This week, Gail reminds us we should be thinking of contributing more to our retirement accounts -- especially if employers match all or parts of our contributions.
Gail,
I am 23 and contributing 17 percent of my salary to the retirement plan offered by the public institution I work for. The company is doubling my contribution. My question: Is it really important for someone in their 20s to have money in bonds and cash? Currently, I've got my portfolio divided among foreign equities, large cap, and growth & income. Would adding a small portion of a bond fund for the very long term be to my advantage?
Thanks,
Michael
Dear Michael -
First of all, congratulations on your early start toward a secure retirement! You are definitely fortunate that your employer is matching your contribution dollar-for-dollar.
I put your question to Don Sowa, a veteran of the financial planning industry. "In my opinion, anyone under age 30, for whom the money in a retirement accounts isn't going to be used for another 30 years, has no need to own bonds at all."
However, if YOU feel your retirement account ought to include fixed income investments, Sowa suggests considering foreign bonds. If your plan doesn't specifically offer a foreign bond fund, then look for one described as a "strategic" or "global" bond fund. This type of mutual fund can invest in fixed income securities anywhere in the world, giving you exposure to this asset class through both U.S. as well as foreign bonds.
Another thing: don't assume all bonds are "boring." At your age you might be thinking you ought to have exposure to investments that offer higher returns and that bonds are way too stodgy. But there are sectors of the bond market that can be pretty exciting and rival stocks in terms of volatility (price swings). Lower-rated, high-yielding bonds come to mind here. Naturally, along with the potential for higher returns from these bonds, you run the risk of significant declines.
In fact, the high-yield bond market has had an impressive return. Based on the 12 months ended Dec. 22, 2003, the JP Morgan Global High Yield Index has posted a total return of 27.4 percent. It's up 36.05 percent since Oct. 8, 2002. Because of this recent run-up in high-yield bonds, Sowa thinks that going forward, higher-quality foreign bonds* may offer more upside potential.
If there is one concern he has about your current asset allocation, it's that it is too heavily-weighted in "large-cap" stocks, that is, big companies. Sowa, a Certified Financial Planning professional, suggests you investigate the choices your retirement plan offers and "broaden out your equity diversification into small and mid-cap stocks.*" Either direct some of your future contributions into these sectors of the market or "perhaps even move some existing money into them."
But don't just look at the size of the companies you own. Sowa says you want to diversify across different styles. In other words, your equity portfolio ought to include small, mid and large cap stocks in both the "growth" and "value" categories.
You're off to a great start, keep it up!
Happy Holidays,
Gail
*(Like high-yield bonds, foreign bonds as well as small and mid-cap stocks can offer opportunity for higher returns but also carry special risks, such as currency risk or the risk of greater price fluctuations.)
Hi Gail. I was wondering if I am allowed to contribute to both a 401(k) and a Roth IRA. There is an employer match of 25 percent of my contribution up to 6 percent of my salary, then I can contribute up to 25 percent of my salary up to the statutory limit. How should I balance the contributions? Thanks.
Landon
Dear Landon-
Most definitely, provided you meet the Roth IRA qualifications.
Thanks to the 2001 Tax Act, this year you can contribute up to $12,000 to your company retirement plan. This includes a 401(k), 403(b), 457, or SEP plan. In addition, if you are over age 50, you are eligible to make a "catch-up" contribution amounting to an additional $2,000.
In 2004, these amounts increase to $13,000 and $3,000, respectively.
On top of the limits on what you, the employee, can contribute, there is also a limit on the TOTAL amount which can be added to your account in a single year. This is called the "415 Limit," after the section of the Tax Code where these regulations are found.
This year, the 415 limit is $40,000. That's the maximum that can contributed to your retirement plan when you add up your contributions PLUS any that your employer makes. Next year, the 415 limit is adjusted for inflation and increases to $41,000.
The good news is that, according to April Caudill at the National Underwriter Company, contributions to either a traditional (tax-deductible) IRA or a Roth IRA do NOT count toward the 415 Limit. In other words, you are free to put as much as $3,000 into either IRA for this year even if you hit the $40,000 limit on your 401(k) account.
As I'm sure you know, contributions to a Roth IRA are made on an after-tax basis, so you don't get to subtract your contribution from your taxable income. The benefit of a Roth is that your money grows tax-free. So when you start withdrawals later in life, unlike a traditional IRA, you will pay no income tax on any gains your investments have made inside the Roth IRA.
But not everyone can contribute to a Roth IRA because there are limits on how much income you can make. If you are single, you are eligible for a Roth if your "modified adjusted gross income" (MAGI) is under $95,000. You can make a partial contribution if your income is between $95,000-110,000. Above that, you are no longer able to put money into a Roth.
If you are married, the income limits for a Roth IRA are slightly higher and your tax return as a couple must be submitted as "married, filing jointly." Provided your MAGI joint income is below $150,000, each member of the couple can contribute $3,000 to a Roth for 2003. The contribution amount is phased out between $150,000-160,000 in income. Above that, you're no longer eligible.
A few of things to keep in mind: while contributions to your company retirement plan must be made by Dec. 31, 2003 to qualify for this year, you have until April 15 to make your 2003 IRA contribution -- or later, if you get an extension on filing your tax return.
If you work for a small company that offers a SEP, or "Simplified Employee Pension," Caudill says contributions to the SEP DO count toward the total 415 limit.
Finally, the income limits on Roth IRA eligibility have not been changed since 1997. Unlike other types of retirement accounts, there is no automatic adjustment for inflation. There was some hope that a provision to this effect would be included in the major tax legislation passed in 2001, but it never materialized. This means that as time passes, fewer and fewer Americans are going to be able to qualify for Roth IRA contributions.
Just one more thing to bring up when your Congressional representative asks for your vote next year.
Happy Holidays!
Gail
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