I have seen individuals make a lot of mistakes – and also good choices — in my 30 years of working with 401(k) participants from companies like Apple, IBM, AT&T, Northwestern Mutual and many others.
Following are my thoughts on managing your 401(k) plan account to attain a balance that will allow you to retire without reducing your standard of living.
1. Contribute at least 15%
Rowe Price, Fidelity and Vanguard all say you need to add around 15% to your 401(k) plan account every year you work. Because none of us do that, especially in our early career years, I suggest that you add more — at least 20%.
As you calculate the amount you can afford to contribute, know that these percentages include any company contributions. So, if your company has a 3% match, plan on contributing 12% to get to the recommended 15%.
If you aren’t at the recommended contribution level right now, increase your contribution percentage every time you get a raise. For example, if you get a 3% raise, increase your 401(k) savings rate by 1%. This is a relatively painless way to increase the amount you are saving while still allowing you to enjoy a bump in your take-home pay.
The two regrets I hear most from retirees are: 1. I should have started saving for my retirement earlier, and 2. I wish I had saved more.
Don’t end up with similar regrets. Target adding 15% to 20% to your 401(k) account each year.
2. Don’t stop contributing
Many participants feel they need to stop making contributions to their 401(k) accounts for various reasons.
I have heard participants say when markets fall, “Bob, I stopped making contributions because I was losing money on my 401(k) investments.”
Please keep in mind that the idea is to buy low and sell high. So, when markets are falling, your contributions are purchasing more shares of your investments at a lower price. Your investment funds just went on sale!
Some participants reduce their 401(k) contributions when they begin saving for something else – like a home, a child’s college education, a boat, a vacation, etc. These are not the best reasons to lower your 401(k) contribution rate.
There are times, however, when it will make good sense for you to lower or stop making 401(k) contributions — if your spouse loses his or her job, for example.
The problem with lowering or stopping your 401(k) contributions is that most of us neglect to begin contributing or increase our contributions once we reach a point where we can contribute more.
3. Always make sure you collect the entire company match
Company matching dollars are free money. Anytime participants ask me what the easiest thing is they can do to increase their 401(k) plan balance, I always respond, “Are you collecting the maximum company match?”
The returns on your contributions subject to company matching contributions are often 25%, 50% or 100% (because that is what the matching rate is) — risk free! There is no better investment anywhere that you can make.
Even if you need to reduce your contributions for some reason, never reduce them below the maximum company matching contribution rate.
In every plan I have ever worked with, at least 10% of employees don’t contribute enough to collect the maximum match. Make sure you are not one of them!
4. Make Roth 401(k) contributions
Contribute at least a portion of your savings using Roth 401(k) contributions. Roth 401(k) accounts can be distributed tax-free at retirement — that’s right completely tax-free — provided your account has been in existence for at least five years.
The younger you are, the higher the percentage of your 401(k) contributions that you should make as Roth 401(k). Those of you in your 20s and 30s probably should elect to make nearly 100% of your 401(k) contributions as Roth 401(k). Just think of the enormous tax-free balance you can build after 30 or 40 years.
If you are in your 40s, 50s or 60s, you will need to evaluate the benefits of making Roth 401(k) contributions by taking a look at tax considerations. Can you expect to be in a lower or higher tax bracket when you retire? Or, since most of us now target 100% income replacement as retirees, will you be in the same tax bracket?
Personally, I think we are living during a time when tax rates at both the state and federal levels are relatively low. I can’t imagine that tax rates will be lower 10 years from now – but it’s easy to envision much higher tax rates in the future.
If you agree that tax rates are low now, then it makes sense to have your contributions taxed now (at lower rates) as opposed to at retirement (at higher rates). Therefore, you would want to favor making Roth 401(k) contributions now over pre-tax 401(k) contributions.
5. Get help with your investment allocations
Whether or not you consider yourself investment savvy, make sure you get advice from a professional on how to structure your investment allocations.
This doesn’t mean that you have to hire a financial advisor and pay him/her forever. Most 401(k) plans have websites that allow participants to receive allocation suggestions based upon their age, gender and ability to bear risk. Many individuals refer to this as receiving advice from a “robo-advisor”. This is a good way of sourcing appropriate investment allocations at no cost.
A second way of getting advice without paying a fee is to contact the advisor who works with your 401(k) plan. Every plan has an investment professional associated with it and most will talk with participants and provide guidance for free.
Finally, if neither of these options appeal to you, hire a financial planner at an hourly rate to give your allocations a look.
All of these approaches are low or no-cost. You have no reason not to do this – and the impact on your final balance can be significant.
You should plan on having your allocations reviewed every couple of years because a change in your family or financial circumstances (marriage, death of a loved one, loss or gain of a job, birth of a child, etc.) can affect your ability to bear risk.
6. Allocate your balance to target date funds if you desire simplicity
Studies have shown that most 401(k) participants should allocate their savings to the target date fund with the date that corresponds to the year closest to the year they turn age 65. Most of us are too busy with our lives to participate more actively in managing our accounts.
This is the easiest way for individuals to invest in their 401(k) plan since no rebalancing or periodic allocation review is required.
There is nothing wrong with investing 100% of your balance in your age appropriate target date fund for your entire career.
7. Rebalance annually if you aren’t in a target date fund
Periodically you will need to rebalance back to your suggested investment allocations. It is usually easiest to do this once a year. Many participants perform this task at the same time they prepare their taxes.
Most of you will be able to elect to have your account automatically rebalanced by making an election on your plan’s website. Typical options will include quarterly or annual rebalancing. I suggest electing annual.
8. Please do NOT sell when markets fall
Without question, the most destructive thing participants do to undermine their retirement savings program is to sell out of their equity investments when the stock market crashes.
I talked to many people when the markets crashed in 2008-09 who said, “I can’t afford to lose any more Bob, I still have some left and I don’t want to lose that. I need to sell everything now.”
First, you haven’t lost anything until you sell those investments. Secondly, the market will come back, it always has.
Many participants said to me, “What if the markets don’t come back this time, Bob? What if this time is different?”
Please understand that if the value of the U.S. stock market goes to zero, we will have much more to worry about than our retirement balances.
Our form of government will have changed. Our country would have been invaded or destroyed or some other horrible situation would have occurred. In instances like these, we would likely be worrying about where we will be getting our next meal and not concerned with the value of our retirement savings.
Please, if you get scared when the market is crashing (and I guarantee it will crash again in the future), do not sell. Talk with an investment professional before you make any changes to your allocations. Don’t be afraid to pay for advice during such times. It will be money well spent.
9. Don’t take participant loans
This is my second balance-preservation recommendation. It is easy to take a participant loan from your 401(k) account because there is no underwriting and the entire process often can be done online.
Most people who take participant loans default on them if they lose their job unexpectedly (because the entire balance becomes due immediately). Also, many individuals default on their participant loans when they voluntarily move on to take a new job.
When taking out loans, most of us are not expecting to change employers and aren’t aware that the entire outstanding balance is due once we end our employment.
Defaulting on a participant loan makes the entire outstanding balance immediately taxable along with a 10% penalty. Although you can repay your loan to avoid this situation, virtually no one does. As a result, these balances are removed from your retirement savings forever.
In addition, while it may seem appealing to pay yourself interest, in this case, it is not a smart financial move. Studies have shown that the interest you will be paying is much less than you would have earned if you left your money invested in the funds in your plan.
In my opinion, participant loans should be banned from all 401(k) plans. They have nothing to do with preparing individuals for retirement. You should not be motivated to use your 401(k) plan account as a bank or emergency savings program. Using your 401(k) account in that way diminishes your chances of having the retirement you dream about.
10. Don’t roll over your account to an IRA
Many participants, when they leave one employer and move to another, decide to move their former employer’s balance to a rollover IRA. This is nearly always a bad decision.
The minimum advisory charge on rollover balances less than $1 million at most brokerage firms, banks and insurance companies is 1%. If you rollover your balance to your new employers plan, your advisory fees will stay the same – zero.
In addition, nearly all of the investment options you have to choose from in a rollover account will be a lot more expensive then what you would pay in a 401(k) plan.
I hope you will consider following these simple steps to achieve the retirement of your dreams.
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