What Is The Main Benefit Of A 401
A 401 plan lets you reduce your tax burden while saving for retirement. Not only are the gains tax-free but it’s also hassle-free since contributions are automatically subtracted from your paycheck. In addition, many employers will match part of their employee’s 401 contributions, effectively giving them a free boost to their retirement savings.
Leave Your Money With Your Former Employer
For some people, the most plausible option is to leave their investment with their former employer. This option allows you to continue making investments with the money even if you are not working with that employer. In most cases, old employers allow you to leave your investment if you have more than $5,000 in your 401 retirement savings account. If your account holds less than this amount, your previous employer may decide to cash out your plan and send you a check for the balance.
The advantage of this option is that it allows you to leave your 401 with your former employer if they offer good terms. Leaving your retirement account with your previous employer allows you to wait for registration to open with your new employer.
When you leave your 401 savings with your former employer, your access to your money can be limited. Some employers can levy huge maintenance fees, implement restrictions on investment choices and prevent access to your savings until you reach retirement age. Unless you’re about to retire and you know you won’t change jobs often, avoid leaving your 401 with your former employer.
Take Full Advantage Of Your Companys Match
To get started on a tangible level, take a look at your companys 401 options, says Driscoll. Many companies offer an incentive match, encouraging you to invest part of your paycheck into a retirement fund. Whatever they match, put that percentage into your retirement fund its free money.
The incentive match is one of the best parts, maybe the single best, of the 401 plan. And the employer match is the easiest, safest money you could ever make, offering you an immediate return for doing what you need to do anyway.
Many employers will match 50 percent of your contribution and sometimes as much as 100 percent up to a certain amount. A few employers do even better than that, although many employers do not offer a match at all. If theres a catch, its that many employers require you to stay with the company for at least a few years for the match to fully vest, though some dont.
Ensure you have contributed enough to get the full company match, says Kirk Kinder, certified financial planner at Picket Fence Financial in Bel Air, Maryland. There isnt any legit reason not to get the full match.
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Why Not Just Take It All
If you’re over 55 and are no longer working, or are over 59-1/2 regardless of your employment status, then you can withdraw your entire account balance in one lump sum. However, this is rarely a good idea, especially if you have a large amount of money in the plan. In addition to losing the creditor protection I mentioned earlier, you could incur severe tax consequences, as the money you withdraw from a 401 counts toward your taxable income.
For example, if you have a 401 account with more than $418,401 in it , a lump sum withdrawal could put you in the highest tax bracket for this year, even if you had no other income. This could take a serious and unnecessary bite out of your retirement savings.
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What’s The Best Choice For You
The best action for your 401 depends on you, and there isn’t just one right answer. I generally advise against taking a lump sum distribution unless you have a small amount of money in the plan. Meanwhile, putting all of your money into an annuity is usually not a good idea, but going this route with some of your 401 may not be the worst idea.
Finally, the best move for you might be a combination of a few of these options. For example, maybe you could take some of the money out right away to cover expenses and treat yourself, use some to buy a deferred-income annuity, and roll the rest into an IRA. The point is that there isn’t a one-size-fits-all answer to the question of what to do with your 401, so it’s important to weigh the pros and cons of each option and make the best decision for you.
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What Is A 401
A 401 is a type of retirement plan that employers provide for their employees. You contribute to the 401 account monthly up to a particular limit. The amount the employees contribute to the 401 account is limited to a maximum of $19,500 for the 2020-2021 fiscal year. For employees who are aged 50 and above, they are allowed to invest $6,500 more as “catch-up contributions.”
Generally, all 401 contributions are profit-sharing plans. For this reason, employer contributions are capped by the 25% deductibility limit. However, salary deferrals are free from this limit. Over the past few decades, the 401 retirement plan has gained popularity among employers and employees alike. It is a qualified retirement plan where employees contribute part of their wages and choose whether it should be pre-taxed or taxed upon withdrawal.
An employee can also choose Roth 401, where the employer funds the investment account with after-tax money . This plan is ideal for those who are likely to pay more taxes in retirement. No tax will be levied when you withdraw from a Roth 401.
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Set Your Own Savings Rate
You may not be aware of the precise dollar amount you contribute to your plan. Thats because about 70 percent of plans use automatic enrollment, according to a recent survey by Callan, an investment consulting firm. Workers are signed up automatically unless they opt out.
Being auto-enrolled is a good thing. But not all employers use these programs, or they may restrict it to new hires. So make sure you are actually signed up for your plan, because automating your savings is the best way to make sure it really happens, says Tom Fredrickson, a certified financial planner with CGN Advisors in Brooklyn, N.Y.
If youre auto-enrolled, dont just go along with the contribution rate set by your plan, which may be less than 5 percent of pay. Adding auto-escalation, if its offered, can help.
Most workers should aim to save 15 percent of pay each year, which can include your employer matching contribution, Ward says. If you cant save that much right now, try to contribute enough to get a full match and gradually boost your savings rate each year.
For those with cash to spare, the maximum dollar amount you can save in a 401 is $20,500 this year, up from $19,500 in 2021. Those 50 and older can stash away another $6,500, which is unchanged from last year.
Roll It Over Into Your New 401
If you start a new job and the employer offers a 401, look at the investment options and the fees in the new plan. Some fees are really low in 401 plans, so you may want to roll your old 401 into your new one.
Having everything in one account, instead of having multiple 401 plans from different jobs, helps keep your retirement savings streamlined, Berra said.
To start the process, speak to your new human resources department to make sure your new plan accepts rollovers. Then, youâll have to fill out paperwork form your new plan, as well as a transfer form from your old employer.
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Key Moves That Can Help Boost Your 401 Savings
With the markets sliding, now’s a good time to take a fresh look at your retirement account
For anyone saving in a 401, its been a rough few months. With both stocks and bonds falling in value, your account balance has likely taken a hit.
If youre a younger investor, dont overreact. You may not have experienced a prolonged down market before, but theyre inevitable. And on the bright side, they give you the opportunity to buy more shares at lower prices.
But if youre feeling anxious, whatever your age, this is a good time to review your 401 strategy. Thats especially important if you havent changed the amount you contribute since you signed up for the plan or were automatically enrolled.
Most people will need to go beyond the default settings in a plan to reach their retirement goals, says Judith Ward, senior financial planner at investment firm T. Rowe Price.
Younger workers may face the biggest savings gap. As a recent study by the Center for Retirement Research at Boston College found, people between the ages of 25 and 35 have higher student loan debt and other financial challenges, which leave them far less prepared for retirement than earlier generations were at their age.
Still, the good news is that its easy to customize your planall it takes is a call or a few clicks on your 401s website. Here are five key moves to make.
What If Your Employer Goes Out Of Business
Under federal law, your employer must keep your 401 funds separate from their business assets.
This means that even if your employer abruptly shuts their doors overnight, your money is protected. It cannot be used to pay off your companys loans, cover employee payroll, or for any other purpose.
If your company shut down abruptly, it is possible that a portion of money will be at risk. If your money has been withheld, but has not yet been sent to the 401 plan to be invested, the company could in theory, access those funds.
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Before You Leave Your Current Job:
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Find out when your insurance coverage ends. Know how long youll have insurance coverage with your soon-to-be former employer. If health coverage ends before it starts up again with your new company, be sure to talk to your employer about your options through COBRA. Although COBRA may be pricey, consider the trade-offs if you were to need medical care during your transition time. Also check out coverage options through federal and state exchanges at healthcare.gov.
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Identify any benefits that will follow you. Some benefitslike a health savings planwill follow you wherever you go, so be sure you know which benefits will come with you and how to continue to access them once you leave.
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Calculate pay thats due to you when you leave. Understand how much unused vacation pay, sick pay, and other compensation should be paid out to you upon leaving. If you have stock options, make sure you know how long you have to exercise them before they expire.
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Know the pros and cons of leaving the money in your current 401 plan versus rolling it over into an IRA or into your new companys 401. Then, decide which option is best for you. Get more information on 401 options here.
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Create a budget for your time between paychecks. Develop a budget that will cover your expenses while youre not receiving a paycheck between jobs. Your goal should be to get by with the money you have rather than going into debt to cover essential purchases.
If You’re Younger In Your Career
Your best bet is to leave your 401 account alone and continue making contributions as normal. This guidance is even more important for younger 401 savers who still have a long way to go before retirement and therefore have time to wait out any market dips their accounts can recover and bounce back long before they enter their nonworking years.
“For investors who have long runways ahead of them, market declines can provide great opportunities,” Winsett points out, suggesting that there are a couple of items younger investors should consider. If you have excess fixed income or cash holdings, it can provide a great opportunity to rebalance capital into equities at discounted prices. Or, if you’re contributing to your 401 on a regular basis through your paycheck, you may want to consider increasing your contribution rate so more money can be deployed during a market decline.
If you’re young and still worried, make sure you know where your 401 money is being invested to make sure the risk is something you can afford taking on, as employers will usually automatically assign a 401 portfolio based on your age and target retirement date. Remember that you can always consult your 401 plan provider for help.
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Debt Relief Without Closing My 401k
Before borrowing money from your retirement account, consider other options like nonprofit credit counseling or a home equity loan. You may be able to access a nonprofit debt management plan where your payments are consolidated, without having to take out a new loan. A credit counselor can review your income and expenses and see if you qualify for debt consolidation without taking out a new loan.
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Keep Things In Perspective
While watching your retirement portfolio drop like a rock is never fun, financial planner Taylor Schulte of the Stay Wealthy Retirement Show says you have to look at this issue from more than one point of view.
Schulte says that, while the S& P 500 is off to the worst start since 1939, it is still up approximately 25% since January 1, 2020.
“Investing is hard. It’s also risky,” he says. “And that’s precisely why the long-term rewards are so great.”
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Search For Unclaimed Retirement Benefits
When all else fails, search for yourself in the National Registry of Unclaimed Retirement Benefits. Not all employers participate in this service, but many do because it provides benefits that help them meet their legal requirements. Its a free service, and it only requires your Social Security number.
You’re Not Invested Aggressively Enough
As you can see in the table below, your average annual returns greatly affect your long-term results.
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Monthly Contribution |
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Data source: Author calculations via Investor.gov.
The $1,708 contribution is the rounded-down monthly equivalent of the 2022 contribution cap for savers under 50 years old, which is $20,500.
Take a look at the difference between the ending balance at 3% vs. the ending balance at 7% — it’s about $1.6 million. That’s not all free money, of course. To realize a 7% return, you must take on added risk by investing mostly in stock funds versus bond funds.
Fortunately, you can mitigate much of the risk by investing regularly over the long term. For your stocks, choose large-cap funds with low expense ratios and keep investing, no matter what. Resist the urge to change your strategy in .
That consistency — over decades — allows you to capitalize on lower share prices and prevents you from realizing unnecessary losses. The result is a higher profit potential over time.
Image source: Getty Images.
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But Avoid Being Too Aggressive
If you have a long time horizon, it can be smart to get aggressive with your portfolio, but those closer to retirement should be careful, too. For retirees and near-retirees, it may be time to shift into preserving your assets rather than trying to play catch-up.
Yet many are focused on growing their assets including aggressive investment strategies rather than preserving their assets against sudden market downturns, says David Potter, former spokesperson for MassMutual Financial, citing the companys research. Many people may be taking more risk than they realize.
Potter suggests that investors reevaluate their portfolio regularly to consider how they would fare if the market declined significantly.
Typically, financial professionals recommend that retirement savers dial back their exposure to stocks as they get within five years of retirement and within the first five years after retiring, he says. A steep market downturn of 20 percent or more during those periods could irreversibly reduce your income in retirement.
Heres how to tell if your portfolio is too aggressive.
Remember Why You’re Investing
According to Los Angeles financial advisor Greg Vojtanek of Fade In Financial, it’s important to remember why you’re in a 401 to begin with. For every single person who uses this type of account or any other retirement account, you’re investing for the future.
“While this market may sting right now, you’re not investing in a 401 for right now,” he says. “You’re investing in a 401 because it will create better returns over time.”
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