At Work

Tips on using your 401k plan

Hey, I'm putting the money in, what do I know about investing?

Hey, I’m putting the money in, what do I know about investing?

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.

  1. 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 The interest you pay that is credited to your account will be taxed as ordinary income when it’s withdrawn.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.
  2. 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
  3. Don’t check your balance frequently; set it and forget it (sort of)
  4. Don’t chase the market by frequently changing your investments, you are saving for the long, really long-term
  5. 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.
  6. 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.
  7. Always contribute to your plan at least to the level of any employer match.
  8. 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.
  9. Find the lowest fee funds offered by your plan; usually this will be an index fund
  10. 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
  11. 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
  12. 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
  13. 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 🎯
  14. 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
  15. 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

Advertisements

2 replies »

  1. Obviously, Bloomberg doesn’t know all that much about 401k plans:

    1. 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. (So is all the interest or capital gain that you might achieve as well). While you have the money it is not earning interest as an investment. (Sure it is, it is earning the interest you are paying on the loan). 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. (That varies from plan to plan).

    2. 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 (Really, how can investing in more funds drive up your fees – I don’t know of even one plan that has 21st Century architecture that charges more fees if you use more funds. I suppose you can make the argument that concentrating assets in fewer funds will lower the fees in the funds that remain – but that must be a plan wide action).

    3. Don’t check your balance frequently; set it and forget it (sort of) ( Stupid advice. One of the largest challenges are people who never change their contribution rate nor their investment allocation – something more prominent now that many plans use automatic features)

    4. Don’t chase the market by frequently changing your investments, you are saving for the long, really long-term. (Again, stupid. Define “frequently” please. And, if I take a plan loan, what is my investment time horizon? And if I am age 64, what is my investment time horizon?)

    5. 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. (Again, stupid. No mention of other financial assets – Social Security, Retirement Plans, IRAs, other investments, etc.)

    6. 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. (Again, stupid. No mention of other financial assets – Social Security, Retirement Plans, IRAs, other investments, etc.)

    7. Always contribute to your plan at least to the level of any employer match. (Actually, since the median worker in America will have 6, 7, 8, 9, 10 or more employers, and since typically, 20% – 40% of those employers may not offer a 401k plan, you probably need to contribute more.)

    8. 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. (More stupidity. Of course, Roth monies, rolled over to an IRA, are not subject to RMD – well, at least not today).

    9. Find the lowest fee funds offered by your plan; usually this will be an index fund (Stupid. You should be looking for the funds that have the highest returns, net net of fees, with regard to future prospects. If, say, the money market fund has the lowest fee, say 10 basis points, you think you should use that fund exclusively. Remember that the past is not necessarily a predictor of the future).

    10. 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. (Again, showing his lack of understanding, the auto- balancing only returns the allocation back to that selected by the participant. If it is 90% in money market … And, with respect to auto-escalation, who says you only see a contribution increase after pay increases)

    11. 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. (Again, he is suggesting that investing of assets stops when you commence payout – what an ass).

    12. 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. (Again, if you are age 70, or age 21, you should allocate everything to a domestic, S&P index fund).

    13. 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 (What is she doing outside the plan? Again, stupid).

    14. 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. Here he shows his greatest ignorance. Most Americans live paycheck to paycheck – one survey confirms that they would have some or great difficulty if their next paycheck was DELAYED FOR ONE WEEK. So, if you encourage people to put money aside outside the 401(k), for many, there won;t be any money left to save inside the 401(k). The better answer was, is, continues to be, to improve the loan provisions inside the 401(k) plan to 21st Century functionality – so that individuals can meet short term emergency needs … without curtailing their savings efforts.

    15. 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. (Again, stupid. He sounds like he is worried about taxes and the RMD. So, why not rollover the Roth 401(k), perhaps consider a Roth conversion, too?! And, of course, he totally ignores the possibility that the individual is still working at age 70 1/2, where no RMD is required with regard to the 401(k) monies in the plan of his current employer.

    What crap.

    Like

  2. Dear Richard, I found this post helpful even though I’m somewhat familiar with some of them as you pointed out.  I’m actually guilty with #1 as I requested a small loan right before I was let go. Regards, Nick Sin

    Like

What's your opinion on this post? Readers would like your point of view.

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s