How To Fix Your 401(k)

If your retirement plan has taken some punishing blows, these remedies can ensure that your golden years aren't tarnished

the maximum contribution to a 401(k), 403(b), or 457 plan will be $11,000. However, your employer might match, say, only $5,000 or $6,000 of your contribution. Should you max out your 401(k), even if your employer doesn’t match some of your contributions?

Some investors are ardent about maxing out. Indeed, Carol N. Brown, an assistant professor at the University of Alabama School of Law, in Tuscaloosa, believes so much in maxing out her retirement funds that she did it twice in 2001. “At the start of the year,” she says, “I worked for a law firm that offered a 401(k). I knew I was going to be changing jobs, so I made the full year’s contribution ($10,500) by the end of April, to reduce my taxable income.”

Then she took a position at the University of Alabama, which has a 403(b), the type of retirement plan offered by nonprofit employers. “I knew I was prohibited from deferring any more pre-tax contributions this year because I had reached the maximum contribution allowed for that tax year,” says Brown, “but I wanted to get the employer match, so I contributed my after-tax dollars.”

You should consider another type of retirement plan, though, before automatically deciding to max out your 401(k). “After you contribute enough to get the employer match, you might put your next $3,000 into a Roth IRA in 2002,” says Darric N. Boyd, an associate portfolio manager and financial advisor with the investment firm Legg Mason in Baltimore.

Like regular IRAs, the cap for Roth IRA contributions goes up from $2,000 to $3,000 next year, and those over 50 may contribute an extra $500 under the catch-up provision. Contributions to a Roth IRA are nondeductible, but all withdrawals are tax-free after five years, provided you’re at least 59 years old. Your income can’t exceed $95,000 ($150,000 on a joint return) in order to make the full contribution (see “what the New Tax law means to you,” November 2001).

3 Take an outside chance. Suppose you can save even more, that you can equal the sum your company will match, plus (if you’re eligible) contribute $3,000 or $3,500 to a Roth IRA? Should you invest this excess inside or outside of a 401(k)? “If you have a weak 401(k), you might be better off investing on the outside,” says Hunt. “That’s true if your plan has only a few choices or poor performers.”

Melvin Carrington Smith Sr., a certified financial planner at First Financial Group in Birmingham, Alabama, says that your tax bracket will make a difference, too. People starting their careers are generally in a lower tax bracket, so they probably won’t be able to contribute the full $11,000 to their 401(k)s that’s allowable. In this case, money invested above the company match won’t amount to much of a tax break; instead, it could be invested in a separate account that can be accessed in the short term with fewer tax consequences. “[Upon retirement], you might wind up paying a higher tax when you take

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