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The Boring but Essential Topic of 401k Plans

401ks, like most other things concerning finance is a boring subject, but you have to know more about this boring topic because it concerns you. A 401k is something that you can use and you should know about it because it is for your benefit that it was created.

Overcoming the Boredom

You have to overcome the boredom that you feel whenever you are studying financial matters especially when it deals with 401k because it concerns your future. The first thing that you need to know is what a 401k is in the first place. A 401k refers to a tax-deferred retirement plan. The term 401k refers to the part of the legislation that was enacted which made this kind of plan a possibility. Under this type of plan you do not have to pay taxes for the amount that you contribute towards it. Taxation would be put off until the time that you use it or when you retire.

How a Tax Deferred Retirement Plan Works

If you are receiving $30,000 on a yearly income and the amount of taxes that you have to pay is valued at $6,000 then that leaves you with $24,000 that you can use. If you contribute $2,000 of your total income to your 401k then only $28,000 would be taxed then. This means that you put more in your savings. Employers usually match a portion of the amount that you contribute towards your 401k. Sometimes the employers add 50% of the total contribution of the employees. This means that the more you contribute to your 401k the faster it grows.

Investing Your 401k

You might have the option of choosing how the money in your 401k can be invested. You can choose to invest it in the stock market. There are various stocks that you can choose from and they all vary in risk potential. You can choose to be safe and invest in food companies or those that are engaged in infrastructure projects. You can choose to be daring and go for the bigger returns but higher risks of computer and hi-tech companies. Planning for your retirement? Figure out how much super you need to retire at Suncorps superannuation site.

You should learn to diversify when it comes to your investments. You should invest in some products that are high risk and some that are relatively safe. That way you can minimize your losses and still take advantage of any trend in the market.

When it Becomes Taxable

Your 401k will become taxable when you use it during your retirement. The rates that would be followed then are those that are in effect in the market.

Do You Have a Good 401k Plan?

Do you think that that you have a good 401k plan? There are several things that you can use in determining whether you have a good plan or not. The first thing is whether it is compliance with government regulations. Is it following what the law says? How are the investments for the plan doing? You know that your money could all end up as nothing if it is invested in the wrong companies.

Discussing a 401k plan might be a boring topic but there would come a time when you would wish that you paid more attention to it.

The preceding was a guest post.

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2 comments - What do you think?  Posted by Cash Flow Mantra - June 22, 2013 at 6:45 am

Categories: Investing   Tags: , , , ,

Ever Hear of Money Illusion?

I was reading an article on retirement this morning and came across a term I had never heard before, money illusion.  It is the name for the phenomenon that psychologists and behavioral economists give people’s tendency to overestimate the value of future dollars.  In other words, we have a tendency to underestimate the effects of inflation.

That is understandable because it has only been about a working generation ago that Nixon closed the gold window allowing paper currency to begin its rapid loss of purchasing power.  In retirement, purchasing power and translating savings and investments into a lifestyle is the ultimate goal and few are thinking in such terms.

Instead, the goal is to save a certain sum of money regardless of the amount of income that those savings generate or the stuff that could be purchased.  So retirees can run the risk of running out of money over the 25 or 30 years of living following retirement, not because they didn’t save enough, but because they underestimated the impact of inflation on those savings and failed to keep pace.

Keeping Pace With Inflation

In order to maintain purchasing power over three or more decades of retirement, an investor should invest for the right combination of income and growth.  Historically, the inflation-adjusted returns of various asset classes from 1926-2010 are below.  The assumption is that $1 was invested in each class at the end of 1925 and held through the end of 2010 (Be sure to visit the link to see the cool graphs).

  • Large US Stocks:  $244
  • Long US Corporate Bonds:  $7.60
  • Long Treasury Bonds:  $6.88
  • Gold:  $5.62
  • Treasury Bills:  $1.68
  • Cash:  8 cents

Real estate is another asset class which is often touted for its ability to keep pace with inflation.  Its real return from 1900-2010 turns out to be 0.2% per year such that $1 invested in property in 1900 would be worth $1.25.

What Will You Do With This Information?

Now, the question is:  Will this information change your behavior?  There are many personal financial bloggers wanting to retire early and live off their investments.  How are you invested?  Are you planning on being in 100% stocks for the next four or five decades?  How will you manage your risk?

You may decide to invest in bonds since the stock market is viewed as too risky.  But are you then underestimating the effects of inflation?  Will you be living off only the income that your investments provide?  Will you be drawing down from your assets or adding to them?  How will you ensure a certain level of income?  How can that income keep pace with inflation?

These are the sorts of questions that everyone looking at retirement should be asking and answering, not just those looking to retire early than what is traditionally considered retirement age.

Your Retirement Plan

So what is your retirement plan?  I am not talking about an IRA or a 401(k).  I am talking about how do you envision getting the necessary income to live through 30, 40, or 50 years of “retirement”.  I have spent a lot of time thinking about this myself and have a decent plan in my estimation.  I will write it all down and share on Monday.  But in the meantime, what is your plan?  How will you maintain purchasing power?  Feel free to share in the comments.

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12 comments - What do you think?  Posted by Cash Flow Mantra - February 3, 2012 at 5:57 am

Categories: Saving, Investing   Tags: , , , , , , ,

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