Our Thoughts

Drive Your Retirement Forward: A Financial GPS to Your New (or Current) 401(k)

By: Kati Krause 

If your workplace offers you the chance to save for retirement with a 401(k) plan, it’s crucial that you opt-in and make the most of this benefit. 

Your 401(k) is vital because very few workers receive a pension after they retire, and Social Security income is generally not considered enough to live on. In fact, experts say Social Security income isn’t enough to pay for a secure retirement even with no frills. 

Early & Often! That’s the Motto

Getting an early jump on retirement savings is key. We all know the value of time when it comes to money in the market. Basically, your nest egg will start to grow, and you’ll lower your taxable income. Remember, never underestimate the power of compound interest!  

In a recent issue of our weekly Highs & Lows, one of our employees in his 20s, Coleman Fox, wrote, “If recent graduates of 23 years of age understood that saving $6,000 per year (assuming an 8% real return) would result in a projected nest egg of around $1,800,000 at age 65, I think they would feel more encouraged to save! To all recent graduates, don’t miss out on over 40 years of compounding returns! It will pay off in the long-run.” 

Sign up for your company’s 401(k) plan as soon as you can, and regularly increase your contributions. Starting a retirement account and steadily investing in it early in your career can make all the difference. 

Take it to the Max 

Many employers will match your 401(k)-retirement contributionsIf they do, you should always take full advantage of that. Otherwise, you’re essentially turning down free money! 

Many employees will match 50% (or 100% if you’re lucky) of the money that you, as the employee, put towards your 401(k) from your paycheck, up to a specified maximum amount. 

Here’s an example scenario:  

Your employer matches 50% of your 401(k) contribution, up to 6%. What are your options? 

  • You contribute 6%: Your employer will deposit an additional amount equal to 3% of your check. 
  • You contribute more than 6%: You’ll still receive an employer match of 3%. 
  • You contribute 4%: Your employer will deposit an amount equal to 2% of your paycheck or 50% of your contribution.   

This match is free money from your employer toward your retirement. You should do what you can to make sure not to leave that money on the table. In other words, you should deposit at least the amount into your 401(k) needed to get the maximum employer match. In the example above, you should contribute at least 6% of your paycheck into your 401(k). 

If you can, you should contribute more than the minimum contribution required to get the most employer match. 

A good rule of thumb is to contribute at least 10% of your income. But, as with everything in the financial world, this should be customized based on your individual circumstance. This percentage may need to be higher if you are playing catch up. If you would like to consult experts on what exactly you should be doing in order to ensure you meet your desired retirement goal, reach out to us at FJY 

Side note: the Internal Revenue Service limits how much you may contribute to your 401(k). For 2020, that limit was $19,500. Workers aged 50 and older may make additional “catch-up” contributions. These can be up to $6,500 for a total of $26,000. 

Consider a Roth Account 

Most employers also give the option to make contributions to a Roth 401(k) account 

What is the difference between the two you ask? Here is a brief overview: 

401(k) 

Roth 401(k) 

Employer-Sponsored Account 

Employer-Sponsored Account 

Contributions are Made Pre-Tax, but Taxed Upon Withdrawal 

Contributions are Made Post-Tax, but Withdrawals are Tax-Free 

Annual Contribution Limit: $19,500 

Annual Contribution Limit: $19,500 

Take note that you can also do a combo investment into each account up to the max (e.g. you can put 50% of savings into a Roth 401k and 50% of savings to regular 401k up to $19,500). 

When considering which route to take, be sure to take your tax rate into consideration. Is it better for you to pay taxes now or later? If your tax rate will be higher when you retire, then it may make more sense to make Roth contributions while you are in a lower tax bracket. If your tax rate will be lower when you retire, it may make sense to contribute to your 401(k) and pay taxes later. As always, it’s best to consult an expert when making this decision. 

So Many Options 

401k-guideWhen you sign up for a 401(k), you’ll likely be given many different investment options. The variety of choices may be intimidating, but don’t fret. 

A good place to start is a target-date fund. In the context of a 401(k), this is a mutual fund designed for someone who expects to retire around a particular date. The professional manager of that fund will make investments in a way that maximizes the payoff while minimizing risks as your retirement date approaches. 

Such funds will have more invested in stocks when you’re younger, transitioning to safer bonds as you get older. 

In addition to looking at a target-date fund, you should consider talking to a financial planner to explore other investment options. 

Try Not to Borrow Against Your 401(k) 

Retirement accounts are for retirement.  

As your money grows, it may be tempting to make use of it as you face life expenses or want to make large purchases. 

An early withdrawal is generally a bad idea, mainly because you’ll face sizable penalties, in addition to taxes. 

Another option to tap into that fund is a loan. Some plans allow you to borrow against your 401(k). These loans may seem attractive as they don’t require you to undergo a credit check. 

Still, you should avoid one of these loans if you can. 

Downsides to 401(k) Loans: 

  • The amount you borrow will not grow in your account until you pay the loan back. That means you’ll lose that time for your retirement funds to increase. 
  • You’ll face double taxation on the loan interest. That’s because the loan interest you pay into your account must be from the money that has already been taxed. It’s not like typical 401(k) contributions that aren’t taxed when they’re made. And when you withdraw that money in retirement, you’ll have to pay income taxes on those funds again. 
  • If you leave your workplace, any of the loan that hasn’t been paid back may be subject to taxes. 
  • The amount of money you borrow won’t be protected from creditors, and bankruptcy like 401(k) funds typically are. 

401(k) Options When You Change Jobs 

If you’re leaving your job, you’ll have a decision about what to do with your 401(k) account. It’s essential to know your options. These include: 

  1. Leave the money where it is. Some plans require you to move the funds after a certain amount of time. For those that allow you to leave your money, this option might make sense. If you don’t have a new job yet or if the plan at your new job has limited investment options and higher fees. 
  2. Roll it into your new plan. This allows you to combine the funds from your old 401(k) with your new one. This can be useful for keeping track of your money as you have only one account to manage. 
  3. Roll it into an IRA. An IRA rollover can offer a broader array of investment options and lower expenses. Remember that if you have your funds in a Roth 401(k), the money can only be rolled over into another Roth account. 
  4. Take a lump-sum distribution. If you are at least 59½, you can withdraw a lump sum from your 401(k) with no penalty. However, the distribution is taxed as income. If you withdraw enough, it could put you in a higher tax bracket. If you are younger than 59½, such a withdrawal would cost you a 10% penalty in addition to the income taxes. 

Whatever you do when you change jobs, make sure you repeat what we’ve discussed here and educate yourself about your new employer’s 401(k) options. If there’s a waiting period, mark your calendar and enroll as soon as you can. And always maximize your contributions and do not leave any employer match on the table. 

Your 401(k) is one of the keys to a secure retirement. By making the right decisions, you can lessen the stress and increase your enjoyment of your golden years. Consult an expert to ensure you are doing all that you can in order to achieve your desired retirement.