Are you confident of your ability to retire and live comfortably during your retirement years? If you answered no, then it turns out you are not alone. Only 14% of Americans indicate that they are very confident about that.1 How can you have a more assured future and feel more confident about it? Many working Americans have a chance to participate in a 401(k) plan through their place of employment. This plan is your personal retirement plan. So, maximizing your benefits from your plan and being knowledgeable about how to make it work for you can help move you into more confident territory! Here are some tips to do just that.
Start Saving! And Keep Saving!
It does no good to have a 401(k) plan as part of your employment benefits if you don’t participate. It turns out that about 25% of American workers with a 401(k) plan do not participate.2 And, it is more likely that older workers will participate rather than younger workers. Yet younger workers have the great benefit of time to earn on their savings. So, there is generally no such thing as too young or too soon. In fact, if you start saving early, you will have the added benefit of having a longer time period for your savings to be earning for you. Those earnings over a lifetime can be significant!
Are you having trouble saving? Remember these are pre-tax dollars, so the amount that your paycheck is actually reduced by could be less than you might expect. And, once you start, you will be able to participate consistently as the money will be placed in your 401(k) automatically. If you are really having trouble getting started, start small and try allocating 1% of your paycheck to your 401(k). I bet you won’t miss it. If you feel comfortable contributing 1%, in the next month, or contribution period, increase your contribution and allocate 2% to your 401(k). As you grow in confidence you will likely find that your savings are accumulating. Keep increasing the allocation until you reach your target. We suggest how to set a target in the next tip.
Matching Money is Free Money for You
In many 401(k) plans, employers will match your contributions up to a certain percentage. This is FREE MONEY! Would you walk by a one dollar bill on the sidewalk? You don’t get this money if you are not participating in your 401(k) plan. And, this can add significantly to your overall savings.
In the latest Retirement Confidence Survey by EBRI, the respondents indicated the following: 60% of workers reported that they had saved less than $25,000 for retirement.3 Let’s say you retire at 65 and live for 20 years. What kind of lifestyle is this going to offer you? Is this enough to support you? The amount you have saved can determine your quality of life in retirement. Saving now to the fullest extent possible can make for a better retirement lifestyle later.
Turn your thinking around. Don’t think about your 401(k) savings as a deduction from your paycheck; think about it as a deposit into your personal retirement account. This is YOUR money. Participating regularly and having an employer’s matching contribution can help your savings grow more rapidly. Then you can consider a much nicer retirement or perhaps even an earlier one.
Avoid Cashing Out of Your 401(k) Early
Using the money in your 401(k) to fund other wants or needs should be an absolute last resort. There is usually a hefty tax penalty, so you will pay taxes on your 401(k) redemption at your income tax level as well as an additional 10% penalty. By so withdrawing you could actually end up with less than you expect. Let’s say you plan to take $50,000 out of your 401(k). If you are paying Federal and State taxes of 35%, those coupled with the penalty, mean that your redemption will net you $27,500. This makes cashing out of your 401(k) a very expensive option.
Even more sobering is the fact that you will need to save much more to replace the money that you have taken out. Three years later if you wanted to replenish your 401(k) (which is generally not possible due to the regulations surrounding how contributions are made) you would need to come up with a way to save $59,550. (This estimate uses a very conservative 6% earnings rate over this time period.)
Avoid Borrowing from Your 401(k)
Since 1996, between 15% and 19% of participants in select surveys have had 401(k) loans outstanding.4 As difficult as the current economy has been, the number of participants taking loans is not appreciably different year to year.
When you take a loan out of your 401(k), you are losing investment earnings on the money that you have borrowed. So that portion of your portfolio will not be earning. Additionally, you will pay interest (to yourself) on this loan, but that interest is paid with after-tax dollars, thereby losing your pre-tax contribution advantage. At the time of this writing, this interest is not tax-deductible. And, you will pay taxes again on that portion of the interest when you withdraw the money in retirement.
It can be dangerous as well in today’s employment market. If you lose your job (or quit), it is typical that you will need to repay your 401(k) loan within 60 days. If you are unable to repay your own loan, it is considered a default. In that case, you will be taxed on the amount of the loan, now considered income. And, you will be charged the 10% early withdrawal penalty.
Consider the Fees on Your Investments
You should have noticed recently that you have a lot more information in your 401(k) reporting about the fees that you are paying. This level of disclosure started this year and should help make you a better consumer! While you can’t really change the fees that your company is paying to implement the 401(k), you will have a chance to review the fees that are associated with your investment choices. Make sure that if you are choosing an option with a high fee, that you really believe that investment is worth it. In particular, be cautious when you see specific sales charges for an investment choice. These are also known as loads or commissions. These are typically high and you may likely find an investment choice that offers similar exposure at a much lower cost.
Diversify Your Portfolio
When you look at your investment options in your 401(k), you want to pick an allocation that makes sense and that you can live with in the long-run. Remember that this is a long-term investment. Even for those nearing retirement, we hope that you are drawing from your 401(k) for 20, 30 or even 40 years. So, realize if you have time to accumulate earnings, and also the ability to withstand market volatility. Choose an allocation that creates good long-term earnings for you.
Also realize that some of the best protection in volatile markets is a diversified portfolio. Don’t gamble on only one segment of the market, especially because it performed well last year! Instead, consider being broadly diversified, so if one part of the market is not doing well, some of your investments will be holding steady. Watch out for holding too much in any one asset. This may especially be the case with company stock in your 401(k). If you have a choice, it may be wise to not let it dominate your portfolio. Many plans offer you a diversified choice that may well suit your needs.
Once you set up your portfolio, you may sabotage yourself if you attempt to trade your 401(k) to capture “hot” markets. You may likely detract from value and lose the protection of a fully diversified portfolio. The participants that exited equities after the 2008-2009 market decline probably missed the market appreciation that followed and that we have experienced recently. And, consequently, many do not have the same level of total wealth as their counterparts who remained invested (and continued to contribute). That is the purpose of your 401(k), after all.
Hold an Annual Review for Yourself
It is a great idea to review your 401(k) regularly. It is probably not helpful to check it hourly to see if you can retire now! But, sitting down on an annual basis and reviewing your target allocation makes sense. Then you can see if your plan has added any new options that are of interest to you. This is also a great time to rebalance your holdings to stay aligned with your target mix. The effect of rebalancing back to your optimal mix periodically can allow you to lock in gains from choices that have done well in your portfolio and can help ensure that your portfolio does not drift far from the risk level that you envisioned. This is an excellent activity to do at tax time every year. Then you don’t have to remember it separately.
Triple Check Your Rollover
If you leave your current place of employment, you may choose to rollover your 401(k) account balances to an IRA or to the 401(k) at your new job. Be very careful that your rollover is made directly to the retirement account. This preserves the value and never creates the unintended consequence of you taking that money as a distribution.
Take time to evaluate your rollover options. A new plan may cost more (or less) and have differing investment options. They are all different, so take the time to carefully review before you initiate a rollover.
Understand Your Required Minimum Distribution
When retirement does come (yippee!), you will need to begin taking Required Minimum Distributions from your retirement accounts. You are required to begin withdrawing at age 70-1/2. It is important to take the full amount by the deadline, as otherwise the amount not withdrawn is taxed at 50%. You may begin taking distributions at age 59-1/2, but are not required to take them until 70-1/2. Hopefully, by this time, you have reviewed your needs and have a plan as to how to use your retirement savings. Enjoy! But, make sure you comply with the distribution requirements.
Know How Much to Save
Most people do not really know what they should save to enjoy retirement. Either way, it is very helpful to have a good financial plan, so that you know what you need in your situation and what you can spend when you retire. This may have the added benefit of helping you figure out a retirement timeline as well, so it is extremely useful.
Remember, in thinking about your 401(k) plan, that this is your money. It is an asset, but even more this will determine what your lifestyle in retirement will be like. Will you be traveling the world? Visiting grandchildren? Attending events that spark your interest? I hope so. Retirement spent monitoring the heating bills and worrying about whether you can go out to lunch is not much fun! A little planning now can help you get on the path to reap the rewards of your work life. Start today because after all your money should be working for you.