If you are one of the more than 28 million Americans covered by a 401(k) plan, this might be good time to take a close look at it. Investment advisers are nearly unanimous in their declarations of love for the oddly named retirement savings plan.
It is, quite simply, the deal of the century and probably the best way for an individual to accumulate a large investment nest egg, says Randi Lewis, an attorney and consultant with Buck Consultants, an employee benefits consulting firm.
Its advantages are numerous -- from tax savings to compounding -- and the risks are few. The key to tapping its possibilities is to get in early and stay invested.
401(k) plans -- the name comes from a section of the tax code -- are company-sponsored retirement savings plans to which the employee and employer contribute.
They work like this: After you have worked for a company for a certain period, usually a year, you become eligible to divert part of your salary -- usually not more than 10 percent, but the amount is set by the company -- into a tax-deferred investment plan.
Most companies make matching contributions, paying in, say, 25 cents or more for every dollar the employee contributes.
The employee generally has to work for the company a few years -- usually seven to 10 -- before he can claim the money paid by the employer.
As part of the plan, the employee decides where to invest his contribution. Most plans offer a range of investments from conservative, government-guaranteed bond or money-market funds to growth and income mutual funds.
A word of advice: Gene Wickes, managing principal of the Denver office of benefits consultants Towers Perrin, points out that in most 401(k) plans, the assets are inefficiently invested in fairly low-paying funds.
"Most employees are risk-averse," he said. "That means we tend be too conservative. We tend to choose safe investments with modest paybacks." Over the long run, that could mean that your earnings are skimpier than they might have been with a different investment, for example a growth mutual fund, Mr. Wickes said.
The key here is to educate yourself about the investment options available through your 401(k) plan. Many plans give you several risk levels to choose from. You may want to put some of your investment in a guaranteed bond fund and some in a more aggressive stock fund. That way you spread the risk but also can take advantage of potentially more rewarding investments.
One of the beauties of a 401(k) is that you may choose to make your contribution in pretax dollars, deferring any federal income taxes owed until after you retire and presumably are in a lower tax bracket.
You will pay a 10 percent penalty for early withdrawal -- that is before age 59 1/2 -- unless it qualifies under the IRS's "hardship rules," Ms. Lewis said.
The hardship definition includes medical expenses, buying a primary residence or college expenses, but it does not include withdrawals for home remodeling or buying a car.
However, many company plans offer a loan feature that will allow you to borrow against your 401(k) for any purpose.
Your loan repayment goes directly into your account, and the rate of interest is generally favorable, Ms. Lewis said. Most often, the loan repayment period is five years, but it can be extended, and you may pay a $50 or $75 upfront loan fee, she said.
However, there are things you should consider.
Mr. Wickes advises you to think through the tax implications. You might find you are better off making your contribution on an after-tax rather than a pretax basis if you think taxes are going to rise. If you think they will, you might find yourself paying a hefty portion to the IRS when you finally cash in.
Paying the tax as you go might be cheaper and allows you to use your money without penalty when you want. The latter may be a key point for some, who are stashing the money for shorter-term goals, he said, although the loan feature may make this an unnecessary consideration.
Another benefit of a 401(k) is its portability.
If you change jobs, you get the money you have paid in plus what your employer paid in if you have held the job long enough plus accrued interest, Ms. Lewis said. You can take that money )) and roll it into your new employer's plan, if there is one, or into an Individual Retirement Account, or you can spend it.
Just remember that you will pay a 10 percent penalty if you withdraw early.
"The key here is that you have control over it," she said. "If you want to keep some part of it to spend on remodeling or paying bills or something, you can, and invest the rest."