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$16,500 and $22,000 (50 and older) are the amounts you can contribute to your 401k plan in 2010. Is this the best strategy for you, considering today's economic and tax-rate environment?
This has been touted by many financial professionals as the best way to save for retirement since 1980. I agree that one of the first places you should save is in your 401k, up to the matching percentage.
Most plans that match will match up to 6 percent of your salary. They often will match 25 percent, 50 percent or 100 percent on the dollar. There is no investment out there that will give you a guaranteed 25 percent, 50 percent or 100 percent return. If they are promising these returns, make sure your FINRA (Financial Industry Regulatory Authority) official knows about it.
These salary deferrals are pretax and are great ways to lower your taxable income while you are saving for retirement. Let's take a look at some other strategies to invest and why.
The Roth IRA is funded with after-tax money. The top marginal tax rate is at one of the lowest levels since 1929. It might make sense to pay the taxes now so you don't have to during retirement. Taxes might go up next year; what do you think? In 2011, the highest marginal tax rate is scheduled to rise to 39.6 percent, and capital gains from 15 percent to 20 percent. If you make too much to fund a Roth, start a non-deductible traditional IRA and convert immediately. This is a great way to get money into a Roth. Make sure you consult a competent tax professional when doing this to see if you qualify. You will have to pay taxes only on any gains in the IRA when converting.
In the Journal of Financial Planning, Irvin G. Schorsch III's article said, "Many municipalities are paying strikingly high rates due to budget shortfalls and fiscal difficulties." This creates opportunities for astute money managers and investors. Irvin also said: "For an investor in a 35 percent tax bracket with a 4.4 percent municipal bond, that yield is equal to a 6.7 percent return on taxable income." This is even more valuable when tax rates increase. Irvin also quotes a study by Moody's about the 10-year default rate of municipal bonds compared to corporate bonds from 1970-2000. The default rate on municipal was 0.042 percent while corporate was 0.675 percent. Corporate bonds were 16 times higher.
It might be easier to get at your money if it is not in the 401k. Some plans do not offer loans provisions on their plans, only hardship withdrawals. The paperwork and staff handling the withdrawal might take a long time to be completed. If you don't have an emergency fund of three to six months you can get to easily, it might not make sense to max out your 401k yet.
I am not saying you should or should not max out your 401k. This is a personal decision that can be discussed with your CPA or financial professional. Estate planning goals might be a factor in your decision making as well.
Scott L. Webb is the owner of Webb Financial Group LLC and can be reached at scott.webb@ lpl.com, (740) 454-6113 or www.Webbfinancialgroupllc.com.