Funds and 401(k)s : Year-End Means It’s Time to Review, Fine-Tune Your Retirement Account

Granted, there are more festive things to do during the holidays. But the end of the year is a wonderful time to review your 401(k). For instance, there are new rules going into effect at the start of next year that will change how much money you can shelter in these tax-deferred retirement accounts.

Also, by now many of you have received year-end bonuses or have learned of either cost-of-living or merit raises that may boost your salary next year. That extra money may give you enough breathing room to boost your contributions for 2000.

Remember, 401(k)s are the hands-down best investment vehicle for the vast majority of American workers. In addition to allowing you to invest your money tax-deferred, 90% of plans match employee contributions.

Finally, this being the holiday season, many of you already have your checkbooks out. And any time you spend unusually large amounts of money, thoughts naturally turn to what you really can and cannot afford.

So to go along with your holiday gift list, here’s a checklist of five simple questions to ask yourself about your 401(k).

1. Can I contribute more to my 401(k) next year? Whether you can or can’t, you certainly may contribute more to your 401(k) next year, at least on a pretax basis.

Starting in 2000, the IRS limit for annual pretax contributions goes from $10,000 to $10,500. To be sure, that doesn’t seem like a huge increase. But if you were to save an additional $500 a year for the next 30 years in your 401(k), earning 10% annual interest along the way, that would give you an additional $82,250 toward your retirement.

Also, if you received a bonus or raise, maybe that money gives you the flexibility to save more. For instance, if you’re contributing 4% of your salary to your 401(k) right now, and you received a 2% cost-of-living raise, why not use that raise to boost your contributions to 6%?

Immediately increasing your 401(k) contributions is best when you get a raise, because chances are you won’t miss the money. After all, it’s hard to miss money if you never see it in your take-home.

To find out how additional contributions will affect your take-home, call your employee-benefits and / or payroll departments. (Some companies will calculate this for you.)

A quick back-of-the envelope way to approximate this is to annualize your current take-home. For instance, if your weekly after-tax paycheck is $700, multiply that by 52 to get an annual take-home figure--in this case, $36,400.

Now, assume you plan on contributing an extra, say, 2% of your salary to your 401(k), pretax. Because 2% of your salary pretax is not the same as it is after-tax, multiply that 2% by 1 minus your combined federal and state tax bracket. For instance, if you’re a non-itemizer in the 28% federal bracket and 9.3% California bracket, multiply 2% by (1 minus 0.373). That works out to 1.25%. (See https://www.latimes.com/taxes to find your own tax bracket.)

Now, calculate what 1.25% of $36,400 is, and you get $455.

That surprisingly small amount is how much it will cost you, really, to contribute an additional 2%. Now divide that $455 by 52 weeks, and you get $8.75. Which means, by giving up what amounts to the cost of buying a cup of coffee at Starbucks each workday, you can boost your contributions by two percentage points.

2. Have I contacted my plan to reset my contributions? If you maxed out on your contributions before the end of this year, now’s the time to go back to your employee benefits department to start your contributions back up again come Jan. 1.

Also, if you’ve stopped your pretax contributions because you’ve maxed out, but have been contributing after-tax money beyond the IRS limit (some companies allow this), make sure that your plan knows you want to go back to making pretax contributions when the new year starts.

“Some plans will do this automatically for you. But in some cases, plans don’t automatically revert to pretax,” says Mike Scarborough, president of the Scarborough Group, an Annapolis, Md.-based 401(k) investment management firm.

If yours doesn’t automatically reset you, you may accidentally go through 2000 making only after-tax contributions.

3. Has my status changed? In this case, the word “status” refers to whether you are deemed a “highly compensated” or “non-highly compensated” employee by your plan.

What many plan participants don’t realize is that 401(k)s must meet a so-called nondiscrimination test. Plans must prove to the IRS each year that they are not disproportionately benefiting highly paid workers at the expense of the rank-and-file.

To pass this test, some companies--based on the participation patterns of their lower-paid workers--restrict what highly compensated employees may contribute. In many cases, that means highly paid workers might not be able to contribute as much as the IRS allows.

Well, starting next year, the definition of a “highly compensated employee” changes. Anyone who earns more than $85,000 in income from their employer that year is considered highly compensated, up from $80,000. (Also, anyone who owns at least 5% of the company, or whose salary ranks in the top 20% of payroll, may also be considered highly compensated.)

If you’re making slightly more than $80,000, the new caps may kick you back into the non-highly compensated group next year--which means you may be able to contribute slightly more to your 401(k) than you’re allowed to now.

4. Have I checked to see if there have been any changes made to my plan or my spouse’s plan? The new year may bring some changes, perhaps even improvements, to your 401(k) plan. For instance, your plan may give you more mutual fund choices. Or the company match may have increased.

Also, when you’re deciding how--and how much--to invest in your 401(k), don’t forget to consider your spouse’s plan alongside yours. You may find ample opportunities to coordinate.

For instance, if your plan has great stock funds but terrible bond fund choices, and your spouse’s plan has good bond funds but few stock funds, why not invest in stock funds in your plan while using your spouse’s plan to invest in bonds?

Coordination may also help you take full advantage of company matches, notes Vernon Kozlen, executive vice president of City National Investments in Beverly Hills.

Let’s say you and your spouse combined can afford to contribute only $12,000 a year to your 401(k)s. And let’s say that both of your plans will match contributions up to 6%. If you decide to max out at say, 10%, while your spouse contributes only 2%, your spouse is leaving some money on the table in the form of her company match.

One way to get around this is for both of you to contribute at least up to the company match--in this case, 6%--and then determine what to do next, based on the quality of both plans.

5. Re-balance your investments. “Now’s as good a time as any to look at your investments and asset allocation,” says Barbara Raasch, partner in Ernst & Young’s personal financial counseling group in New York.

For instance, let’s say that at the start of this year, you determined that it was wisest for you, based on your needs and time horizon, to invest 40% of your 401(k) money in the Vanguard 500 index fund, 30% in PBHG Growth and 30% in Pimco Total Return, a bond fund.

In just one short year, your asset allocation would have shifted to 40% PBHG Growth, 37% Vanguard 500 and 23% Pimco Total Return.

Says Scarborough: “This is a great time of year to re-balance your portfolio.”

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Do you have ideas for mutual fund or 401(k) topics for this column? Times staff writer Paul J. Lim can be reached at paul.lim@latimes.com.