Investing in a company retirement plan (401K/403b/457/TSP) does not have to be complicated, but you MUST do a little research before making the most of this great opportunity. When your employer offers a retirement plan, they must provide you with the details about the plan. Read the booklet they give you closely and look for those low-cost, broadly diversified index funds hopefully offered by Vanguard, Fidelity, or Schwab. ALWAYS keep your costs as low as possible when investing and that equals low cost index funds.
Before we move on let me say just a few small words about borrowing against your retirement plan. Don’t do it! People borrow money against their retirement plan all of the time, and this is again another reason why so many people are BROKE! Do not borrow money out of your plan for any reason other than you have a few days to live and you don't give a damn about the future. That will not apply to almost all of you so keep the money in there working for you until you need it years down the road.
If you receive company stock as part of your matching money, sell it as soon as you can and move that amount into diversified index funds. You definitely want to avoid owning the stock of the company you work for. You already rely on them for your income. Do not rely on them for your retirement as well. Google Enron for an example of what not to do with your retirement money. Finally, identify your vesting period. This is the time needed before the matching money becomes yours. Stay put as long as needed to get that money!
You may have a target retirement or lifecycle fund in your plan that says something like Target Retirement 2020 or 2040. The 2020 fund may have a breakdown of 30% U.S. Stocks, 20% International Stocks, 45% Bonds, and 5% Money Market funds (cash). The 2040 fund may have a breakdown of 56% U.S. Stocks, 32% International Stocks, 10% Bonds, and 2% Money Market funds. As time goes on, those funds will become less aggressive (more bonds and cash, less stocks). They rebalance for you. If you want to use one of these types of funds, go for it. They are simple and a good choice for many. One fund may be all you need.
There is a default fund that your money goes into initially. It is usually a very low-risk investment or a Target Retirement Fund. Your company starts you there, because it is safe or geared to when you hit age 65. You don't have to keep your money in that fund. Review your options and make changes based on your personal situation and understanding of asset allocation. This could mean more low fee stock index funds for many of you based on what is offered and your current situation, age, risk tolerance, etc. For all military members and government workers, you will see a list of your funds (in parenthesis) that are basically identical to the fund in front of it. See below.
You want to identify if you have a traditional plan (before tax) or a Roth plan (after tax). You should consider a Roth plan, if you are not making that much money and you expect to pay more taxes later — $70,000 is a rough number to use when deciding. Under $70,000, go with the Roth; over $70,000, go with the traditional. This is not a hard science; make the call after plenty of consideration, when taking into account your own particular situation and the federal and state income taxes you pay. Take your time, and educate yourself about your options before you act.
This issue gets a bit more complicated when you live in a no income tax state. You might want to increase that number to $80,000 when determining whether to go Roth or Traditional. As for the married folks, $140,000 in total family income could be used as a threshold. Under that amount go with the Roth and over that number, go with the Traditional. What if you live in a no state income tax state? You might want to increase that amount to $160,000 or something close to that amount. If you are close, you could also do some Roth and some Traditional. Make the call!
Here is one approach for those of you who want to retire early (before 59.5). No matter what your income, put your contributions in via Roth. Be sure to open a Roth IRA as soon as possible outside your work. Load up for years inside that Roth 401(k). When you are ready to leave the world of work, transfer all of that Roth 401(k) to your Roth IRA, which has been opened for over 5 years. Move your matching money to a Traditional IRA. You can now treat all of that Roth 401(k) as contributions. That is a BIG deal. Keep reading as I describe an example.
Let's you have put in $150,000 in contributions over time into your Roth IRA and that produced earnings of $100,000. Next, you transfer the Roth 401(k) money and its earnings over to your Roth IRA. In this example, that amount is $600,000 (you were able to put in more into the 401(k) than the IRA. That $600,000 added to the $150,000 could be used by you immediately tax free and penalty free for you to pay the bills. The $100,000 in earnings from the Roth IRA will need to be delayed until age 59.5 to avoid a penalty on early withdrawal. The rest is for you right now!
Here is what I would do. If my time horizon was beyond 10 years, I would be as aggressive as possible and that means mostly stocks and probably all stocks. This means a lifecycle/target date fund (owning index funds) with the biggest number attached to it or select some combination of an assortment of stocks to include small-cap, international, and large-cap mix, preferably broadly diversified index funds.
Once I came up with a plan, I would sock that money away each month and ignore everyone who tries to predict the market. If I got matching money in individual stock, I would monitor it carefully and sell it one time each year, and then move the money into the funds that I just mentioned. Keeping much, if any, money in your company stock is unwise. Read about Enron, Tyco, and Lehman for further details.
If you are young, you will probably have many employers over your career. Every time you start with a new employer, review their retirement plan and their investments carefully and start investing as soon as you can. Find out how long it takes to get vested (the time it takes before that matching money they give you is all YOURS). This is usually around 5 or 6 years.
When you leave an employer, take your plan with you. This is quite simple. Go to vanguard.com and have them transfer your money (you want to do this trustee-to-trustee, without touching it yourself to avoid any possible penalties or taxes) into a traditional IRA (from a traditional 401K) or a Roth IRA (from a Roth 401K). DO NOT let your retirement accounts languish at previous locations. Go get them!
