401(k) Overview

A 401(k) or similar investment vehicle (403(b), 457) provide a way to contribute pretax income into an investment option selected by the administrator of the retirement plan. Pretax investing allows money to invested without reducing your take home pay as much as investing after tax. The effect on tax home pay depends on where you live and the number of dependents you are currently claiming. There is a good calculator from Wachoviahttp://partners.financenter.com/wachovia/calculate/us-eng/paycheck01.fcs where you can see the effect on your paycheck as well as the differences between investing after tax and pretax.

While investing pre-tax income is great, many employers provide some level of matching employee contributions.
This also varies on the employer, but many people are leaving money on the table and not taking advantage of an enhanced return.
Lets consider a hypothetical 50% match on 5% of your salary.
Pay period salary $1,000
Employee contribution 10% = 1000*.1 = $100
Employer match 50% of 5% of your salary = 1000*.05*.5=$25
Total contribution = $125
Return on investment = 25/100 = 25%

The return on this investment is much better than the historical stock market (around 10%). My recommendation is that if you have an employer match, I would strongly recommend participating in the employee plan at least to the maximum extent you will be matched by your employer. The employer match is hard to beat, but when deciding how much to contribute beyond what will be matched by your employer consider the following:

• What investment options are offered by your employers plan administrator. For money without an employer match one of the biggest factors in the rate of return is the expense of the investment. Most employers typically offer mutual funds, so the expense of the mutual fund will strongly influence the rate of return. If the funds offered are low performers or there expense ratios are higher than the expense ratios for other funds in the same investment class (small cap, large cap ...), then it maybe worthwhile to contact your plans administrator and ask to enhance your choice of investements as well as considering investing additional funds through an IRA (the fund alarm website is a good resource to check the performance of mutual funds relative to other funds in the same class). Many companies provide access to the investement grade funds, which have large minimum investments ($1,000,000 or more) as well as lower expenses.


• What matching options are available. Some companies do not match investment funds or match funds in company stock. Matching in company stock is tricky as your retirement and continued employment are with the same company. If the company were to go bankrupt, not only would you lose your job but some of your retirement assets as well. This is what happened to a lot of Enron employees. I would not invest my retirement assets in company stocks (an ESPP is a different matter however)


• How long until you are vested. Vesting is when the matching funds are effectively transferred to the employee. For example, if an employer has a 5 year vesting schedule then the matching funds are only available if the employee stays on the job for 5 years. If you don't think you will stay with an employer long enough to be vested the investment options are important