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| What's So Great
About DC Plans |
| DC plans may not
offer a defined benefit at retirement, but they
offer plenty of benefits during the working years.
Following are the most popular features of defined
contribution plans. |
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| Accessibility |
| For employees, the appeal of DC plans
begins with their "hands-on" accessibility.
Unlike pension funds, in which employees' money
is pooled together and invested by the company,
DC plans are administered on an individual basis,
with a separate account for each employee. Consequently,
you--not the company--decide how your retirement
savings are invested, giving you much greater control
over your money than in the pension system. |
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| Portability |
| DC plans are also portable--that
is, you can take the money with you. If you quit
before retirement you can roll your funds over into
an IRA, or in some cases, to the next employer's
DC plan. Even if you leave the money at your former
company, your investments will remain active until
you retire. With pensions, your benefit is typically
frozen if you leave the company early. |
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| Pretax Contributions |
| Perhaps the biggest plus of DC plans
is the tax advantage they offer participants. Normally,
when you invest in stocks, bonds, or mutual funds,
you pay taxes on any interest or dividends you receive
and on capital gains (profits you or your mutual
fund realize from the sale of investments). Defined
contribution plans, on the other hand, allow your
investments to grow tax-free. Uncle Sam will collect
his due when the funds are withdrawn, but not before
then. And beginning in 2002, the government is increasing
the annual amount you can contribute to 401(k) and
403(b) plans. |
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| Pretax Contributions |
| Some plans--most notably, 401(k)s--allow
employees to deduct contributions from their paychecks
before taxes are calculated. For someone in the
28% tax bracket, this means that a $100 contribution
will result in only a $72 dollar reduction in take-home
pay. |
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| Employer Matching |
| Many employers offer to match employee
contributions according to a certain formula--for
example, a 100% match of the first 5% of employee
contributions. This is one of the best investment
deals going! Consider that a 100% match means that
you double your money instantly without any risk
whatsoever. Generally, you earn the right to employer
contributions over a period of one or more years--a
process known as vesting. If you leave your job
before you are totally vested, you'll forfeit some
or all of the employer's contributions. But you
are always fully vested in any contributions you
make. |
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| Things to Keep
in Mind |
| With so many advantages to consider,
it's easy to overlook an important fact about defined
contribution plans: they are riskier than pension
programs. There is no predetermined benefit with
DC plans, so what you end up with at retirement
depends on how well your investments do. |
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| Your long-term results, in turn,
depend on how well you invest your money--and here's
where another risk emerges. Specifically, some people
invest their DC money only in bond funds, money
markets, or other conservative investments, rather
than shooting for the greater growth potential offered
by stocks. The problem with the "safe"
approach is that the investments likely won't even
keep up with inflation, resulting in a puny payoff
come retirement. |
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| Another risk of DC plans is that
an individual may choose not to participate at all.
Some people opt out of the plan, either because
they think retirement is still too far off, or because
they don't want to reduce their take-home pay. |
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| Clearly, DC plans won't pay off if
you don't pay in to them. But if you participate,
take the long view, and invest wisely--by diversifying
into stocks and taking full advantage of any employer
matching--defined contribution plans can provide
you with a solid source of retirement income. |
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