The most important decision you’ll ever make about your employer’s retirement plan is to SIGN UP! Many of the retirement plans offered by employers give the employee the choice of whether or not to participate. Do participate!
Why should you consider your employer’s retirement plan? You will need savings in addition to Social Security and your pension (if you even have one) to have the kind of retirement you want. And, your employer may offer a company match that you’ll only get by making contributions to the plan. You can consider this a tax-free raise.
In addition, the plan’s tax benefits help your money grow faster. When you put money into your employer’s retirement plan, those contributions are subtracted from your taxable income. You will pay taxes when you withdraw money (ideally, years from now when you’re in retirement), but in the meantime you’ve used the government’s money to make more for yourself. For example, if you decide to live on $50 less per month, you will be able to contribute around $65 because of the tax savings. That extra $15 will earn even more money, since it is compounded every year until you take it out.
What if you decide you’re contributing too much, or not enough? You can change the amount of your contribution at any time. And, you can enroll or stop at any time, not just during your company’s annual open enrollment period for other benefits.
Choosing among the investments offered can be baffling. Keep it simple by following these tips. Whether your plan offers five mutual funds or 500, most will fall into five categories: Large Cap funds that invest in the stock of large US companies, Small or Mid-Cap funds, foreign stock funds, bond funds, and stable-value, short-term or money market funds. You might also see sector funds, which invest in just one industry, or funds that invest in both stocks and bonds such as asset allocation or lifecycle funds. But the first five categories listed above provide all the choices you need for a well-diversified portfolio.
Which fund should you choose in each category? If your plan offers index funds, they would be an easy choice. Index funds try to match the performance of a large basket of stocks or bonds, rather than trying to choose the best stocks or bonds in hopes of beating the market. Research indicates that, over time, index funds tend to do better than other funds, partly due to their lower costs—index funds seldom buy or sell investments, so trading expenses are very low.
Another approach would be to compare your plans funds with the ratings published annually in the March issue of Consumer Reports to choose a fund that has performed well over time. Virtually every financial magazine also publishes ratings of mutual funds, but those listings can be overwhelming. Consumer Reports narrows down the choices based on sound criteria (for example, they only list funds that charge no commission to invest in the funds) and makes the information easy to digest.
A well-diversified portfolio has money in stocks, bonds, and “cash” which includes money market and other savings accounts. Look at all your investments together to decide where new money should be invested. Keep money for your emergency fund in CDs or a money market account. (Emergency funds should NOT be in a retirement plan.) Your next investment might be either large cap stocks or bonds—or some of both. Round out your investments by adding small company stocks or foreign stocks.
Start with just one fund if each charges a fee that seems large in comparison with your contribution. For example, each fund might charge $20 per year and you’re contributing just $500. In a couple of years, transfer some of that money to another fund or split your contributions between two funds. As the value of your portfolio grows, you can gradually spread your money across all five categories.
For more help understanding investments and retirement plans, visit University of Illinois Extension’s Plan Well, Retire Well web site at www.RetireWell.uiuc.edu.
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Source: Karen Chan, Extension Educator Consumer and Family Economics
Countryside Extension Center
University of Illinois
(708-352-0109
November 2004
Edited by: Lois Smith (618-692-9434)
