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July 7, 2011

More can be less

Congress passed a law in 2006 intended to increase retirement savings.  As intended the law resulted in more employees enrolled in 401(k) plans.  Unfortunately they are contributing less.  The concern was that inertia resulted in many employees not signing up to participate in 401(k) plans.  The law permits employers to automatically enroll employees in 401(k) plans.   As intended there has been an increase in the number of employees enrolled in 401(k) plans.  
A majority of employers elected a default contribution rate of 3%.  That is, the employees contribution would be 3% of their salary unless the employee elected to contribute more.  Apparently inertia set in and fewer employees increased their contribution rate.  Previously the contribution rates averaged between 5% and 10%.  As a result there are more people contributing to their employers’ 401(k) plans but they are contributing less.  
Employees are permitted to contribute up to $16,500 in 2011.  Employees that are 50 and older can contribute an additional $5,500 in 2011.  Each plan has its own requirements and limitations.  Check the plans Summary Annual Report for the details of your employers’ plan.  
Studies have shown that a significant portion of our population have not saved enough to have the retirement they expected.  Generally, employees should be increasing their savings for retirement. 
A “qualified” plan like a 401(k) plan offers tax incentives.  Most significantly, the income contributed to the plan is not currently taxed.  For plans with a “Roth” feature the income contributed is taxed but qualified distributions are not taxed.  Both types of 401(k)s allow income, capital gains, to accumulate and reinvest without being taxed.  This tax-free compounding is a powerful tool to meeting your retirement goals.
If your employer, or you are self-employed, have a 401(k) plan review the amount you are contributing.  Make sure that you are contributing the maximum that you can.  If you can not contribute the maximum, contribute enough to maximize your employers’ match if they match your contributions.  
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