Benefits 2005, Part 1: 401(k)
November is the benefit open enrollment season for both my wife and I (actually we work for the same company now and you know what the company is :-)), so I am starting this new series to explain my logic in choosing the right menu for our benefits for the next year. It should serve as a good case study as well as a showcase of the myriad of benefit choices from my employer.
Some of the topics I will discuss, like 401(k) decision in this first post, actually can change over the course of the year, but I will blog them anyway to serve as a record of my plan into 2005; I am the type of person who is in love with year-end planning.
So let's start discussing 401(k) now. As a common-sense knowledge, 401(k) is the retirement plan in which you can delay paying income tax on part of your job income and let the money grow till your retirement with tax burden. The key parameters for my 401(k) decision include:
- Microsoft allows 0% to 25% pre-tax deduction and 0% to 7% after-tax deduction to be contributed to the 401(k) account
- According to IRS, annual 401(k) contribution limit is $14,000 in 2005 (details)
- Company will provide a match of 50 cents per dollar for the first 6% pre-tax contribution.
- There are 16 investment options in Microsoft 401(k) plan, ranging from money market funds to international equity funds and Microsoft company stock.
Needless to say, I view 401(k) as a terrific vehicle for wealth building. As I pointed out in a previous post "The Cost of Not Saving for Retirement", investments in 401(k) can grow faster thanks to the tax deferred status of 401(k) account. With an estimated free cash flow of at least $60,000 in 2005, I don't have any liquidity issue if I choose to contribute to the maximum of both 401(k) and Roth IRA accounts, and it is what I intend to do: contributing to the maximum.
To reach this strategic goal, my tactics will be:
For myself: If I contribute at 25%, I will easily exceed the $14,000 annual cap before August, so I will choose to do this: I will elect to contribute 6% for the first half of 2005 (6% is what is necessary to get the maximu employer match salary), and change the contribution to 20%-25% starting in July. This way, I can get the maximum employer match, plus lots of after-tax cash liquidity in the first six months, and still contribute to the maximum allowed limit to 401(k). (I have the majority of my 401(k) balance sitting in money market funds due to my outlook of the market so I am not eager to contribute to 401(k) account as early as possible.)
My wife's case is a bit different: Even if she chooses to contribute at 25% thoroughout the year, she will not reach the $14,000 limit by year end. So she will elect to contribute at the 25% rate from day one and get as much fund into 401(k) as possible.
With two 401(k) accounts and more assets in 401(k) accounts, I will try some new investment strategies in the next year. This is a different question than benefit election though.
Read The Complete Benefits 2005 Series:
Benefits 2005, Part 1: 401(k)
Benefits 2005, Part 2: Term Life Insurance
Benefits 2005, Part 3: Flexible Spending Accounts
Benefits 2005, Part 4: Accidental Death and Dismemberment
Benefits 2005, Part 5: Everything Else
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Just curious - by my rough estimates, you make over $95K/annum at which level the IRS puts you in the HCE(highly compensated employee) category where your elibility to make the full $14K contribution to your 401K plan fades - how do you manage to make the $14K contribution?
CD: good question! The IRS rule is to ensure 401(k) is not geared toward highly compensated employees only. It seems that at our company, people earning less than that also contribute enough to 401(k), so in the last two years I was able to contribute to the max.
