A 401(k) plan is one of the better perks of employment. It is a tax-advantaged retirement plan that -- as of 2012 -- allows contributions of up to $17,000 toward retirement savings, much more than the $5,000 permitted for individual retirement accounts. Employers often contribute additional funds on behalf of employees. While your 401(k) nest egg should ideally be used in retirement, you may be able to access your funds in case of emergency.
If you are still young, you can afford to invest your 401(k) a little more aggressively since you have time on your side. According to Forbes.com, the stock market consistently has higher returns than the bond market over 25-year periods. If you have more than 20 years until retirement, you can ride out the short-term ups and downs of the market in search of the higher average long-term return. Questions arising about the long-term solvency of the U.S. Social Security system, coupled with the abandonment of traditional employer pensions, may mean your 401(k) might be your only source of retirement income. Growing your 401(k) nest egg to the highest possible value might be a necessity.
While the goal of most 401(k) investors should be to accumulate the largest possible balance by retirement, you can't simply throw caution to the wind. Protecting your 401(k) nest egg is critical, particularly if it is going to be your main or only source of retirement income. You can afford to be more aggressive while young, but as you age you should dial down the "high-risk, high-return" portion of your 401(k) toward investments that are more conservative in nature, such as bonds. Even while young, being aggressive should not equate with investing solely in speculative stocks. Owning a diversified portfolio that you can modify over time is the best way to help protect your nest egg.
Roll It Over
If you leave the job through which you have a 401(k), you have the option of rolling it over into an individual retirement account. In an IRA, your investment options are nearly limitless. They include stocks, bonds, mutual funds and real estate investment trusts. In a 401(k), you are typically limited to a selection of mutual funds, often from the same investment management company. If you do roll your 401(k) over into an IRA, however, you will no longer have the option of borrowing from your funds.
You generally can't take money out of your 401(k) before you are age 59 1/2. If your distribution is allowed, which typically only happens in cases of extreme financial hardship, you will have to pay income tax on the withdrawal, plus a 10 percent penalty if you are under the age of 59 1/2. You are also prevented from contributing to the 401(k) for the following six months. However, if you have a true emergency, such as a pending foreclosure or overwhelming medical bills, you may consider tapping your nest egg. While not the most prudent action for your long-term retirement plan, tapping your 401(k) might be the only way to go if you have limited options.
- Forbes.com: Why Stocks Are Still the Best Long-Term Investment
- U.S. Social Security Administration: The Future Financial Solvency of the Social Security Program
- Forbes.com: Make Sure Your 401(k) Nest Egg Isn't Cracked
- CNN Money: How to Invest in a 401(k)
- Fidelity.com: What to Do With an Old 401(k)
- Smart Money: Tapping Your 401(k) Before You Retire
- IRS: IRS Announces Pension Plan Limitations for 2012
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