Do you have a 401(k)? Are you taking full advantage of what your plan has to offer? Do you know what to do and not to do with your 401(k)? Well, there are a few things that everyone who has a 401(k) needs to be aware of and in some instances ask questions. In many cases, the plan’s administrator can address many of the possible questions that you may have about your 401(k). If they do not have the answers you need, it may be wise to seek the advice of a financial planner. There are many advantages to a 401(k) and they are matching funds, automatic savings, and tax-deferred growth among others.
One of the primary benefits of a 401(k) is that they are set up as automatic investments. This means that the funds are taken from your paycheck or account prior to you even knowing that they were there. This allows for better savings and reduces the likelihood that your savings will not be done. Anytime you can set up a savings plan for automatic payments to the account, think 401(k) and IRA here; it is to your benefit. Also, as the funds are going from your account in an automatic manner, you will be much less likely to spend these funds as you never really see them in the first place.
A technique that goes hand in hand with automatic withdrawals of your funds is setting up increases in the amount you save. This simply means increasing your savings percentage as you get salary increases instead of saving the same percentage of a higher salary. What I mean here is that if you are saving 5% and get a 3% raise you should save something like 5.5% of your new salary instead of the same 5%. By increasing your percentage, you will save more and set yourself up for a much better retirement. Do this each time you have a salary increase and do not increase your standard or cost of living while you live on the same as prior to the raise and you will not even know anything is different.
Many companies now will enroll all new employees in the company’s 401(k) plan when they are hired. While this is a good thing, in theory, it does pose some issues to the savers involved. Many default percentages are 3% and this is not an adequate amount to be saving to retire comfortably. That and in many instances companies will match up to 5% meaning you are leaving free money on the table, and that is never a good thing to do. In 2015 if you are under the age of 50 you may contribute up to $18,000 and for those over the age of 50 there is an ad hoc catch-up contribution of $6,000 meaning you may add a total of $24,000 a year to your plan.
Besides the company match that you always need to take advantage of by getting an instant return on your investment there may be additional ways to get employer contributions. This may be a percentage of your pay or a bonus. If your company pays out a portion of its profits they could be done in the form of 401(k) contributions. While these may be non-matching contributions, they are essential none the less.
By contributing to your plan, you are deferring taxes on the money that you contribute to your account. This will lower your current year’s income taxes and allow you to maximize the growth in the account as all earnings do grow tax deferred as well. In the event, you have a ROTH 401(k) your contributions are taxed in the year in which they are made and all earnings grow tax-free. In a traditional 401(k) all earnings are taxed as ordinary income while ROTH earnings are not taxed at all. If you get a company match in a ROTH account, the matching funds are placed in a traditional account as they have not had the taxes paid on them yet. By having both types of 401(k) accounts, you can add tax diversity to your retirement portfolio.
Into keep as much of your money as you can for it to also continue to grow you need to use low fee investments if possible. All funds have fees associated with them and by picking funds with low fees you allow more money to continue to work to your advantage. The more you keep invested, the more you will have when it comes time to take out your funds in retirement. A few tenths of a percent can translate into thousands of dollars over a 30 or 40-year period. Never underestimate the power of compound interest or the effect it can have on your account balance. Also, do not consider taking money our prior to age 55 if you are retired or age 59 ½ for those not yet retired.
401(k) plans are extremely common in today’s workplace, and they have replaced the concept of pensions. If your company has a 401(k), I strongly recommend utilizing it to the best of your ability provided it is a good and well-managed plan. In the event, it does not have reasonable investment choices I advise anyone to contribute at least what your company will match then look to an IRA.
If you have any questions or concerns about 401(k) plans, do not hesitate to contact me.
