One of the most common types of retirement accounts in the United States is the 401(k), an employer-sponsored plan. For many people, it can be practical to maximize their savings in a 401(k) before opening other types of retirement accounts.
The decreasing popularity of pension plans means that a large number of Americans will depend on a 401(k) to fund their retirement. At the most basic level, a 401(k) is a tax-advantaged account that involves setting aside pre-tax income and allowing it to grow tax free throughout your career. Then, when you retire, you can take money out of the account and pay taxes on the total at that time.
However, the strategies for getting the most out of a 401(k) are sometimes not immediately clear. Read on to learn some tips for maximizing retirement income from your 401(k).
1. Utilize match programs
Not all employers have a match program for 401(k) accounts, and unfortunately, fewer and fewer companies are offering this benefit. However, if you do have access to it at your company, you should take advantage.
With a matched contribution, your company is essentially giving you free money, so it makes sense to at least maximize it. One of the most common match policies is 50 cents for every dollar, up to 6 percent of total pay. In this situation, you should strive to save at least 6 percent of your salary. Make sure you understand the exact matching rules at your company, however, and ask about the benefit when looking for a new job.
2. Roll balances between jobs
Nowadays, people generally switch companies several times throughout their career. When you leave a company for another, you will need to decide what to with your 401(k). One of the major temptations is cashing out, but that means paying a 10 percent early withdrawal fee on top of income tax.
You can leave the 401(k) alone and allow it to continue growing or roll it over into your new employer’s 401(k) or an individual retirement account (IRA). Rolling the balance between accounts is usually the best way to keep all your savings in one place and limit any confusion about accounts. To avoid rollover fees, ask your former employer to transfer the balance directly to the new financial institution rather than cutting you a check.
3. Revisit the savings rate.
When new employees set up a 401(k), they will often be registered automatically for a savings rate—3 percent is most common. However, 3 percent is unlikely enough to help you reach your retirement savings goals. Increase the rate if you can, and aim for maximizing match benefits, as outlined above. Also, you will need to revisit the rate regularly to see if you can increase it, particularly after a raise. Financial planning experts recommend trying to increase the rate with each raise to reach the eventual goal of 20 percent of pay. Regularly revisiting the rate helps you keep on top of your savings.
4. Pay attention to vesting.
Employers often require their employees to become vested in a 401(k) plan to get the full benefit of a match program. Understanding the vesting policy is critical. Some companies will allow employees to keep a portion of the match based on their time with the organization if they leave before being fully vested, while others require a complete forfeit of that amount. Becoming vested can take up to five or six years.
Knowing the time it takes to become vested and the specific policy can help you make the right decisions when it comes to changing jobs. Sometimes, staying with a job for an additional year can mean a retirement account boost of thousands of dollars—missing out on this money could be very unfortunate.
5. Keep fees low
As you put money into your 401(k), you will have a variety of choices in terms of investment options. These investments have different fees and costs associated with them. High fees can quickly cut into the growth achieved by these accounts, so you should make sure you pay attention to the overall costs and choose options that are appropriate for your risk tolerance while also minimizing the number of administrative expenses.
401(k) plans are required to send all participants an annual fee disclosure statement, so this is a great place to begin your investigation. Sometimes, 401(k) plans in general have very high fees. In this case, it could make sense to focus on an IRA rather than a 401(k).
6. Diversify your portfolio
A 401(k) is an investment account. Any investment comes with risk, meaning there is the chance that the account could lose money. You can minimize this risk through diversification, or choosing a variety of different types of investments in varying industries. At the most basic level, you should have a mix of both stocks and bonds.
Over time, you should revisit the balance in your portfolio to make sure you are maintaining diversification. Assets that perform well tend to become overrepresented in a portfolio, and failing to rebalance puts you at an increased risk of losing money.