With the migration from company sponsored Defined Benefit
Plans to Defined Contribution Plans such as a 401(k), 403(b) or Deferred
Compensation (457), it is critical to choose the correct plan, allocate your
assets according to your objectives and designate the appropriate
beneficiary(ies).
Having been in business for over 25 years we have been
witness to some mistakes in each category.
Assuming that you are in a combined Federal and New York
State tax bracket of 30%, it is generally to your benefit to choose a
retirement plan that allows for tax deductible contributions. If we use the tax
brackets above as an example, for every $1,000 deposited into the plan, your
tax savings would be $300. Therefore, saving $1,000 would only cost you only
$700. The other $300 would be tax savings.
As a rule of thumb, remember that it is better to choose
plans that allow for tax deductible contributions if you are in a relatively
high tax bracket versus plans that do not allow for tax deductible contributions.
The opposite holds true if you are in a low tax bracket.
Most company sponsored plans now offer tax deductible
contributions defined as a Traditional 401(k), 403(b) or 457 as well as Roth
401(k), 403(b) and 457. Traditional plans offer tax deductible contributions
and taxable withdrawals while Roth plans offer non-deductible contributions and
tax-free withdrawals. Keep in mind that regardless of whether you choose the
Traditional or Roth, both may levy tax and penalties should you need the money
prior to normal retirement age.
Please check with your tax advisor prior to investing.
After selecting the plan that fits your needs, your next job
is to fund the plan. Under this category, try to deposit at least an amount
that maximizes your employer match, should there be one. Most employees tend to
become too conservative with their investment strategy or concentrate their
deposits into company stock. Both are mistakes. As a rule of thumb, we would
recommend those under 50 with more than 10 years until retirement invest on no
more than a 3:1 ratio of stocks to bonds.
Those over 50 with five to 10 years should use a ratio of no
more than 2:1 stocks to bonds while those within five years of retirement 1:1
stocks to bonds. Those under 40 with more than 20 years until retirement should
invest nearly their entire balance in the stock market. Once again, every
situation is different so consult your advisor.
An asset allocation mistake that we have also noticed is
having an over-concentration of contributions and accumulated balances in the
stock of the company you are employed by.
In the Capital District, some employees of General Electric
have deposited more than 50% in their company stock. We believe that in so
doing, you are assuming an undue amount of company specific risk and creating
an undiversified portfolio that has a low correlation and low level of
predictability relative to the total stock market.
This can lead to a high level of volatility and poor
performance.
On the flip side, upon retirement and the attainment of age
72½, make certain that you are taking mandatory retirement distributions.
Coordinate this with you planner and/or tax advisor. Also, keep in mind that
the tax on the withdrawal that should have been made but was overlooked is 50
percent, a pretty steep penalty.
Let’s now touch on the designation of a beneficiary or
beneficiaries. First and foremost, make certain that you designate a
beneficiary. Should you fail to choose a beneficiary, your estate becomes the
beneficiary by default. If married, you will lose the valuable spousal rollover
option as well as the option to stretch the payout beyond the life expectancy
of the beneficiary.
Finally, make certain that you designate contingent
beneficiaries that will receive the proceeds from your retirement plan should the
primary beneficiary predecease the account holder.
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