With the migration from company-sponsored defined benefit plans to defined contribution plans such as 401(k), 403(b) or deferred compensation (457), it is essential to choose the right plan, d Allocate your assets according to your objectives and designate the appropriate beneficiary(ies).
In business for over 25 years, we have seen some mistakes in every category.
Assuming you’re in a combined 30% federal and New York state tax bracket, it’s generally to your advantage to choose a retirement plan that allows tax-deductible contributions. If we use the tax brackets above as an example, for every $1,000 deposited into the plan, your tax savings would be $300. Therefore, saving $1,000 would only cost you $700. The other $300 would be a tax savings.
As a general rule, remember that it’s better to choose plans that allow tax-deductible contributions if you’re in a relatively high tax bracket than plans that don’t allow tax-deductible contributions. The reverse is true if you are in a low tax bracket.
Most company-sponsored plans now offer tax-deductible contributions defined as traditional 401(k), 403(b) or 457 as well as Roth 401(k), 403(b) and 457. Traditional plans offer tax-deductible contributions and tax-free withdrawals while Roth plans offer non-deductible contributions and tax-free withdrawals. Keep in mind that whether you choose Traditional or Roth, both can levy taxes and penalties if you need the money before normal retirement age.
Please consult your tax advisor before investing.
After selecting the plan that suits your needs, your next task is to fund the plan. In this category, try to deposit at least an amount that maximizes your employer, if there is one. Most employees tend to become too conservative in their investment strategy or concentrate their deposits in company stocks. Both are errors. As a general rule, we recommend that under 50s with more than 10 years before retirement invest in a stock/bond ratio of no more than 3:1.
Those over 50 with five to 10 years should use a ratio of no more than 2:1 stocks to bonds, while those within five years of retirement 1:1 stocks to bonds. Those under 40 with more than 20 years before retirement should invest almost all of their balance in the stock market. Again, every situation is different so consult your advisor.
An asset allocation error that we have also noticed is the over-concentration of contributions and accumulated balances in the shares of the company that employs you. In the Capital District, some General Electric employees deposited more than 50% of the shares of their company. We believe that by doing so, you are taking on an excessive amount of company-specific risk and creating an undiversified portfolio that has a low correlation and low level of predictability relative to the broader stock market.
This can lead to a high level of volatility and poor performance.
On the other hand, upon retirement and at age 72.5, make sure you are taking mandatory retirement distributions. Coordinate this with your planner and/or tax advisor. Also keep in mind that the tax on the withdrawal that should have been made but was overlooked is fifty percent, a pretty high penalty.
Now let’s talk about designating one or more beneficiaries.
First of all, make sure you designate a beneficiary. If you fail to choose a beneficiary, your estate becomes the default beneficiary. If you’re married, you’ll lose the valuable spousal rollover option as well as the ability to extend the payout beyond the beneficiary’s life expectancy. Finally, be sure to designate contingent beneficiaries who will receive your retirement plan proceeds if the primary beneficiary predeceases the account holder.
Please note that all data is for general information purposes only and does not constitute specific recommendations. The opinions of the authors do not constitute a recommendation to buy or sell the stocks, the bond market or any security contained therein. Securities involve risk and fluctuations in principal will occur. Please research any investment thoroughly before committing any money or consult your financial advisor. Please note that Fagan Associates, Inc. or related persons buy or sell securities for itself which it also recommends to its clients. Consult your financial advisor before making any changes to your portfolio. To contact Fagan Associates, please call (518) 279-1044.