Expert Advice on Retirement Plans

When a Savvy Miss member asked the following question, we turned to Sharon Rich for her expert opinion.

I'm currently making about $28,000. The company I work for offers a 401(k) program, and I’m not sure if I should take advantage of it. What is a 401(k), how does it work, and does it matter that I don't plan on staying here more than a year?

A 401(k) plan is an employer-sponsored retirement plan which allows employees to make pre-tax contributions up to a certain amount, a limit determined either by the plan or the IRS. [For 2006, the IRS limits contributions to $15,000 for individuals under the age of 50.] The primary benefit of the plan is that the money will grow tax deferred until withdrawn at retirement. In addition, many employers will match the employee's 401(k) contributions, even though they are not required by law to do so.

Enrolling in a 401(k) at one company doesn't mean you'll lose the money if you change jobs. Whether you leave your job in a year or twenty years, you will be able to roll over your share of the 401(k) plan into a Rollover IRA—an individual retirement account, not connected with an employer’s account—or into your new company's 401(k) plan. If your employer has made matching contributions, a vesting schedule will determine how long you need to work for the employer in order to keep certain percentages of that contribution.

If you need to withdraw the money you’ve invested in a 401(k) before age 59 ½, you will be subject to federal income taxes and may have to pay a 10% penalty on the amount of money you withdraw. Many plans, however, do allow for penalty-free withdrawals to cover home purchases, college costs, uninsured medical expenses or hardships from a natural disaster, which you must “pay back” to the 401(k) account over time.