The Basic Types of Retirement Plans

Retirement plans have been front page news in the past few years, mostly in negative ways. Polaroid retirees watched their pensions disappear. Enron employees were prodded to put their retirement money into Enron stock, and you know what happened to that. Then there are General Motors's current problems.

If you're changing jobs, you'll want to know whether your prospective employer offers a traditional pension plan, a 401(k) plan, a 403(b) plan, a stock purchase plan and/or stock options. But it's never a good idea to base your job decisions on these free or cheap benefits, for the reasons noted above. They're usually cheaper for employers than increasing salaries, but they're riskier for you. However, they're part of your pay package and you need to calculate their impact.

Old-fashioned "defined benefit" pension plans
There aren't many of these any more except in government and old companies like GM, where people used to take jobs right from school and stay with them forever. They sound wonderful, but the Polaroid folks didn't think so when theirs went south. Yes, the plans are protected by the Pension Benefit Guaranty Corporation and regulated by ERISA, but protection is far from a hundred percent.

If all things are equal between two offers and one of them has a defined benefit plan to which you don't have to contribute, it's probably a plus. But don't take it to the bank.

401(k) and 403(b) plans
These are the most common form of retirement plans offered nowadays. (403(b)s are 401(k)s for non-profits.) They're good things because so much has been done to make them attractive taxwise. We all know that the money you deposit into them is tax-deferred. In other words, the amount is deducted from your taxable income. You'll be taxed when you take it out, which can be any time after age 59 1/2. When you take it out, you may be in a lower tax bracket. A chilling thought.

A less-noticed benefit is that when you invest in a mutual fund, any income the fund earns is taxable. You usually don't see that income, of course, because it stays in the fund; but you have to pay on it anyway. The interest and dividends that pile up in a 401(k) build up tax-free, and that means there's more of it every year to get interest and dividends on.

Most 401(k)s offer a choice of mutual funds, and sometimes government securities and-this is what happened at Enron-company stock. You can move your money around among the funds fairly often, just as you'd do with your independent investments.

If your employer matches contributions to the 401(k) it's a no-brainer to contribute to the limit of what it matches. That's free money. Many employers match half the contribution, and all of them limit the amount they'll match. A typical half-matching deal: The employer will match half your contributions up to eight percent. So if you contribute six percent it'll match three percent, if you contribute eight percent it'll match four percent, and if you put in twelve percent it'll still match four percent.

The downside is that there's a tax penalty if you withdraw the money before you're 59 1/2. But-and this is another cool thing-you can often borrow money from your plan, subject to individual plan restrictions. Then when you repay the loan, the repayment-and the interest-goes right back into the 401(k). So you're borrowing from yourself instead of sending the money to a bank. Plans are portable; if you leave your employer you can roll them over into another 401(k) or an IRA, or keep them where they are. Do the math before you move your plan; sometimes the employer's contribution isn't vested, and thus can't go with you, until after a certain waiting period.

Some companies, although they're fewer since Enron, match contributions in company stock. You want to make sure you can get it out. See also below.

Stock plans
Stock options were big in the nineties, and haven't disappeared. If you're offered some as part of your salary package, say thank you and take them, but don't count them as part of your compensation. Stock options are cheap for employers, despite increased accounting regulation, for the simple reason that many of them become worthless before they can be exercised. It sounds great if the stock is at 15 and you're offered an option to buy a bunch at 17; but what if it goes down to 13? Also, it takes money to exercise stock options, and maybe you'd rather invest somewhere else. It's an old corporate canard that if employees invest in company stock they'll be able to reap the results of their work. Hey, if your salary can't let you do that, you need a higher salary.

Stock purchase plans can be a good deal, if you keep a close eye on them. Typically your employer deducts money from your paycheck to buy stock for you. The stock is purchased every six months, at up to a 15% discount from the lower of two prices: the beginning price of the six-month period and the ending price. Usually you can then turn around and sell the stock right away, probably without a brokerage fee. Of course, if you sell it you'll be taxed on your profit as income. If you keep it you have a shot at being taxed at the lower capital gains rate later.

My advice: Take the deal-it's more free money-but sell the shares immediately, except for whatever portion you would have bought anyway. So you're taxed. You've also received income. It's dangerous to have too much invested in any one stock, particularly that of your employer. If it goes, everything goes: your job, your savings-you know, the Enron thing.

Salary
The safest part of the deal. Make sure it's what you want, benefits or no benefits.

Article by Homesteader

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