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We receive a
number of e-mails from workers who are upset that their new
employer won't let them start contributing to the 401k plan
right away.
These workers want to
know what is the best way to keep saving in the interim.
When you start a job with a new
company, there's a good chance you'll be in this situation. More
than one-third (41.6 percent) of employers surveyed in 2000
required workers to wait six months or more before they could
participate in the 401k plan. Just over one-quarter (27.2
percent) had a one-year waiting period, the longest permitted by
law, according to a study by the Profit-Sharing/401k Council of
America (PSCA).
So how do you keep saving
for retirement? It's a very good question. In order to answer it,
you need to first answer this one: Are you concerned about the
lost tax deduction or the lost savings opportunity?
Your answer will help direct the
strategy you choose to keep your savings program going. There are
tax-deductible and nontax-deductible strategies.
The Cost of
Missing
There's a good reason why you
should think about the impact of interruptions on your retirement
savings. If you don't, you could be hurting your future.
Missing a year early in your
working career will have the greatest impact on your retirement
balance because you will miss out on compound interest, said Bob
Francis, president of corporate markets with ING-Aetna Financial
Services.
"The front-end deposits (and
growth on them) represent the biggest share of the ending account
balance," said Francis.
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"The
front-end deposits (and growth on them) represent
the biggest share of the ending account
balance."
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—
Bob Francis, president of corporate markets,
ING-Aetna Financial Services.
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Here's how compounding works.
Suppose you're 25 years old and make a one-time
contribution of $2,000 to a 401k plan with a 50 percent employer
match. The total amount contributed would be $3,000. If you got an
8 percent annual return, in 30 years, the $3,000 would grow to
about $30,000.
Now let's look at what that same
$3,000 contribution would be worth if you made it at age 45. In 10
years, it would only grow to about $6,500.
Those numbers are a compelling
reason to figure out a way to save.
Tax Strategies
If getting a tax deduction is your
big concern, you probably have only one alternative: making a
tax-deductible contribution to a traditional IRA. But, if you
contributed to a 401k or other employer-sponsored retirement
plan at another employer during the tax year, you can only make a
deductible contribution to an IRA if you meet the income
requirements.
Also, the maximum IRA contribution
limit is $2,000 a year, well below the 401k pretax contribution
limit of $10,500 for 2001.
Savings
Strategies
Retirement experts interviewed for
this article said that while a tax deduction is attractive, it's
more important to make sure you don't stop saving.
"A concern I would have is the
loss of (savings) momentum," said Elise Pilkington, assistant
director of retirement and investor services with the Principal
Financial Group, a 401k plan provider.
Workers who don't save regularly
may find that the cost of their lifestyle rises to match their
income. "Could you adjust if you jumped back in (to
saving)?" she asked.
Here are strategies for maintaining
your savings rate while you're waiting to become eligible for your
401k.
IRA: Contribute to an IRA. Anyone
with earned income can contribute to an IRA. As explained
above, if you participated in an employer-sponsored retirement
plan at any time during the year, your income level will determine
whether your contribution is deductible and to what extent.
Even if you can't make a
tax-deductible contribution to a traditional IRA, you can still
make an annual contribution of $2,000 to the account and take
advantage of tax-deferred growth.
A number of retirement experts
recommend that instead of contributing after-tax money to a
traditional IRA, consider a Roth IRA, providing you meet
the income limits. Here's why: Both accounts are funded with
after-tax dollars (you can't deduct your contribution), and both
accounts grow tax-deferred. The difference is that you won't have
to pay tax on your withdrawals from a Roth IRA, if you meet the
conditions, whereas you do have to pay tax on your earnings when
you take withdrawals from a traditional IRA.
Double Your Contributions:
Another possible strategy is to double your contributions when you
finally can participate in the 401k. Here's how: While you're
waiting to become eligible, open a savings account and deposit the
money you would contribute to the 401k if you could. When you
become eligible for your 401k, double your contribution,
providing you stay within the contribution limits stipulated by
the plan document. To make up for this drain on your income,
gradually withdraw the money from your savings account.
The drawback to this strategy is
that the money in your savings account won't compound over time,
unless you can afford to leave it there while you're contributing
double to your 401k.
Negotiate: You could ask
your employer to compensate you for the lost savings
opportunity. Some employers offer nonqualified plans that you
might be able to contribute to. Or, you might be able to receive a
bonus.
The drawback to this strategy is
that it's often only for top employees. But, given today's tight
job market, it may be worth a try.
Open an Annuity: If you
think the $2,000 annual IRA contribution limit is too low, you
could consider contributing to an annuity.
You use after-tax dollars to invest
in an annuity but, like an IRA, all your money grows tax-free. You
pay income tax on the earnings when you receive payments from the
annuity. There is no federal maximum contribution limit, and the
limits set by individual providers tend to be high (over
$100,000).
But, you also have to consider that
annuities generally carry higher fees than other investments
because of the guarantees they provide.
Buy Growth Stocks: If you
feel comfortable making your own stock picks, you could do what
Virginia Morris, author of The Essential Guide to Your 401k
Plan, recommends — buy growth investments that you will own
for 10 years or longer. "Don't look for stocks that provide
income (dividends)," she urged.
Over time, hopefully the stocks
will appreciate, and you only pay tax when you sell them. You will
owe long-term capital gains tax, which for many folks will be less
than their normal income tax rate.
If you opt for this strategy, you
must be comfortable with the relatively high level of investment
risk you will be taking.
Younger Than 21
Employees under 21 may have to wait
longer than one year to become eligible to participate. Many
401k plans exclude these workers figuring that they will likely
change jobs soon, which complicates administration of the plan.
If you're in this situation and
want to start saving, try an IRA, Pilkington says. If you remain
ineligible for the employer-sponsored plan for the entire tax
year, you will be able to make a fully deductible contribution to
a traditional IRA.
But, don't overlook the Roth IRA
and the tax advantages it offers at retirement, Pilkington said.
This may be even more beneficial; it depends on how badly you want
the tax deduction now.
Other strategies listed in the
section above might also appeal to you. 
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