Just about every working adult has a 401(k). As far as investment channels go, this is an old standby most people simply start on when they get their first real job and never stop contributing to until they finally retire.
The problem with this is that you might learn the hard way that, after decades of work, a good amount of your returns has been swallowed up by fees.
What Is a 401(k)?
Let's start here to make sure we're all on the same page. A 401(k) is what is known as a defined contribution plan. This means a fixed amount is contributed into it. You put a certain amount in from every paycheck and then your employer matches some percentage of it.
When you finally retire, you get that amount to help you live out your golden years in comfort. Basically, your employer is helping you save.
Sadly, naïve investors eventually find out that their stockpile of retirement funds was slowly raided while they were hard at work.
See, the 401(k) may work through your employer, but a mutual fund is actually in charge of administering it. They obviously aren't going to do this for free.
One of the most entrenched means by which they get paid is with 12b-1 fees. They're named after the corresponding section of the Investment Company Act of 1940. While 12b-1 is capped under the law at just 1%, that can definitely add up quickly over time.
Now add to that the investment management fees a mutual fund will charge you as well. These usually hover around 1.5% to 2%. How much you get charged will usually depend on your balance, which is one more incentive to make it as high as you can as soon as you can.
How to Save Your Money When You Switch Jobs
If you change employers, it usually makes sense to transfer your money out of one 401(k) and into an individual retirement account (IRA). This is what we call an IRA rollover, and it is a smart way to keep your savings accumulating, tax deferred.
To perform this maneuver, you transfer the balance of your 401(k) to an account at a private organization. In order to keep it tax-deferred, you just have to be sure you deposit the funds into the IRA within 60 days of their withdrawal.
Unlike a 401(k), qualified distributions from an IRA are taxed just like ordinary income. If you decide to crack it open and take your money out before you reach 59½, you may get hit with a federal tax income penalty of as much as 10%.
Anytime you plan on investing in a certain channel,you need to be smart about understanding all the "fine print." A 401(k) is no different despite its reputation for being such a reliable way of saving money. Pay attention to all the hidden fees and check back on them regularly to ensure you're not losing money. Should you ever decide to leave an employer, consider saving money by doing it with an IRA rollover.
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