Whether you’re looking to make changes to your 401(k) or you’re enrolling in one for the very first time, having the right information will help you make crucial decisions and put yourself on track for saving for retirement. With that in mind, here are the common questions we get and tips we like to share:
1. How aggressive or conservative should you be in your 401(k) allocation?
This is a very personal decision because everyone is different, but there are some common guidelines. Generally, you want to invest based on your age, risk tolerance and goals for retirement.
If you’re younger, investing more aggressively (i.e., your allocation consists of more stocks than bonds) can net you higher returns over the long-term. Younger investors also have more time to recover if the stock market trends downward.
Conversely, older investors may not have as much time to weather the storm and make up for market losses. They’ve built a nest egg and are going to want to focus on protecting those dollars, which generally means incorporating more bonds and cash into their investment allocation.
Whatever age you are, your risk tolerance also comes into play. If you simply aren’t comfortable with an allocation high in stocks, you may want to choose a more balanced portfolio. Just be aware that the stock market over time has generally outperformed bonds and cash. The key in choosing your investment allocation is finding a strategy you can stick with in good and, more importantly, bad market periods.
A great example of this is March 2020 when the market pulled back sharply. If your allocation was too aggressive for your personal risk profile, you may have been tempted to sell at an inopportune time. Those who stayed disciplined with their strategy were provided an opportunity to not only buy stocks at lower prices but also benefit from the ensuing strong market recovery.
Lastly, factor in your retirement goals. Even if you’re young and have no idea what your life will look like in retirement, there are certain assumptions that can guide you. Whether you like spending time at home or going out will factor into how much savings you’ll need for retirement. So will your overall spending habits — and those of your spouse, if you’re married.
2. What 401(k) contribution percentage should you aim for?
It’s true that every little bit counts. And the younger you are when you start contributing to a 401(k), the more time your contributions have to grow. However, we all know cash flow tends to be tighter when you’re just starting in your career.
If your company offers a match, your starting point should be putting in at least that same percentage. If they offer a 3% match and you contribute 3% of your income, that’s an immediate 6% going towards your retirement. If you don’t contribute at least as much as the company match, you’re essentially leaving free money on the table. A dollar-for-dollar match is a great way to expedite retirement savings.
From there, you can increase the percentage of your contribution based on your cash flow requirements. This is where creating a budget can be incredibly helpful. Many plans also now allow for automated annual increases to your contribution amounts, which can help boost your savings without even thinking about it.
3. Should you make traditional or Roth contributions to your 401(k)?
This is one of the more common questions we get, and it’s another one that’s very specific to the individual.
The general rule of thumb is that Roth contributions favor those in lower income tax brackets and those further from retirement. That’s because it lets you pay taxes on 401(k) contributions now while you’re in a lower bracket and then take them out tax-free in retirement after you’ve likely gone up some brackets as your career progressed. Also, the longer you have until retirement, the more opportunity for tax-free growth on your balance.
Those who are closer to retirement or making higher incomes might want to use traditional (or pre-tax) contributions under the assumption that retirement will drop them into a lower tax bracket. This allows them to pay a lower tax on these later-career 401(k) contributions when taking distributions in retirement than they would have when making the contributions during their working years.
When in doubt, consult your tax advisor on which option may be best for you.
4. What other 401(k) tips do you have?
Beneficiary designations are one of the most overlooked 401(k) aspects. You should absolutely name a beneficiary to your 401(k). It’s easy to set up and gives you the confidence your money will be distributed how you intended if you were to pass away unexpectedly.
If you’re married, your spouse is automatically your primary beneficiary (you would need their consent to name someone else the primary beneficiary), but you can also name contingent beneficiaries such as any children you have.
Remember to update beneficiaries as you go through different stages of life. Marriage, divorce, having children — these life events should spur you to review your beneficiary designation.
Putting these 401(k) tips into action
If you’re early in your career, it may be difficult to imagine your 401(k) ever providing enough for your retirement. But you’d be surprised how much money you can put away over the length of your career. Compounding interest certainly helps in growing that money. So does staying invested through market ups and downs.
We also recommend talking more in-depth with a professional about the decisions you need to make. Whether it’s choosing your investment allocation, picking traditional or Roth contributions, or selecting a contribution percentage, they can help you make the best decision based on your unique circumstances.