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7 ways to make the most of your 401(k)

401k workplace retirement plan road sign

Some of my retirement money is in stock funds. They've been going gangbusters. Until this week.

I'm fighting the urge to look at what's happened with these plans' value. Did they tank along with the broader market a few days ago? Or are they edging back up with today's sort-of recovery?

I'm curious, but I don't need that money right now. And I believe my investment choices are sound. So I'm going to ignore the current market gyrations and just let things ride.

That's the advice most financial gurus are offering now.

This week's downward trend is just an overdue correction, they say. Hang in there. Even after losing more than 1,300 points at midweek, the Dow Jones Industrial Average still closed on Thursday over 25,000. And this morning, it's regained more than 300 points.

Heck, it even could be a good time to go shopping for some now more reasonably priced stocks to add to your portfolio.

I'm no market master, so I'm not going to suggest any specific retirement account investing moves. Everyone's financial situation is different and you and I likely tolerate different levels of risk. If you want guidance here, it's better for you to consult a financial planner and/or adviser.

However, since it is workplace benefits open enrollment season and tax-favored 401(k) defined contribution retirement plans are among the most popular offerings, this week's Weekly Tax Tip is my list of seven general do's and don'ts for these accounts.

1. Do participate.
For most workers, 401(k)s are their primary retirement savings vehicle. Unfortunately, most workers aren't making the most of these plans. In fact, some studies show that as many as one-quarter of eligible workers choose not to participate in their company's 401(k) plan.

I know that sometimes it feels like you need every last dollar of your pay. But seriously consider putting at least a minimal amount into a 401(k). Your contribution comes out of your pay before taxes are deducted, so that's a bit of a saving upfront. And you might be surprised as to how quickly you can adjust to that "missing" amount, which actually is making more money in the long-term for you.

2. Do contribute enough to get a match.
Many companies match their employees' contributions up to a certain amount. A typical match is 50 cents on your dollar up to 6 percent of your pay, giving you an added 3 percent of money to grow tax-deferred. That's an immediate 50 percent return. Some firms even match your contributions dollar-for-dollar, but at a lower maximum (typically 3 percent).

Either way, a match is free money from your company. So as soon as you can, up your contribution level so that you get the maximum match from your boss.

3. Do your homework before signing up.
Even when employees do participate in their company 401(k)s, too often they invest in a way that doesn't make sense. For example, a young employee who can afford to take some risks because she has a longer investment time line, might invest too conservatively. Meanwhile, an older worker who feels a need to catch up quickly has put his retirement money at too much risk by selecting a plan with volatile stocks.

Before selecting your 401(k) option, assess your other investments and how your company plan will fit in with your overall strategy. Carefully examine the various options available. Talk with your plan administrator if you have questions about the company's offerings. Some companies now offer added guidance, thanks to the Pension Protection Act of 2006, which enables plan sponsors to offer investment advice to employees.

4. Don't over invest in your employer.
Remember Enron? If you don't, check out the stories (or the documentary "The Smartest Guys in the Room") on how this energy industry's star flamed out, taking down not only the company and its executives, but also the retirement savings of thousands of its workers who were convinced that their employer's stock was their best retirement bet. That's usually not the case, even when a company is in good shape.

You need to stay diversified. You're already getting a paycheck from your company, so look at other options for your 401(k). Even when a business' stock is a great investment, you don't want your portfolio (or life) dominated by that one asset.

5. Don't borrow from your plan.
Your 401(k) is a retirement savings vehicle, not a revolving credit account. Don't borrow from your account unless it's a dire emergency. True, you'll pay yourself back, but by taking some money out, you lose the earnings it would have produced and you'll likely never recover them.

Plus, if you leave your job while you're still paying back your 401(k) loan, you could be asked to settle the loan as soon as you leave. If you don't repay it, the loan balance will be treated as a distribution, which leads us to the next tip.

6. Don't take early distributions.
In most cases, if you take funds from your 401(k) plan before you are 59½, you must pay a penalty of 10 percent additional tax on the withdrawal. The Internal Revenue Service does make allowances for certain hardship instances, but it's generally wiser to tap your retirement accounts only a last resort.

7. Do roll it over.
Early, and costly, distributions commonly occur when folks change jobs. They take their 401(k)s with them, which is a good idea, but they do so the wrong way.

Don't have your former employer give you the account funds. Instead, have your 401(k) rolled directly into a plan at your new job. This trustee-to-trustee transfer will keep you from facing any potential tax that might be due on the withdrawal as well as the previously mentioned penalties.

What if your new employer doesn't have a 401(k) program? Don't worry. You can roll your old 401(k) into an IRA.

An earlier version of this post ran on Oct. 21, 2008

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