Do you use an employer-sponsored 401(k) plan to save for retirement? A 401(k) is one of the most powerful savings tools available, primarily because it offers tax-deferred growth and possibly employer matching contributions. Those two features can help you accumulate a significant amount of assets over time.
Your 401(k) plan is meant to be a savings vehicle for retirement. However, many plans allow you to take distributions before you reach retirement age. For instance, you may be able to take a loan from your plan. Or you can even cash out your plan balance if you leave your employer.
It can be tempting to dip into your 401(k) balance before retirement, especially if you face an emergency. However, you may want to resist that urge. A new study found that early 401(k) distributions may be creating a retirement crisis. A study from Deloitte estimates that there will be more than $7 billion in 401(k) loan defaults in 2018 alone. The study also found that the loan distributions and the loss of future investment growth could create a $2.5 trillion shortfall for retirees.1
Plan distributions and cash-outs are also creating issues. This usually happens when people change jobs. After leaving an employer, many people opt to take their vested balance in a lump sum rather than roll it into an IRA. This decision eliminates future tax-deferred growth and creates current penalties and tax liabilities. More than 40 percent of job changers cash out their plan, and in 2017 the total value of cash-out distributions reached almost $68 billion.2
You can avoid these risks by planning in advance and staying informed about your options. Below are a few tips on how to protect your 401(k) assets. Your financial professional can also help you develop a strategy.
The costs associated with a 401(k) loan can be significant. Of course, the best way to avoid those costs is simply not to take a loan. If you’re facing a significant financial challenge, however, it may be too tempting to pass up. You may feel like a loan is your best option.
Consider the consequences and the alternatives, though, before you take a loan. You’ll lose future compounded growth on the loan amount. That could substantially reduce your future savings. Also, a portion of your future 401(k) contributions will go toward loan repayment instead of retirement savings. And if you default on the loan, you’ll have to pay taxes and maybe an early distribution penalty. Look at your budget and other options to find an alternative to taking a loan.
If you already have a 401(k) loan, you may want to see if your plan administrator allows early repayments. Some plans allow you to increase your regular contribution and pay off the loan faster. That could reduce your interest payments and get you back on track to saving for retirement.
It used to be that people stayed with one employer their entire career. Those days are long gone. Today, more than 20 percent of 401(k) participants change jobs each year.2
When you change jobs and leave behind a vested 401(k) balance, you have a few options. One is to cash out the plan, which can be tempting. The distribution can provide a quick lump sum of cash to help you pay off debt or achieve other short-term goals.
However, a plan cash-out can be costly. You lose future tax-deferred growth on those funds, and you’ll likely have to pay a 10 percent early distribution penalty on the entire amount. The result is that you’ll get an amount that’s far less than your actual balance.
One way to avoid these costs is to roll your 401(k) balance into an IRA. There are no taxes or penalties when you roll over a 401(k) balance. Also, an IRA offers tax-deferred growth. You can choose from a wide range of tools and allocation options to meet your needs, and then your funds will grow tax-deferred until you retire.
Ready to implement a strategy to protect your 401(k) plan? Let’s talk about it. Contact us today at J. Harris Financial. We can help you analyze your needs and develop a plan. Let’s connect soon and start the conversation.
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18184 - 2018/10/22