When working with clients to develop their financial plans, integrating 401(k) accounts into an overall retirement strategy is an important part of the process.
For most people, their 401(k) represents their largest source of funds set aside for retirement. Whether deciding how much to contribute, choosing investments within the 401(k), or wondering if it is the best way to save for retirement, here are six tips to get you started.
1. What do I need to think about during enrollment?
Assuming your company offers a retirement plan — 401(k)s and 403bs are most common — your HR department will address enrollment when you are hired. For existing employees, if the company is rolling out a new 401(k) plan, there will typically be a group meeting where HR and a representative from the plan sponsor — Fidelity Net Benefits, Vanguard and Prudential are a few common providers, but there are MANY more — will summarize the plan and lead you through enrollment. In both circumstances, you will typically receive your login credentials for your online investor portal where you can complete your investment choices and set up your contributions. Two things you need to keep in mind during enrollment:
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- You must clearly understand the company match. If at all possible, contribute up to the company match to maximize your employer’s contributions.
- If there is no company match, it may be better to focus on personal Roth IRA and IRA contributions before considering your employer retirement plan.
2. Should I choose the Roth or Traditional option?
Though not as common, more employer retirement plans are offering Roth options. Choosing between traditional or Roth to save for retirement is an important decision. You must realize that in a traditional 401(k), you are not getting a tax write-off from your pre-tax contributions: You are getting a tax deferral. You will eventually pay taxes on the money in these accounts funded with pre-tax dollars when you take withdrawals in retirement. It is very important to understand that you will pay tax not only on the pre-tax contributions, but on all the gains as well.
For the Roth option, you pay tax on the dollars going into this account before your contributions are made. In this way they are funded with post-tax dollars, never to be taxed again. The benefit is that your withdrawals in retirement are tax-free for your contributions and your growth. The question to ask is, do you want to pay the taxes now (Roth) or pay taxes during retirement (traditional)? While this topic warrants an entire dedicated post, to be brief, I recommend to my clients that we always maximize Roth and other tax-free options first.
If your plan offers a Roth 401(k) option, it is best to put your contributions here, knowing that this money will be tax-free after you have retired. It also protects your retirement assets from the possibility of income-tax rate increases in the future.
3. How much should I contribute?
There are two sets of guidelines to consider here. There are current IRS contribution limits, and possible additional contribution limits set within your specific company plan. Current IRS contribution limits for employer-sponsored retirement plans in 2017 are as follows: $18,000 for employees under age 50. Those 50 and up are allowed a “catch up provision” giving them an added $6,000 of annual contribution for a total of $24,000 per year. (For more details click here.)
To reiterate a point made above, make it a priority to contribute up to the company match in order to maximize your employer’s contributions to your retirement savings. In addition to contribution limit guidelines, it is also important to consider how much you can afford to contribute based on your monthly budget and cash flow. After contributing up to the match, if you are able to save more for retirement, it is best to look again to your Roth IRA and other tax-free options.
4. How should I invest?
There are many factors here to consider, and there is no “one-size-fits-all” answer. You will need to consider key factors such as your age, risk tolerance, investment time horizon, other retirement assets available to you, fees, taxes, how much you can afford to contribute, etc. Most employer plans will offer some high-level guidance through the plan sponsor to help you decide based on age and risk tolerance. You will also want to be sensitive to the cost and fees incurred with your different investment choices.
Do not be afraid to get on the phone with your plan’s representative to get some help. This is one of the valuable advantages of working with a financial adviser – getting help to identify proper investment strategies specific to your life and your overall retirement preparation.
5. How often should I change my investments?
The majority of employer sponsored retirement plan participants never make changes to their investment choices after the initial plan enrollment, according to studies, including one by the Invesment Company Institute. While this is not a reliable path to retirement success, checking and changing on a daily basis is not wise either. Broad exposure to low-cost index funds and ETFs across multiple asset classes should help most investors weather the ups and downs of the market, however this is not a license to completely ignore your account for years or decades leading up to retirement.
Your risk tolerance, investment time horizon, goals and even the available investments within your plan will change with time. Major life events like marriage and children, buying a home, etc. can all warrant changes to your investment strategy. While seeking financial advice can be very helpful, a general guideline would be:
- Check on your account quarterly.
- Consider making annual adjustments to rebalance your allocations as needed.
What if I change companies?
Job mobility is a modern reality. Gone are the days when people retire from the first company they joined right out of college. While it is possible to roll your funds over to the new employer’s 401(k) plan, I recommend opening a personal IRA to roll these funds into as you move from one employer to the next.
Shifting your retirement funds into personal accounts grants you more control as well as offering you more freedom of choice when it comes to investments. You are no longer limited to the menu of investment choices within your 401(k). It is important to remember that you must roll the 401(k) funds into “like” accounts. Pre-tax 401(k) funds must go into a traditional pre-tax IRA, and Roth 401(k) funds must go into a Roth IRA. It is also important to note that when rolling a Roth 401(k) account over to a personal Roth IRA, you will also need a traditional IRA to complete the transaction. Your employer contributions were likely be pre-tax, while your personal contributions were post-tax, thus requiring both a Roth IRA and a traditional IRA to properly receive the funds.
Again, each of these six points could justify its own independent post, and keep in mind that this is not meant to offer definitive advice on retirement planning nor how to manage your 401(k), as there is no way I can know the financial specifics of anyone reading this. However, I hope you found this general guidance helpful.
When it comes to saving for retirement, start early, be consistent, maximize your Roth options first whenever possible, and do not be afraid to ask for some help.
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