How to Make the Most of Your 401(k) Part II

How well you manage your 401(k) in your working years can have a big impact on your financial security in retirement. This is Part II on How to Make the Most of Your 401(k) and the following tips are designed to help you from the time you sign up for the plan until the time you retire.

For Part I, please click here

Choose an appropriate asset allocation.

How you divide your 401(k) account among stocks, bonds, and cash can have a big impact on your financial account balance. That is because each asset category has a different potential for reward and a different level of risk.

Generally, the higher the potential return, the higher the risk. Of the three major asset categories, stocks have historically provided the highest returns over the long term and have the most risk. Bonds tend to provide lower returns than stocks over the long term and are generally less risky. And cash investments tend to have the lowest returns and risk.

So how should you divide your investments among stocks, bonds, and cash? The proportions that are right for you will typically depend on how much time remains before you will need your money, your tolerance for risk, and the amount you need to save for retirement. Your objective is to choose a mix of assets that offers a good probability of reaching your goal, within your time frame, and at a level of risk that is acceptable to you.

Here are a few guidelines:

The longer you have until retirement, the more stocks you may want to hold. This is because stocks generally offer greater growth potential over the long term than bonds or cash. Despite stocks prices changing, the longer an investor has until they need the money the longer they have to wait it out.

As you get closer to the time when you will need your money, you may want to reduce the risk level in your 401(k) account by gradually shifting to more conservative investments such as bonds and cash.

Don’t dip into your 401(k) savings when you change jobs.

Although you have the right to withdraw money from your 402(k) account when you leave a company, it is usually not a good idea to dip into your retirement saving s before retirement.

You’ll have to pay ordinary income tax on the taxable portion of your withdrawal, which may be all of it, and perhaps 10% early withdrawal tax penalty if you are under age 59 1/2. Plus, you risk falling short of your retirement savings goal.

Instead consider leaving your money where it is, transferring it to your new employer’s retirement plan, or transferring it to an IRA. Each of these options avoids immediate taxation and makes it possible for your savings to continue to grow.

Arrange for a direct rollover if you move your 401(k) savings.

If you decide to move your money to your new employer’s retirement plan or to an IRA when you leave your job, it’s generally wise to arrange for a direct rollover. This is done with an electronic transfer between two institutions or with a check made payable to the receiving plan or IRA.

If you have the check made payable to you with the thought that you will deposit it yourself, there will be tax consequences.

Avoid early withdrawal penalties if you retire early.

If you plan to retire and tap into your 401(k) account before age 59 1/2, it’s a good idea to find out if you qualify for one of the exceptions to the 10% early withdrawal tax penalty that generally applies to withdrawals made before age 59 1/2.

There are several exceptions to the penalty, but two may come in handy if you are retiring. The first states that if you leave your job in or after the year you reach age 55 (age 50 if you are a qualified safety employee), withdrawals that you make from that employer 401(k) plan after you leave are penalty-free.

The second states that the money you withdraw as part of a series substantially equal periodic payments avoids the 10% penalty.

There are also other exceptions for people with total and permanent disabilities and those with certain amount of unreimbursed medical expenses.
If you retire early, avoiding the 10% penalty can help you make the most of your 401(k) savings.

These tips are general in nature so please speak to us for specific advice on your personal situation and how you can make the most of your 401(k). 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 jennifer@dh-cpa.com.