TAKE FULL ADVANTAGE OF A 401(K)
In addition to IRAs, the retirement savings account you're most likely to run into is an employer-sponsored 401(k) if you work in private industry, or its twin, the 403(b), if you are a public school teacher or are employed by a nonprofit organization. Those retirement plans, named after sections of the tax code, put you in charge. Although your employer chooses the plan to set up, you decide how much to contribute and how to invest your money, choosing from a menu of investments your employer offers. Many employers throw in a company match- 50 cents on the dollar is common; some employers are more generous. And Uncle Sam chips in with a double tax break:
- Because contributions you make to the plan come right off the top of your salary, that money is not taxed by the IRS. Putting in $5,000 during the year would cut your take-home pay by just $3,250 if you are in a combined 35% federal and state income-tax bracket.
- As with IRAs, earnings inside the plan aren't touched by taxes; you don't owe any until you begin withdrawals.
All around, it's a great deal that's getting better and a great opportunity for women who entered the work force late, or delayed starting a retirement plan because they were using their income to pay for the kids' braces, the family vacation, or tuition bills. Even if you can't afford to make the maximum contribution to a 401(k), at least put in enough to capture the maximum employer match. That 50 cents on the dollar is free money-and no one can afford to turn down a risk-free return of 50%.
Companies often make employees wait-sometimes for as long as a year-to join the 401(k). Don't let that requirement deter you. Squirrel away part of each paycheck, in a savings account or mutual fund. Then when the 401(k) opens up, double your contributions and use the money you have saved to make up for the shortfall in your paychecks. You can retroactively capture both the tax savings and the employer match.
THE NEW ROTH 401(K)
Starting in 2006, companies may amend their 401(k)s to include the new Roth 401(k). Rules are similar to those for Roth IRAs: Pay-ins do not reduce taxable income because they are made with after-tax dollars. Withdrawals from them are tax free, including earnings on the account, if you take them after more than five years and after you reach age 59 1/2.
But there are important differences, most of them favorable. The Roth 401(k) pay-in cap will be higher than for a Roth IRA. The standard 401(k) limits will apply-a $15,000 maximum for 2006 plus up to an additional $5,000 for participants over age 50. The 2006 ceiling on pay-ins to Roth IRAs seems paltry by comparison-$4,000 plus up to $1,000 extra for individuals who are age 50 or older. Note that any Roth 401(k) pay-ins will count toward the regular 401(k) cap. You won't be able to contribute the maximum to both types of accounts.
No income limitations apply to contributions to Roth 401(k)s, unlike the $160,000 adjusted gross income ceiling for regular Roths. Distributions will generally have to be made after you reach age 701#2, unlike for Roth IRAs, which do not require lifetime withdrawals.
Contributions to Roth 401(k) plans will have to be segregated from deferrals to regular 401(k)s, along with earnings on each account. Matches of employee Roth 401(k) contributions aren't tax favored. The matches go in a special account and are taxed as income when paid out.
DON'T SQUANDER YOUR KITTY
Because women tend to move into and out of the work force more frequently than men, and spend less time in any one job, it has always been tougher for them to put in enough years to earn the full right to benefits accrued under any employer's retirement plan-what's known as becoming fully vested. You are always vested in any money you contribute. Recent changes in vesting schedules speed up your claim on your employer's matching contributions. A plan may have a vesting schedule that gives you the right to 100% of your benefits after just 3 years of service. Or your employer may have a gradual vesting schedule that gives you full vesting after 6 years.
But as always, it's important that you don't fritter away the money. As mentioned earlier, statistics show that women borrow from their retirement plans more frequently than men do, usually to finance such things as tuition and to pay off debts. And when they get a distribution because they change jobs, they tend to spend the money instead of rolling it over into an IRA. Whereas both of these strategies may seem to bail you out in the short turn, you're jeopardizing your retirement security.
Don't get suckered into the mistaken belief that 401(k) loans are a free ride. Most plans charge the prime rate plus one or two percentage points. Because the interest you pay goes right back into your 401(k) account, you might think there's really no cost. Not so. In fact, the cost could be significantly higher than the stated interest rate. Say, for example, that you borrow at 7%, but the money you pull out of the 401(k) would otherwise be earning 10%. That 10% is the real cost of your loan. If that's better than you could get if you borrowed elsewhere, fine. But it's not a free loan. And if you change jobs, you'll have to repay the loan or the amount you withdrew will qualify as a taxable distribution, and you'll also owe a penalty for early withdrawal.
When you leave a job, you may want to roll over your 401(k) balance into an IRA. The best way to do that is to arrange a direct transfer from your employer. Because you won't actually have the money in your hands, you'll avoid tax consequences- and you won't be tempted to spend the money. You might also have the option of leaving your money in your old employer's 401(k) or transferring it to your new employer's plan.
WHAT CAN WOMEN EXPECT FROM TRADITIONAL PENSION PLANS?
For men, the strongest leg of the retirement stool has historically been the traditional defined-benefit pension-a fixed monthly payment pegged to their years of service and their salary level. For women workers, traditional pensions have never provided so much support for these reasons:
- Many women work in the service sector and in small businesses, where pensions are less common.
- Many women work part-time. Companies are permitted to exclude even long-term employees from their pension plans if they work less than 1,000 hours a year.
- Many women don't stay in a job long enough to qualify, often because they drop out of the work force for an extended time to raise children.
- Many women earn less than men even when they are covered.
Unfortunately, just as women have expanded their presence and longevity in the work force-and might be expected to expand their eligibility for traditional pensions-companies are moving away from defined-benefit plans toward defined contribution plans. Still, many women are covered by traditional pensions-or would be, if they stuck around long enough. You need to know what you're entitled to. Go to your benefits director and ask first if your company has a defined-benefit plan. If so, find out what you have to do to qualify.
If your employer has a plan, federal law requires that you must become a member no later than age 21 with 1 year of employment. Once you're a member, you start building up your rights to pension benefits year by year. (The "summary plan description" can give you the precise formula your employer uses.) Even though you may be building up pension benefits, you're not completely entitled to them until you're 100% vested. Now that full vesting is available in as little as 3 years, you could qualify for benefits even if you're on the move. If you switch jobs, keep a record of what you're entitled to from each employer-or contact past employers if you have lost track.
Each plan also lays down rules defining your pension status when you have a "break in service"-from a layoff, say, or from an extended leave-or if you do not work a full year. Federal law says that a full year is 1,000 hours of service, and that a break occurs if you work fewer than 500 hours in a year. But the law protects you if you miss an extended period of work because of pregnancy, childbirth, or adoption of a child (see below).
HOW CAN YOU MAKE THE MOST OF YOUR HUSBAND'S PENSION?
For married women, your husband's pension benefits can provide a big chunk of your financial security-or a comfortable cushion if you also have a pension. This is particularly true in the case of widows. Federal law requires that company pension plans offer survivor's benefits. Electing a survivor's benefit (also called the joint-and-survivor option) reduces the pension you and your husband receive during his life, but you would continue to get payments after his death.
If your husband wants to give up his (and your) right to survivor's benefits in favor of a higher pension during his lifetime, you have to agree in writing. Think twice about it. It's generally not a good idea, unless you don't expect to outlive your husband, or you have access to substantial assets of your own.
For your own pension, though, the joint-and-survivor option may not be the best choice. Unless your husband is significantly younger or in better health, chances are he won't survive you; so you might as well take full benefits during your lifetime.
In selecting a joint-and-survivor option, you and your husband need to consider your relative ages and financial resources. Say that your husband chooses joint-and-survivor 100%. This guarantees that the payments he gets over his lifetime will continue at the same level for you after he dies. If he opts for joint-and-survivor 50%, payments will be somewhat higher during his lifetime but they will be cut in half after he dies. Which option is better depends on your financial situation and health. If you're substantially younger than your husband and don't have a pension, joint-and-survivor 100% may be the better choice. But if you have your own financial resources, you may want to take advantage of larger payments during your husband's lifetime.
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