Why participate in a salary deferral plan?
A salary deferral plan lets you shape your own retirement savings program so you can think beyond Social Security. Here are three reasons to participate in the plan:
Everybody loves a tax break
When you make pretax contributions to your retirement plan, you postpone income taxes on your contributions until the money is withdrawn. After–tax money going into a Roth account is taxed before you invest it, but qualified withdrawals, including earnings, are tax–free.* Either way, once the money is in your retirement plan, you won’t have to pay taxes on earnings every year. The more money you have working for you, the greater the effect of compounding.
The chart below shows the hypothetical growth over 30 years of a tax–deferred investment compared with a taxable account.
The tax–deferral advantage
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- The use of an 8% annual return (compounded monthly) relates in no way to the actual results of any mutual fund. Your investment experience will differ. Results shown for the taxable investment assume 25% in taxes is paid from the account each month. Lower maximum tax rates on long–term capital gains and qualified dividends could make the taxable investment return higher, thus reducing the difference between the two ending values shown. This chart does not address the impact of Roth after–tax contributions.
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- When you withdraw only a portion of your retirement plan balance, you’ll likely pay less in taxes and continue to have the remaining balance grow tax deferred. However, if you take the $225,044 as a lump sum, you’d be left with $150,779 after being taxed at the 33% rate. (Your actual tax rate may vary.) The money you take out of your plan is subject to ordinary income tax and, if applicable, to an additional 10% federal tax penalty on early withdrawals.
A program of regular investing does not guarantee a profit or protect against loss.
You wouldn’t turn down free money
Many companies offer matching funds as an incentive to encourage employees to contribute to their salary deferral accounts. If your employer offers to match your retirement contribution, take it. It’s as if your employer is paying you a bonus — and all you have to do is save in the plan. Contribute at least enough to get the full match. If the match is in company stock, think about diversifying the rest of your account. The match is part of your benefits package. Don’t walk away from it.
Social Security won’t be enough
If you plan to rely on Social Security to pay all your bills, your retirement dreams may need to be trimmed back. The rule of thumb is that Social Security probably represents only 40% of your retirement needs. The average Social Security benefit in 2009 will be $1,153 a month. Even with cost–of–living increases, this won’t buy the kind of retirement most Americans dream about. When you participate in your retirement plan, you take control of supplementing Social Security.
Visit the Social Security Administration website for more information about the retirement benefit you can expect.
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- Withdrawals from Roth accounts are tax– and penalty–free if the account was established at least five years before, and if the participant is at least 59-1/2 years old, has died or is disabled. For nonqualified distributions, earnings are taxable and may be subject to a 10% early withdrawal penalty.
Return to topInvestors should carefully consider the investment objectives, risks, charges and expenses of the American Funds. This and other important information is contained in each fund’s prospectus and/or summary prospectus, which can be obtained from your plan’s financial professional or downloaded and should be read carefully before investing.