How well you manage your 401(k) in your working years can have a big impact on your financial security in retirement. The following tips are designed to help make the most of your 401(k), from the time you sign up for the plan until the time you retire.
Choose a contribution rate that is right for you.
To make it easy as possible for employees to begin saving for retirement, many employers automatically enroll new employees in their 401(k) plans and assign them a default contribution rate, such as 5% of their wages. While it may be convenient to accept the default, there are two things to keep in mind. First, the default is merely a suggestion. You can choose the percentage of your salary that you want to contribute. Second, the default rate may be much lower than what you need.
So how much should you be contributing and saving in your 401(k)? The answer is different for everyone, but for many the percentage will be closer to 10% or 15%.
Another thing to consider when contributing is the company match. Many employers will match the amount you contribute, up to a certain percentage of your salary. It is also possible that if you don’t contribute you may miss out on essentially free money from the company match. So be sure you are contributing enough to receive the full match.
Please note the 2021 maximum 401(k) contribution is $19,500. If you are 50 years or older, you may be able to contribute an additional $6,500 if your 401(k) plan allows catch-up contributions.
Consider sticking around until you are vested.
To help make the most of your company matching contributions you receive, it’s important to understand your 401(k) plan’s vesting schedule. The schedule will tell you when you become the owner of the matching contributions in your account.
Vesting schedules differ from plan to plan, but they are generally structured in one of the following ways.
Immediate vesting. If your plan offers this type of vesting, all the matching contributions made to your account are yours immediately.
Cliff vesting. With this type of investing schedule, you must work a few years before you will own any of the company matching contributions in your account.
Graded vesting. If your plan has this type of vesting schedule, you will gradually gain ownership of the matching contributions overtime.
To learn when the company’s matching contributions become yours to keep, please review your 401(k) plan’s Summary Plan Description.
Consider contributing to a Roth 401(k).
Does your employer’s 401(k) plan offer a Roth option in addition to traditional 401(k) accounts? If it does, it is a good idea to consider which approach to saving may benefit you more.
With a traditional 401(k) account, your contributions are made with pre-tax dollars and withdrawals are subject to income tax. This approach provides an immediate tax benefit because your contributions reduce your taxable income for the year, which in turn reduces your current income taxes.
Some 401(k) plans also offer a Roth option, in which contributions are made with after-tax dollars (income that has already been taxed) and qualified withdrawals are tax-free. (Qualified withdrawals are generally those made after age 59 ½ and after the Roth account has been open for at least five years.) Although Roth accounts do not offer an upfront tax break, tax-free withdrawals in retirement may be more desirable in some situations.
Roth accounts tend to benefit people who will be taxed at a higher rate in retirement than they are now because it allows them to pay the tax on their contributions now when their tax rates are lower.
A Roth account may also be a good choice if you are simply looking for some income-tax-free income for retirement or to pass on to your heirs.
Another thing to know about Roth 401(k) accounts is that, unlike Roth IRAs, Roth 401(k) accounts do not have income limits. This means that even high-income individuals can contribute to Roth 401(k) accounts, as well as to traditional 401(k) accounts.
To learn more about how you can make the most of your 401(k), check out Part II by clicking here.
These tips are general in nature so please speak to us for specific advice on your personal situation. With offices in Rutland and Williston, Vermont Copper Leaf Financial develops a customized wealth management plan designed to integrate every aspect of your financial life. Our approach is to provide clarity and calm amidst the chaos. Where there is uncertainty, we look for facts. We call our approach evidence-based investing. Call us today at 802-878-2731 to schedule a strategy session and begin building your road map to financial success.
Article published in March 2021 edition of Eye on Money. If you would like to be added to our mail list please email [email protected].