5 Ways to Make the Most of Your 401(k)
Nov 05 2020
A 401(k) plan is an easy way to set aside money for retirement because it happens automatically. You don’t have to remember to send in a check, because contributions are taken directly from your paycheck. If the money doesn’t come home, you don’t need to worry about spending it. Those dollars are going straight to the plan and working to help take care of you in your later years.
While simple and automatic, it’s not entirely hands-off. Here are 5 things you can do to make the most of your 401(k) plan:
- Contribute to the plan throughout your working career.
It sounds simple, but contributing to your 401(k) plan, whether or not there is company match, is one of the most important things you can do for your financial future. The sooner you start and the more you can contribute, the larger your balance will be when you’re ready to retire.
Far too often, we hear people say they regret not taking full advantage of their retirement plan. Putting away $10 in your twenties can give you a bigger bang for your buck than putting away $100 in your fifties. That’s because your money has more time to compound – where you’re building earnings off of your earnings.
Sometimes life gets in the way of our best laid plans. If you’re in a financial bind – as many have found themselves during the COVID-19 pandemic – and you’re using credit cards to survive, it might be better to pause your 401(k) contributions than to go into deeper credit card debt. However, if you can continue to contribute, even a small amount, that’s always the best option.
Note: Some people mistakenly think if the markets are down, they should stop contributing. That’s actually the worst time to stop! If it helps, when the markets are down, think of the stocks as being “on sale.”
A good goal to shoot for when contributing to a 401(k) plan is to start with a percentage you’re comfortable with, then increase your contribution by 1% every year until you’re putting in at least 15-20% of your salary.
- Don’t leave “free money” on the table.
If your company offers a 401(k) match, try to contribute at least enough to get the full match. Something else to consider is staying with that company until you’re fully vested. There are some company retirement plans with a vesting schedule, which means you need to be employed with the company a certain amount of time to receive their match and/or profit sharing dollars that they have contribute on your behalf. Each year you work for the company earns you an additional percentage of those matched and/or profit sharing dollars. Of course, anything you contribute to the plan and the earnings on those dollars, are always yours to take if you leave.
- Consider the tax advantages.
Some workers have the option of contributing either Roth or pretax dollars to the 401(k). (Some are able to contribute both Roth and pretax dollars.) The main difference between Roth and a traditional pretax is when taxes are paid. Any pretax dollars you contribute from your paycheck are made before federal and state taxes. This lowers your taxable income, but it also means you have to pay taxes on the money when you withdraw it from the plan.
Roth contributions from your paycheck have already been taxed. You can withdraw Roth money once you reach the appropriate retirement age and have held the account for at least 5 years. Any earnings on that money are tax-free, so when you withdraw Roth money from the plan, you do not pay any tax, nor is it included in your taxable income. (Employer matches are still taxable at withdrawal.)
The best plan depends on your age and tax bracket.
- Leave your money alone.
In some cases, it is possible to take a loan from your 401(k) plan, but then the money doesn’t have a chance to grow, because you’re using it. A hardship distribution not only deprives you of the opportunity to continue to grow funds for your future, but it is also taxed. Taking withdrawals early could result in extra taxes or penalties. If you leave your job, stay in your employer’s plan, if allowed, or roll your funds into another 401(k) plan.
- Review your investments
To ensure your plan is set up to help you meet your goals, it’s a good idea to schedule regular “checkups” with a financial advisor. Target date funds, which are structured based on your age and retirement goals, can also be a good way to help you reach your goals and maintain a diversified portfolio across different asset classes.
This article has been written for the general information of clients and friends of Bell Bank. It is not intended, nor may it be relied upon, as tax or legal advice with respect to any matter. This article also cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by the Internal Revenue Service or other taxing authority.
Investing and wealth management products are not FDIC insured, have no bank guarantee, may lose value, are not a deposit and are not insured by any federal government agency.