Money Matters

Money Matters: Advice for a newly employed worker on setting up a 401(k)

CorrespondentFebruary 8, 2014 

Note: This is the second part of a question asked last week from a newly employed reader.

Q. The 401(k) plan offers a “50 percent match up to the first 6 percent.” I’m not sure what that means, but a match sounds good. I’ve never invested in the stock market before and don’t have a clue what investments to select or if I should participate in the 401(k) or do something else. I’ve looked at my budget and I think I can afford to pay for my health insurance, the long-term disability, put up to a $1,000 a month in the 401(k) and save another $250 a month. Any advice you can offer would be great.

A. Definitely participate in the 401(k) plan, not only to save for retirement but also to obtain the matching funds from your employer. If you don’t contribute to the plan up to the amount your employer matches, it’s like turning down free money. The matching plan your employer has means that for every dollar you contribute to the 401(k) they will contribute 50 cents. They are limiting their match to 6 percent of your salary. Example: If your salary is $40,000 and you contribute at least 6 percent, or $2,400, you will receive a matching contribution of $1,200 from the company.

The money you contribute is yours regardless of how long you remain an employee of that company. The employer match is usually tied to a vesting schedule, and if you leave before becoming vested, you may lose all or a portion of the employer’s contribution.

Vesting schedules can be either graded or cliff. With a graded schedule, you own an increasing portion of the company match each year. A five-year graded vesting schedule is typical. After one year of employment, you would own 20 percent; after two years, you would own 40 percent, and after five years, you would own 100 percent and therefore be “vested.”

With a cliff vesting schedule, 100 percent of employer contributions become yours after a set period, but if you leave before that time, none of the employer contributions will be yours. If the cliff vesting requirement is three years and you remain employed for three years, you are vested. Once you are vested, all previous and future employer contributions are yours, regardless of how much longer you stay with the company.

For 2014, the maximum an employee can contribute is $17,500, with an additional $5,500 catch-up allowed for those participants age 50 and above. The company match doesn’t count toward these amounts. As your income rises, you will probably want to increase your savings, but before you adjust the contribution amount, make sure you get the maximum match. Most company matches are made each pay period you make a contribution. If paid monthly, they will contribute 1/12 of the annual match amount each pay period.

If you elect to have a high percentage of your income contributed to the plan, you may reach the maximum contribution limit early in the year, and contributions must stop. If this happens, you will miss out on any company match for the remainder of the year. Some companies will have a “true up” feature and will make an additional contribution at the end of the year if you reach the allowed maximum contribution prior to year end. Ask the plan provider or your human resources representative about any features you don’t understand.

If you’ve never invested before, you could either research the investment options yourself, meet with a representative from the plan provider or meet with an objective knowledgeable outside adviser such as a fee-only financial planner/investment adviser. Many 401(k)s are offering a Roth 401(k) as well as the typical pre-tax salary deferral. The company match will always be pre-tax, but you may have the choice to invest your salary deferral amount in either an after tax or before tax 401(k). An adviser can also help determine which type of deferral would make the most sense in your situation.

Holly Nicholson is a certified financial planner in Raleigh. She cannot answer every question. Reach her at askholly.com or P.O. Box 97128, Raleigh, NC 27624

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