will be lower.)
Of course, your 401(k) earnings are tax-deferred -- not tax-free. So, you will eventually have to pay taxes on withdrawals from your 401(k). But by the time you start taking 401(k) distributions, presumably when you're retired, you may be in a lower tax bracket. And even if you're not, you can find ways to spread out your payments to help you minimize your tax burden.
Clearly, these tax benefits will be of great value to you as you build your 401(k). So, no matter what the markets are doing, or what's happening with your employer's match, be persistent and keep putting away money in your 401(k).
If you just can't stand to see your balance dropping, review your plan with an investment professional to discuss your goals, risk tolerance, and time horizon. In the long run, investing regularly in those 401(k) options that offer you growth potential, diversification and quality should bring you closer to your retirement goals.
See the Columnists section for some past articles.
Guy Steele is a financial planner and head
of the Pali Palms office of Edward Jones. Send
planning and investing questions to him at 970
N. Kalaheo Ave., Suite C-210, Kailua, HI, 96734,
or by email at: gsteele2@pixi.com