Saving for retirement may not be at the top of your priority list, but you’ll be glad you did it when the time comes.
One of the easiest ways to do so is to invest money in a 401(k) fund, a type of investment-based retirement account typically offered by employers (the self-employed can obtain them, too).
What should you know about 401(k)s to optimize yours? And what should you do with yours when you switch jobs? Financial experts offer advice.
Always Take Matching Compensation
If you are lucky enough to receive employer matching contributions for your 401(k), you should absolutely jump at this, because “it is essentially free money going toward your retirement goal,” said Brittney Castro, CFP with Mint.
Your 401(k) plan is important because it allows you to save and invest for your retirement goal and offers tax advantages for doing so, she said. “All the funds within your 401(k) plan grow tax-deferred until withdrawn.”
“If the employer offers matching contributions, consider them as part of your compensation and don’t waste them,” agreed Matthew Jenkins, CFA, CFP with Noble Hill Planning LLC.
But you want to make sure you’re contributing the right amount to benefit. “Look up the rules for your 401(k) plan — or ask the HR team — and make sure you contribute enough to receive the full benefit of the employer match,” he said.
For example, if the employer will match 50% of employee contributions up to 6%, then you need to contribute at least 6% of your income to the plan to receive that match.
Increase Contributions Every Year
If you have a 401(k) with your current employer, try to increase by 1% annually to achieve the desired savings rate through a combination of employee and employer contributions, said Matt Fleming, CFP, senior financial advisor with Vanguard Personal Advisor Services. “The 2022 annual limit for employee contributions is $20,500 for those under age 50 — or $27,000 if you’re age 50 or older and the plan allows catch-up contributions.”
Know Your Vesting Schedule
If your employer is matching funds, you may have a “vesting time” to consider, according to Kyle Bingham, CRPC, senior financial education consultant at Financial Fitness for Life. “The vesting of your 401(k) refers to the amount of time that must pass before those matching contributions belong to you.”
For some employers, this vesting happens immediately; other employers create a vesting schedule that happens over a period of several years. “If you leave that employer prior to meeting the vesting requirements, they could take back some or all of those matching contributions.”
Choose Between Roth and Pre-Tax Contributions
There are different ways to contribute to your 401(k), Jenkins said. Pre-tax contributions give you that tax break up front, which is probably better for higher earners. Roth contributions, where the taxes come out when you withdraw the funds, are probably better for those in a low marginal tax bracket, he advised.
Ask Your Employer for a Better Plan
Jenkins encourages employees to be bold in asking employers for better 401(k) deals if they are not satisfied.
“All employers offering a 401(k) retirement plan have a fiduciary responsibility to their employees,” he said. “The employer must create a plan with reasonable fees and features that will allow the employees to effectively save for retirement. Many companies, especially smaller ones, don’t have a 401(k) specialist on staff, so they might not be getting the best deal in the marketplace.”
When You Switch Jobs
What about when it’s time to switch jobs? What do you do with an existing 401(k)?
Leave It Where It Is
If your current 401(k) plan has low fees, no harm in leaving it where it is and starting up a new one with the new employer, Jenkins said. “However, if you switch jobs often, you’ll leave a trail of old 401(k) accounts behind you. These can be a pain to clean up and consolidate later on.”
Don’t Forget About It
Castro warns that you don’t want to forget about the 401(k)s you leave behind. “It’s always a hassle to get everything consolidated after so much time has passed. Some employers will accept the rollover and add it to the current 401(k); but, if it’s not accepted, an IRA Rollover account will be opened and the money will be deposited into that account.”
Transfer To an IRA
Another option if you leave your job is to roll your 401(k) funds into a traditional IRA through a third-party financial institution, said Zachary A. Bachner, CFP, with Summit Financial Consulting. “IRAs do have slightly different rules than a 401(k), so it is important to review the pros and cons before making this transfer. An IRA will normally expand the universe of available investment options.”
IRAs are a good option “if you want to invest in more individual stocks, since typically 401(k)s just hold mutual funds,” said Brooke Cantrell, a financial planner at Windsor Wealth Planners & Strategists. “The disadvantage for this option is that you may encounter larger fees.”
Transfer To Your New 401(k) Account
Another option is to roll your old 401(k) into your new job’s 401(k) plan,” Jenkins said. “(This) can keep everything consolidated and easy to manage.”
Before doing so, however, he urged you to check out the fees associated with the new plan. If they are high, then consider transferring to an IRA instead.
Always request a trustee-to-trustee transfer when moving retirement funds. Avoid using a 60-day rollover, as there is a significant risk of unintended tax consequences.
Cash It Out
As a last resort, you can cash out your 401(k), but know that “cashing out … has serious tax consequences,” Jenkins said. “If your funds are in a pre-tax 401(k) account, then you’ll owe taxes on any amounts you withdraw. For Roth funds, you’ll be giving up all future tax protections.”
Cantrell agrees withdrawal is not a great idea. “If you take this route, the distribution will be considered ordinary income; and, if you are under the age of 59½, then you will also pay a 10% penalty as well.”
However, the IRS will allow you to take a hardship withdrawal based on set conditions that would not trigger a 10% penalty, said Randa Hoffman, founder of RADIANT Wealth Planning, LLC.
Talk To a Financial Advisor
Whatever you decide to do, be sure to talk with a financial advisor. “An advisor who is in your corner will discuss all of these options with you and let you make the choice,” said Corey Noyes, owner and financial advisor of Balanced Capital.
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