It’s no secret that many Americans are worried about financial security in retirement. Recent surveys suggest that the majority of retirement planning clients place running out of money as their top concern when planning for their financial future. For those who are still in the workforce, utilizing an employer-sponsored 401k retirement plan can be one of the most powerful tools for helping to ensure a comfortable retirement. The funds you invest in your 401(k) will grow tax deferred, likely receive an employer match, and they generally only become taxable once withdrawals begin during one’s retirement years. Contributions to your employer-sponsored retirement plan are also tax deductible, which reduces your income each year, helping to lower your annual tax bill. Here are some ideas for making the most of your options if you have the ability to contribute to a 401(k) retirement plan:
THE GOLDEN RULE OF 401k PLANs: CAPTURE THE EMPLOYER MATCH
One of the most common features of 401k plans is the presence of an employer match. Employers can design their plans to fit the needs of the business; therefore, employers may match your contributions in several ways. A key for you as a plan participant is to get very clear on how the match works and what you need to contribute to get 100% of the match. By taking advantage of your employer’s extra contributions, you can dramatically increase your savings over time.
Let’s take a quick look at a basic example:
Your employer chooses to match 100% of the first 3% of contributions and 50% of the next 2%. This means that if you contribute 5% of your income, your employer will match 4%; and the two combined give you a total contribution of 9% in your 401k account. Now, consider 5% of your salary is $2500. If you capture the FULL match, the total contribution would be equal to $4500 ($2500 from you and $2000 by your employer). That is an 80% increase in your account simply because you captured the match!!
MAXIMIZE YOUR RETIREMENT PLAN CONTRIBUTIONS
In the first step, I recommended that you capture the employer match as a minimum level of plan participation. The next goal you should set for yourself is to escalate your savings rate up to the point where you have maximized your allowable contribution. This may take time, and it will not likely happen overnight. I don’t recommend my clients have a “no-fun” budget, but I do recommend that they become champions at saving.
It can be hard to suddenly increase your contribution rate, which is why I like to recommend taking a gradual approach by increasing your deferrals a small percentage each year. Using the earlier example, if you are already contributing 5% to capture the match, consider increasing your savings percentage by 1-2% per year. In 2 to 3 years, you should be contributing roughly 10% of your income towards your retirement.
Another way to boost your savings is to take windfall events like bonuses, tax refunds, or other sudden infusions of cash to grow your nest egg. An IRA or ROTH IRA can be an excellent complement to your 401(k) plan and give your savings the benefits of tax-deferred growth.
Quick tips for Boosting Contributions:
-Increase your salary deferral every time you get a raise
-Create a budget and minimize unnecessary expenses to leave extra room for savings
-Clarify your plan fees and maintenance charges to be sure that you’re not paying too much
-Understand Your Plan Features
Every 401(k) plan is a little different, and it’s important to learn about the different plan options available to you. It’s been my personal experience that some plan participants plans get little assistance when it comes to their plan features, especially when it comes to how they should invest their funds. Your plan administrator should be able to provide you with details about vesting schedules, loans, investment options, and any limitations to withdrawals that you should know about. 401k plan providers today may have technology tools that can simplify the process, so using your online access can be valuable as well.
If you’re not happy with the investment options available to you, or if you feel completely lost, I encourage you to seek the help of a CERTIFIED FINANCIAL PLANNER™.
DEVELOP A LONG-TERM MINDSET
Working with a CERTIFIED FINANCIAL PLANNER™ can help ensure that you are on track for retirement by developing a financial plan that takes into account your current financial circumstances and future goals. It’s important to craft a long-term strategy that considers personal milestones like a house purchase, a child’s college expenses, your future retirement, and the funding needed to meet these future goals. Working with a good advisor can also help you to create and stick with a disciplined investment strategy. Advisors can be very influential in helping clients avoid the pitfalls of emotional investing mistakes like chasing returns or pulling out when markets decline. These behavioral errors have been shown to have a big effect on your long-term investment returns.
UNDERSTAND INVESTMENT RISK AND YOUR TIME HORIZON
As workers progress through different phases of their career, it seems only natural that their investment strategy may change as they get closer to their retirement years. One way that investors address this need is by utilizing an appropriate asset allocation. Asset allocation is an investment strategy that is designed to help balance risk and return by adjusting the allocation (aka percentage) of different investment types in your portfolio according to your age, goals, risk tolerance, and other factors. Though no investment strategy can guarantee profits or completely protect you from losses, a prudent allocation strategy can help you control risk while pursuing investment returns.
If you have many years of employment ahead of you, you may want to consider a more aggressive investment strategy that offers higher potential returns. As you get closer to retirement, your needs and ability to absorb risk will likely change; therefore, it’s important to review your investment strategy and make changes, if necessary. Over time, market performance will cause alterations in the respective values of your different asset classes, creating the need for adjustments and rebalancing to bring your portfolio back in line with your target allocation. You should review your investment strategy at least annually or whenever your needs change.
Most 401(k) plans today offer asset allocation options to suit a variety of ages, risk tolerances, and investment goals. A good CERTIFIED FINANCIAL PLANNER™ can help you review your options and help ensure that your investment allocations fit your overall financial strategy.
KEEP YOUR SAVINGS INVESTED WHEN YOU SWITCH EMPLOYERS
When you leave an employer, you will likely have a couple of basic options available to you. If allowed, you can leave your plan with your old employer, or you can decide to: rollover the funds into an IRA, rollover the funds into the plan at your new employer, or you can cash it out. It can be quite tempting to take a check and cash out your funds, especially if the balance is small. However, I encourage you to take this option completely off the table unless you truly are facing serious financial hardship. Cashing out your qualified retirement funds will create a taxable event, and if you are younger than 59 1/2, you may face additional penalties. The worst part is that it will potentially rob you of income in retirement.
If you no longer want to keep your plan at your old employer, the easiest way to avoid temptation is to transfer your money to your new employer or roll it over into an IRA. Talk to your employer and plan administrator to be certain that you understand timelines for moving your money and the relevant regulations regarding transfers and rollovers. I personally am a fan of using the rollover opportunity to place the funds in an IRA account because IRAs allow planning and investment flexibility that may not be available in 401k plans.
HOW CAN A CERTIFIED FINANCIAL PLANNER™ HELP ME?
Regardless of what stage of life you are currently in, prudent financial planning can help you set financial goals and build strategies to achieve them. For most Americans, a comfortable retirement is their primary objective, yet the idea of “comfortable” is unique to each of us. The role of a good financial life planner is to help you discover what truly matters to you, and then we work with you to create strategies to make your goals become reality. Like any journey, there will be obstacles and course corrections, but that’s why “planning” is an active verb—-because it’s an ongoing process.
In my opinion, one of the greatest benefits of working with a CFP® practitioner is the confidence and reassurance of knowing that you have a knowledgeable professional on your side. Families today may have complex financial questions and concerns, and professional guidance can help you be better prepared to live your financial life by design and not by accident.