The 401k plan is the retirement vehicle for most private sector workers. But after all these years it is still misunderstood and misused to the detriment of plan participants. Here are a few tips I learned over the years designing and managing such plans.
- Think twice before taking what may appear an attractive loan from your plan. While it may seem you are borrowing from your account, you are actually borrowing from the plan trust. The interest you pay that is credited to your account will be taxed as ordinary income when it’s withdrawn. While you have the money it is not earning interest as an investment. If you have an outstanding loan when you terminate employment, if you don’t pay back the outstanding balance, it will be treated as a withdrawal and taxes (and penalties) may apply.
- You don’t need to invest in many funds, just because you invest in several mutual funds does not mean you are diversified. You may also drive up the fees you pay
- Don’t check your balance frequently; set it and forget it (sort of)
- Don’t chase the market by frequently changing your investments, you are saving for the long, really long-term
- Determine the best mix of investments based on your age and expected retirement date. That means the portion of your account at the most risk for volatility should decline gradually as you get closer to needing the money in retirement. Remember the Great Recession? People who claim they lost their retirement savings probably didn’t consider this.
- If you play it safe by using very conservative investments, your chances of accumulating money in excess of inflation are greatly diminished. In other words, you are treading water.
- Always contribute to your plan at least to the level of any employer match.
- If your plan allows after-tax or Roth contributions, consider using both for a portion of your contributions. Having tax-free income in retirement can come in handy, especially in the early years when you may not need or want the amount you are required to take because of the required minimum distribution. After-tax contributions count toward the RMD, but are not taxable.
- Find the lowest fee funds offered by your plan; usually this will be an index fund
- Consider using auto-balancing and auto-escalation of your contributions if offered by your plan. The first keeps the mix of your investments on target and the second increases your contributions as your pay rises
- Your investment horizon (the point you start using the money) may not be that date you retire, especially if you plan on taking another job and or Social Security; plan your investment mix accordingly
- If you are overwhelmed by investment choices or which allocation to make, seek assistance from a professional or automated retirement planning tool. In the absence of that consider using an S&P index fund if available in your plan
- If you are using a target date retirement fund, that is intended to be where you invest all your contributions. If you mix it with other funds, you defeat the purpose of the fund 🎯
- Save for emergencies and other goals outside your 401k plan. Loans and hardship withdrawals can be costly both from a tax standpoint, but also by screwing up your future retirement
- If you are nearing 70-1/2 remember you will pay ordinary income tax on your pre-tax contributions, your employer contributions and all earnings in your account (except Roth). Your initial RMD will be about 4% of your account balance and that percentage will increase gradually as you age. It may not be a good idea to delay your distribution until the April after you turn 70-1/2 because you will be required to take a second withdrawal before the end of December.
🎯 A big chunk of the 401(k)s tallied are wholly invested in target-date funds (TDFs). Those savers account for 44 percent of 401(k)s at the company, up from 41 percent a year ago. These all-in-one accounts are the default investment option for an increasing number of retirement savings plans. More than 65 percent of the millennials in Fidelity’s pool of participants have all their 401(k) money in a TDF. Of all the people with 100 percent of their 401(k) money in a TDF, millennials make up 40 percent. Source: Bloomberg.com