C A 401(k) plan is the duffel bag of retirement investments.
You can stuff more into it every year than you can into an individual retirement account. And it's perfect as carry-on luggage if you change jobs or don't need the money immediately after retirement. Also, the 401(k) is easier to dip into for unexpected needs than an IRA.
When the 401(k) legislation was written in the late 1970s, its authors wanted to encourage people to put money away for retirement and not touch it.
So, they included some stiff disincentives for withdrawals before age 59 1/2 : a 10 percent penalty plus taxes on both the pretax wages and the plan's earnings.
Some people misread those rules and think that they'll be liable for those penalties if they leave their jobs before they're 59 1/2 . That may stop some people who expect to stay in a job for a short time from joining their company's 401(k) plan. Wrong.
"Plans are portable. You can leave them for a while, they can be rolled over into an IRA or rolled over into another existing retirement plan," said Hal Cumberland, a stockbroker with American Discount Securities in Wichita, Kan.
When you retire, you can either take your 401(k) savings in a lump sum or take it as an IRA.
If you take the lump sum and want to roll the money over to an IRA, you should keep that IRA account separate from any other IRAs you already have, said Steve Yager, a certified financial planner. That's because there will be different tax liabilities on that rollover IRA when you reach the mandatory age to start withdrawing money.
If you take the money as an IRA, you can use five-year forward averaging to save taxes. You will still pay all of the taxes in one year, Mr. Yager said, but it will be at a lower rate.
That applies to anyone who reached age 50 after 1986. For those who were 50 before 1986, they can elect to take five-year or 10-year averaging. Those taking the 10-year averaging, however, must pay the single tax rate in the 1986 income tax schedule.
Most people find the five-year averaging to be the most advantageous, Mr. Yager said. But he suggests having your financial adviser figure it both ways if you're eligible for the 10-year averaging.
But what if you need money in your 401(k) plan early?
If you can prove financial hardship and that you've exhausted all other savings, you can claim the money you have contributed without a penalty. No matter what your need, you can't touch your accrued earnings or your employer's matching contributions.
But many plans offer an alternative: borrowing from your account. You'll pay interest, and you can only borrow half of your plan's assets.
Is it wise to borrow from yourself?
"Assuming you had other funds -- a money-market fund, a passbook savings account, even bonds -- it's better to use them," Mr. Cumberland said. That's because the money you borrow won't be earning on that tax-deferred, compounding basis.
You also wouldn't qualify for income tax deductions on the interest, as you would for a home-equity loan, for example, Mr. Cumberland said. However, if you're borrowing less than $5,000, a home-equity loan with its paperwork and loan costs might not be the best choice.
He also cautions employees to consider the psychological costs of borrowing, particularly if the work for a small company where ++ the executives might be closely involved managing the 401(k) plan.
"A smaller company, it might put the staff to a bit of trouble -- setting up the payroll deductions, for instance. So they wouldn't want to see you do it very often," he said.
"If you're continually dipping into your retirement account, it might give the impression that you can't handle your own finances -- which might count against you for a promotion."