Most of us know what 401(k)’s and IRA’s are, but these very common forms of investing are often not fully understood or used to best advantage. Fee-Only CFP® professionals and Accredited Investment Fiduciaries (AIF®) are a knowledgeable resource for decisions about these types of accounts and appropriate investment options. This is the first of two blogs exploring 401(k) and IRA plans and their variations, as well as the most common investment features you may be considering.
401(k)’s are retirement plans sponsored by employers for themselves and their employees. Participating employees are allowed to divert a portion of their salary into this long-term investment plan, while being eligible for special tax benefits under IRS guidelines. If your employer does not offer this retirement option, or for some other reason you do not have access to a 401(k) plan, you have the alternative to start your own IRA (Individual Retirement Account) and receive tax benefits in this form of retirement planning.
Let’s take a look at the two most popular types of 401(k) plans, Traditional 401(k) and Roth 401(k).
Traditional 401(k) plans allow you to make contributions without paying taxes on that money but, you will pay taxes when you take distributions in retirement. The benefit to the Traditional is that when you do take distributions during your retirement, it’s likely you will be in a lower tax bracket than when you first earned those dollars. In a Roth 401(k) your contributions are taxed, but the dollars grow tax deferred and qualified distributions are not taxed at all. So when you take distributions, you will get the full amount of the distribution.
Your company’s 401(k) plan presents you with many types of investments and the plan is typically administered by one of three types of ‘third-party administrators’ (TPA); a bank, a brokerage or an insurance company. You are then left to choose your contribution levels and select your investments. Most people are like a “deer in the headlights”, not knowing what to do. Though you’re told there are representatives available to help you, unless the 401(k) plan offers an independent fiduciary investment advisor (not provided by banks, brokerages or insurance companies), they cannot advise you on how much to invest or how to choose your investments. Only an independent fiduciary investment advisor is legally permitted to assist you in selecting the right blend of investments from the options presented by your employer’s plan. You would expect this service to be expensive, yet the fees associated with this type of arrangement can be quite competitive or even less than the typical plan where many hidden fees are frequently imbedded.
So, it’s important for employers and their employees to be aware and to consider this option for their plans. An independent, Fee-Only Certified Financial Planner™ professional or an AIF® has the knowledge, experience and fiduciary status to advise employers and their employees on the best selection of investments that will blend with their worthwhile plan. Next time we will take a similar look into IRA’s.
Have a great weekend!