If you are not already participating in your company’s 401(k) retirement plan, enroll as soon as you can. Just like winning the lottery, you don’t have a chance to benefit unless you buy a ticket. Now that you are enrolled in the plan, one critical step is to select your investments. It is very important for savers to get their 401(k) investment strategy right from the beginning. Many plans offer some kind of help to the participant to choose investments that make sense for their situation. Some plans may offer online tools, some may offer a telephone consultation with an advisor, and the most robust plans may offer individual counseling for each participant, one on one with a qualified financial advisor. The younger the participant, the more likely that a more aggressive investment strategy may be appropriate because of the long time frame until retirement age.
After selecting investments appropriate to your goals, deciding how much to contribute to the plan is another important decision to carefully consider. It is very important that a participant at least plan on a contribution level that qualifies them to receive any matching funds offered by the employer. An employer match effectively amounts to free, extra money from the employer that the employee would otherwise not have access to. Why pass up free money?
Choosing a default contribution amount or contributing enough to qualify for employer matching funds is a fine place to start, but for many people, saving 10 to 20% of their income will go a long way toward helping them build a retirement nest egg that can meaningfully impact their future. For some participants, setting a goal to contribute the maximum permitted by the plan may be the best way to go. If saving 10 to 20% or maxing out the plan limits on contributions sounds daunting, they should consider working toward those goals in small increments.
Start contributions with the most you can feel comfortable with and then increase contributions by 1 or 2% of compensation after six months or a year. When there is a raise or a bonus, consider bumping up contribution levels as the raise is happening. That way, you never really feel too much of a pinch as you raise contribution levels. If you wait until after the raise is in place, it is easy for most people to absorb that raise into incremental increases in lifestyle cost. Later trying to increase contributions might cause a feeling of having to “tighten the belt”.
Participants should keep in mind that regular contributions to a traditional retirement plan are typically made on a pre-tax basis. That means that when they raise their contribution levels by a dollar, it does not mean that they have a dollar less to spend on lifestyle. Depending on their income tax bracket, a dollar of contribution may only “cost” them 70 cents of take-home pay. If the plan offers a Roth 401(k) option, contributions are made with after-tax dollars but withdrawals in retirement are made tax-free. For younger participants, choosing a Roth option in a plan may be very beneficial to their long-term financial success.
Some plans offer an auto-escalation feature. This helps participants increase their contributions gradually over time without feeling too much of a strain on their current lifestyle. I typically recommend to participants to take advantage of auto-escalation features if they are offered. Auto-escalation does not take the place of personal responsibility and commitment to saving for retirement. Each participant should seek out help, ideally from a qualified financial professional; to assist them in determining how much they should be contributing to retirement plans, savings accounts, and other investments. This guidance can help them decide on appropriate savings goals suited to their individual needs.
Some plans offer the option for new employees to enroll in the plan even before they are actually eligible to contribute to the plan. This can be very helpful if the employee has funds with a prior employer’s plan that might benefit from a rollover to the new plan. For example, an old employer’s plan might have higher fees than the new employer’s plan and therefore a rollover of the old funds might make sense. An old employer’s plan might have limited investment options and the new employer’s plan might have a more robust set of investment options, offer individual counseling with a qualified investment advisor, or other features that make the new plan more attractive than the old plan.
In handling a rollover, it is important to make sure that the paperwork is filled out properly to ensure the transfer of funds takes place directly from the old financial institution or service provider to the new financial institution or service provider. Ideally, the participant would never actually handle the funds. If the old plan does issue a physical check instead of an electronic transfer of the funds, it is very important to get that check deposited into the new plan as quickly as possible. The IRS only allows 60 days for such a transfer where the participant is temporarily in possession of the funds. Remember, typically the funds in a retirement plan have never been taxed. If you miss the 60-day deadline, all of the intended transfer is immediately subject to income taxes and potential penalties as well.
Even if there is no need for a rollover from an old plan, participants can make the most of their waiting period by setting aside a savings amount equal to their intended retirement plan contribution in a savings account. That money can become part of their emergency cash reserves and then when they do become eligible to contribute to the retirement plan, they are already used to set aside a certain amount of money and will not even feel a pinch when plan contributions begin.
Retirement plans such as 401(k), 403(b), 457, etc. are valuable savings vehicles and really represent a very important part of anyone’s overall savings and investment plan, especially with the tax advantages the plans offer. Take advantage of all that is offered to you. Do your homework and get professional advice to make the most of your plans. Your life may likely be much better as a result.
The opinions expressed in this commentary are those of the author and not necessarily the views of United Capital Financial Advisers, LLC. Certain statements contained within are forward-looking statements, including, but not limited to, predictions or indications of future events, trends, plans or objectives. Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties. This material is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. United Capital does not warrant the accuracy or completeness of the information. The commentary is intended for information purposes only, is not a recommendation to buy or sell any securities, and should not be considered investment advice. Investing involves risk, including the possible loss of principal.