How to Make the Most of Your 401(k)
You work hard for your money and therefore should make the most out of your retirement savings. With half of the year already behind us, I thought it would be an appropriate time to review steps to make sure that your 401(k) is working as hard as you are for your retirement as there is still plenty of time in the current year to take advantage of any changes.
Get Started
Although it may seem obvious, you can’t benefit from your employer’s 401(k) plan unless you are participating. If you haven’t started deferring a portion of your salary into the plan there is no better time to start than now. Review your cash flow needs and budget, determine how much you can afford to defer each pay period and get started. Contact the plan administrator at your company and find out how to enroll. Remember, some savings is always better than no savings.
Traditional or Roth
Most plans allow participants to be able to contribute either pretax dollars to a traditional 401(k) or post tax dollars to a Roth 401(k). The value of contributing pretax dollars is that it doesn’t impact your current cash flow dollar for dollar as part of your contribution would normally go to federal and state taxes. The upside to a Roth contribution is your contribution is more impactful for your retirement since you do not need to pay taxes on any distributions. In general, it is better to contribute to a Roth when you are early in your career and your compensation is lower and to contribute to a traditional pretax account later in your career when your income is higher.
Increase Your Contributions
With half of the year still ahead of us, now is a great time to review your current salary deferral and increase it if you are not already maximizing your contributions. For 2019 the maximum contribution limit is $19,000 if you are under 50 and $25,000 if you are age 50 or older.
Often, participants in plans contribute at least enough to receive the full amount of any company match. I agree that it is a good strategy to go for the full match, however employee participants should consider increasing their contributions beyond the minimum amount required to receive the full company match. Especially if your employer’s plan offers solid investment options and reasonable expenses. A good rule of thumb to use is to contribute 10-15% of your gross income annually. The earlier in your career you can meet these savings goals the more likely you will be able to retire when and how you want.
Use a Target Date Fund
Employees sometimes fail to enroll in their employer’s 401(k) because they worry they will make a mistake in investing their contributions. Most plans offer target date retirement funds, also known as lifecycle funds or age-based funds. Instead of having to select from a menu of available investments and create a portfolio to help reach your retirement goals, you can choose a single target date fund to match the year you plan to retire.
Target date funds are mutual funds designed to provide a simple investment solution with a portfolio with an asset allocation mix that becomes more conservative as the target date, usually retirement, approaches. The asset allocation mix of a target date fund typically provides exposure to return-seeking assets, such as equities, in early years when risk tolerance is higher, and becomes increasingly conservative as time progresses with more allocation towards capital-preservation assets, such as bonds and cash equivalents.
Use Funds with Low Fees
Fees of investment funds within retirement accounts can be a drain, holding down gains when the markets are up and increasing losses when stock prices are falling. The lower the fees, the more your 401(k) is available to work for you. So, if you are building a portfolio of funds within your 401(k), choose funds with lower expense ratios.
Actively managed funds are funds that hire analysts to conduct research on securities. This research is expensive and typically drives up the management fees and expense ratio of mutual funds. Index funds, on the other hand, generally have the lowest fees because they follow a market index and require little if any management by a professional. Index funds are automatically invested in shares of the companies that make up a stock index, such as the NASDAQ Index or S&P 500 Index and change only when the respective underlying index changes.
The Bottom Line
Your 401(k) is an important step in planning for retirement and building a roadmap to retirement starts with saving. If you are young, keep in mind that your time horizon is long, so be patient. You are in this to build wealth over the next several decades, so don’t worry about the ups and downs of the market. Stay the course and maximize your annual match and contribution limits. Trust me, you will find a lot of joy watching your nest egg grow year after year.