Getting Your 401(k) In Shape

If managed properly, this account should far exceed the monthly social security check as a source of retirement income

tilted too far in favor of higher-income workers. For instance, only those [who are] able to afford to contribute the maximum amount will typically be able to put away even more under the new limits. These workers are likely to be higher-, not lower-, paid. To defuse political opposition, the act added a new tax credit for certain low- and middle-income individuals who contribute to 401(k)s or other plans. The tax credit, ranging from 10% to 50%, depending on salary, is on contributions up to $2,000 for income below $25,000 for singles, $37,500 for heads of households, and $50,000 for married couples filing jointly. The credit is not available to students or dependents. You should find out if you qualify and make sure you take advantage of these tax credits if you do.

If you are contributing the maximum and you want to save even more, you may be able to make after-tax contributions as well. While the earnings on after-tax money will grow tax-deferred, the contributions aren’t likely to be matched by your employer. And if you choose to withdraw your after-tax contributions early, you must also withdraw a proportionate amount of the earnings the money has generated–and you’ll have to pay taxes, plus a 10% penalty, on the earnings (though not on the after-tax contributions themselves).

Is my employer required to match my contributions?

No, but most do. The consulting firm Hewitt Associates reports that 97% of employers provide some form of match or contribution to employees’ 401(k) plans. Typically, employer matches are set as a percentage of worker contributions, or based upon company profitability. Many companies, for example, put in 50 cents for every dollar of employee contributions; other companies match dollar-for-dollar, and some even match two-for-one.

Six years ago, the William M. Mercer benefits consulting firm found that 85% of plans with some form of employer contributions matched at least one-half of worker contributions. By 2000 that number had risen to 89%. But in response to the slower economy, lower profits and cost-cutting pressures, many companies contributed less money to 401(k) programs in 2000 than in 1999.

What happened to 401(k) assets in the 2000-2001 bear market?

The bull market of the late 1990s covered a multitude of 401(k) investor sins and it wasn’t hard to be a big winner. In fact, about 80% of the growth in 401(k) assets from 1995 to 2000 was due to market appreciation, according to consulting firm Cerulli Associates. Today’s market leaves no room to hide.

In August 2001, EBRI and the Investment Company Institute, the Washington, D.C.-based trade group for mutual fund companies, reported that the average 401(k) account balance declined by 12% in 2000, to $48,988 from $55,502 in 1999. This marked the first year ever in which 401(k) assets declined.

Why can’t I just lock in my gains by cashing out when the market is turning down, then get back in when the market is turning up?

This is called market timing and it rarely works. When investors try to get all the upside and

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