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Moneyline: Protecting Your ...Nest Egg

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They're 401(k) fanatics. You can find them in almost any place that has an employer-sponsored retirement savings system known as a 401(k) plan (named after a section in the federal tax code).

They boast about how much they've saved. They monitor by the minute what their accounts earn. They debate about investment options. And they dream aloud about a wealthy retirement.

Rarely, however, do the 401(k) fanatics talk about this dirty little secret -- most workers never get to see the full benefit of 401(k) plans.

The truth is that most 401(k) participants, regardless of age, take their benefits in the form of a lump sum when they change jobs, instead of rolling over the money into their new employer's plan or into an Individual Retirement Account (IRA), according to a new survey by Hewitt Associates, an Illinois-based consulting firm.

That's bad. The 401(k) plan offers tax breaks to encourage you to save for retirement. The money you contribute typically isn't taxed. The money your account earns isn't taxed. In fact, the only time your 401(k) dollars are taxed is when you withdraw them.

And there's the rub. If you change jobs, you can continue to shelter your 401(k) dollars from tax -- and preserve them until retirement -- if you move them directly to an IRA or to your new employer's plan.

The problem is that only 26 percent of workers who change jobs roll their balances into IRAs, and only 6 percent move the money to their new employer's plan. Most workers -- 68 percent -- withdraw their 401(k) dollars in a lump sum.

That's when taxes strike. Most or all the money you withdraw will be slapped with a federal income tax, a state income tax (depending on where you live), and maybe an early withdrawal penalty. (Your employer will also withhold 20 percent of your payout.)

But most workers don't care. They typically view the money as a windfall and spend it, regardless of tax. "Whether it's using the money to buy a new car, take a vacation or pay off credit cards, 401(k) participants are losing out in the long run," said Hewitt consultant Mike McCarthy.

What can you do? First, ignore the 401(k) fanatics. Then take an honest look at your household budget. If you spend more than you take in, cut back. The point is to take control of your finances. Only then should you start saving in a 401(k). When it's time to change jobs, you'll be less tempted to take a lump sum, and better poised to keep your money working for you by putting it in an IRA or in your new employer's plan.

Most of all, remember that 401(k) plans aren't like traditional pension plans (known as defined benefit plans), which are federally insured and guarantee you income in retirement. Once you spend your 401(k) dollars, they're gone.
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