We live in an age where pensions are a distant memory for the vast majority of working Americans. The primary retirement savings vehicle today is the 401(k). Unlike a pension, your 401(k) requires that you make the right financial moves to maximize its value.
1. Put Uncle Sam on hold and compound your savings.
A 401(k) is a retirement savings plan offered by employers. It gives employees the opportunity to save for retirement by having money deducted from their paychecks before taxes. In other words, the money in your 401(k) is not taxed until you withdraw the funds. That means you pay less tax today while your savings grow tax-free. 401(k)s, like Individual Retirement Accounts (IRAs), have required minimum distributions beginning in the year you turn 72.
The Roth option – Your 401(k) may have a Roth option. This allows you to contribute post-tax income to your retirement account. A key difference of a Roth plan is that required minimum distributions (RMDs) aren’t required. All withdrawals (after age 59½) are tax-free. If you can afford to pay the tax now and anticipate being in a higher tax bracket in retirement, this option may be for you.
2. Max out your savings…or make a plan to get there.
- Contribute the maximum allowable amount to your 401(k). For 2022, that’s $20,500 per year. If you’re age 50 or older, you can make an additional catch-up contribution of $6,500 ($27,000 total).
- If you can’t participate at the maximum level, contribute at least as much as your company match. Most businesses offer a match on 401(k) contributions up to a stated percentage of employees’ annual salary. Don’t leave money on the table. Most important takeaway: This match is FREE money.
- At FJY, we encourage employees to contribute at least 10% of their annual income to their 401(k). If you can’t hit this level right away, at least take full advantage of your company match. Then, gradually increase your contribution by 1% each year until you reach 10%. This phased approach helps you achieve your goal without feeling the pinch because you’re upping contributions as your salary increases.
3. Want to set it and forget it? Choose a plan that changes with your needs.
401(k)s typically have a limited number of investment options. Employees tend to arbitrarily choose several different funds when they set up a 401k, then fail to track their investments. This is a case of diversification gone wrong. It’s like preparing a meal by using a pinch of every spice in your pantry. That’s no way to flavor a dish.
Just as with cooking, you need the right recipe when investing. It’s called asset allocation. Target Date Funds are an excellent 401(k) choice for people with a limited attention span for investing. As the name implies, these funds are based on a target retirement date. As time progresses, the mix of stocks and bonds change to become more conservative as your retirement date approaches. This strategy helps you take advantage of market growth during your early and middle working years and protects your account as you near retirement.
4. Consolidate accounts, but do so with care.
If you have 401(k) accounts from prior jobs, consider consolidation to simplify your finances. FJY recommends consulting a financial planner to determine which option best fits your situation:
- If your current employer’s plan allows rollovers, you can roll all your old 401(k)s into your current account. If that account offers limited investment options and potentially higher mutual fund expenses, a rollover may not be your best option.
- An alternative is to establish a new Rollover IRA in which you can consolidate all your old 401(k)s. This option provides a greater range of investment choices and the potential for lower fees. A financial planner can help if the variety of options induces investor paralysis.
- The least favorable option is to cash out your old 401(k) accounts (called a lump-sum distribution). Your entire distribution will be taxed as income. If you’re under 59 ½, you will also be charged an additional 10% penalty (ouch!).
5. Don’t borrow against your 401(k).
Some 401(k) plans allow employees to take out loans. Avoid this if you can. You’ll bite into your earnings to finance your lifestyle. A professional can help you balance your finances and brainstorm better alternatives to address your situation.
Feel free to contact FJY if you need help in setting up a 401(k) strategy that best suits your unique circumstances and financial goals. We love writing about all things finance to help you learn more about how to achieve financial goals; both personally and with your business. Be sure to check out our blog page for an array of topics covering various aspects of finance, wealth management, and all things employer-sponsored retirement planning. FJY Financial specializes in Financial Planning, Investment Management, and Company Employee Retirement Plans, crafting the right strategy and plan for your specific needs. Contact us today to learn more!