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Managing Your 401K. One of the major changes resulting from the shift away from pension funds to 401K plans, is that responsibility for choosing investments also shifted from the employer to the employee. That may seem like a scary prospect if you have no investing experience, but you don’t have to be an investment pro. 401K plans are professionally managed by money management firms. These firms put together a wide selection of investment options that an employee can choose from to build their retirement account. Each pay period, the employee and employer’s contributions are automatically deposited into the employee’s 401K account with the money manager. The employee can log into their account, track balances, growth and performance, review different kinds of investments, and change their investments, if they wish. A few money managers whose names you’ll recognize are T. Rowe Price, Vanguard, and Fidelity. Growing Your 401K. In the last lesson, you learned how the power of compounding can supersize savings and investments. Regular long term, employer-matched contributions to a compounding 401K can make an employee very wealthy over time. For example, assume a 30 year old employee regularly contributes 12% of their $65,000 salary to their 401K. The employee’s salary increases a modest 2% per year and the employer matches up to 6% of the employee’s salary. At a compounding rate of 6%, the employee will have about $1,200,000 socked away for retirement in 30 years. It’s really important to not stop or reduce contributions to your 401K. When funds are tight, people sometimes cut back on their contributions to increase their take home pay. The 401K should be the last place to cut back, if at all possible. Reflect on Learning: How potentially valuable is a 401K? A retirement calculator will tell you! Go to www.bankrate.com/calculators/retirement/retirement-plan-calculator.aspx and submit a variety of contribution, investment term, and rate of return scenarios to observe how retirement savings can create a valuable source of retirement income. Vesting in Your 401K. An employee must work for an employer for a specific number of years before they have a permanent right to receive the employer-funded portion of their 401K retirement account. This is referred to as vesting . If the employee leaves the job before they are fully vested they won’t get their full retirement benefits, although they are always 100% vested in the amounts they personally contributed to their account . Vesting Schedules. All 401Ks have vesting schedules , which is a time table that tells how much of the employer’s matching contribution the employee gets to keep if they leave the company. Some vesting schedules provide that employees are immediately 100% vested in the employer’s contributions. Others are graded , meaning the percentage increases each additional year the employee stays with the company . For example, a typical vesting schedule provides that in employment years 1 and 2 the employee is 0% vested, years 2+ = 30% vested, year 3+ = 60% vested, year 4+ = 100% or “fully vested”. It’s important to know your 401K vesting schedule so you don’t quit to start a new job just before you’re scheduled to vest in a significant sum of your employer’s matching contributions! When you start a new job, vesting status does not carry over. You begin again on the new employer’s vesting schedule. Rolling Over Your 401K. According to the Bureau of Labor Statistics, the average worker holds ten different jobs before age forty. What happens to the money in their 401K? When an employee gives notice they are quitting their job, they “roll over” their money to Individual Retirement Account (IRA) , discussed below. The rollover process is managed by the company’s HR department so that the employee is not considered PRODUCT PREVIEW
THE 21st CENTURY STUDENT’S GUIDE TO FINANCIAL LITERACY 179
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