Monday, August 29, 2011

Financial FICTION #6: 401(k)s, or qualified plans in general are the best way to plan for your retirement

Financial FICTION #6: 401(k)s, or qualified plans in general are, hands down, the best way to plan for your retirement.
How did this belief become so prevalent in the first place? The two biggest reasons are that you receive matching contributions from your employer, and you also get a tax break. But is that the end of the story? Of course not. Generally speaking, these programs come with the following rules (also known as restrictions):
  • Your contributions are limited to a certain dollar amount or percentage of your income.
  • You’ll have to wait until you reach age 59½ to withdraw the money in your account, because not only will you be taxed on any withdrawals made before that age, but you’ll also be penalized with an extra 10 percent excise tax for not playing by the rules of the game.
  • You can avoid such taxes by taking a “loan” instead of withdrawing the money permanently – if your employer allows it. What most folks don’t realize is that such a loan must be repaid on a set schedule dictated by Uncle Sam, or else it will be considered a distribution and therefore taxed (plus the 10 percent penalty if you are younger than 59½ ).
  • Once you have reached age 59½ and you begin taking distributions, you’ll have to pay taxes on 100 percent of those amounts at whatever the current tax rates is. That is because these programs simply postpone, delay, or defer the taxes until a later date. Please read my column on Financial Fiction #1 for how that really works 
  • Then at age 70½, you must begin withdrawing a certain “Required Portion” of these funds, the amount of which depends on your age and the amount of money in your account. If you breach either of these, there’s a 50 percent penalty on what you should have taken out.
Another thing I keep wondering is, if the matching contributions are the sole benefit of participating in an employer-sponsored plan, what happens if the matching ends? Does the whole program go from “good” to “bad”? There must be a better way, wouldn’t you agree?

What most investors need to understand is that there are alternatives to qualified plans that can produce the same – or in some cases, better – returns, without all the strings associated with qualified 401(k)s and the like. Of course, I’m not saying that these alternatives are necessarily better. But it would behoove investors and their advisors alike to consider the complete picture, including what actually happens when retirement arrives.
Contact a financial professional at Laser Financial Group today to schedule your complimentary session where we can investigate whether a qualified plan like a 401(k) is really the best option for you. or 301.949.4449

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