8 tips to maximize your 401(k) for retirement
Pensions are pretty much a thing of the past. With the switch to company-based 401(k) plans, the burden of saving for retirement falls to you.
"The Leave It to Beaver idea of a worker spending 40 years with a company and retiring with a pension and a watch went out with black-and-white television," says Sen. Ron Wyden D-Ore., chairman of the Senate Finance Committee, who held hearings on the retirement crisis last month.
So it's vital for you to be engaged in your company-sponsored 401(k) plan. Financial planners have some common tips to help you get more out of those plans.
•Contribute at least enough to your 401(k) to meet the employer match. Otherwise, you're giving up free money.
•Early withdrawals (before 59? in most cases) can result is significant taxes and penalties.
•If you're 50 or older, take advantage of the "catch-up" provision, which lets you put an additional $5,500 into your plan each year (on top of the $17,500 annual max).
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By now, most people have heard those. So, here are a few financial tips you may not have thought about, but will help maximize the value of your 401(k) by the time you retire.
The best 401(k) plans
1.The 1% rule. "One of the things we encourage people to do is increase (your contribution) by 1% each year," says Larry Rosenthal, of Rosenthal Wealth Management in Manassas, Va. "Each year, up it by 1% till they reach the maximum. You can work that into a savings each year. It slowly puts more money each year without hurting the budget."
2. Save that bonus. If you get a bonus, max out your 401(k) withholding for that month and live off the bonus," says Andrew Rafal, founder of Strategy Financial Group in Phoenix. "If you get a $5,000 bonus, normally, you'd live off your salary, and you'd save 10%, or $500. I want you to withhold 100%, put it in the 401(k) and live off the bonus for that month."
3. If you delay retirement, keep your 401(k). "I work with a lot of retirees, and those getting close to retirement," says Rafal. "If you are 70?, you have to withdraw a certain amount. But if you are still working at 70? and you have a company 401(k), you do not need to take out that minimum distribution until you actually retire. We often see the wrong advice — roll that into an IRA. Then that individual would have to take out the minimum distribution."
4. Don't forget about that old 401(k) you left at your last job. Lena Haas, senior vice president for retirement, investing and saving at E-Trade, says never leave your money at the old job and forget about it.
"Many people work tirelessly and diligently to contribute to a 401(k), and then they leave their job and don't carry that diligence over," she says. They leave that money and forget about it. The money they worked so hard to save ends up underperforming.
"There is a myth when it comes to retirement savings," she says. "You stash it, and forget it. The opposite is true. If you don't proactively take care of all that money you save, no one else will."
5. Know your company's vesting schedule: Many companies have a vesting schedule with the company match in 401(k) plans. "The money doesn't really become theirs till they have stayed with the company long enough," says Jeanne Thompson, vice president of thought leadership at Fidelity Investments. "This is especially important for Millennials. They tend to change jobs every three or four years. Many plans don't vest for three or four years.
"Overall, one out of every four job changers are not fully vested and forfeited money," says Thompson. "In Millennials, one out of two forfeited money when changing jobs. Multiple job hopping could reduce retirement income significantly when they go to retire."
6. Beware of the 'retirement tax time bomb.' "You get a good tax benefit up front from putting that money in a 401(k)," says Don Chamberlin, president of the Chamberlin Group in St. Louis. "Everyone sees that their salary has been reduced. The problem is by the time they are ready to retire, most people will have several hundred thousand dollars in a 401(k). And when they take it out, they are taxed. It's a huge tax bill accumulated. Ed Slot, IRA consultant, calls it the 'retirement tax bomb.'"
"Many people lose sight of the fact that the majority of 401(k) assets are pretax," says Thompson. "People don't realize that all the money is taxable. If they have $100,000, and are in a 25% tax bracket, they only really have $75,000."
Chamberlin and Thompson say more employers are offering a Roth 401(k) option, and they especially recommend it for younger workers. Since taxes have already been taken out, you won't be taxed when the money comes out. But Thompson says just under 50% of employers offer the Roth 401(k) option, and only 7% of employees are using it. You should talk to a financial adviser to see if the Roth works for you.
7. When you retire, don't withdraw too much, too soon. "As they are entering retirement or thinking about retiring, they should not withdraw too much too soon," says Thompson. "We recommend 4% to 5% (a year). That number can be higher if you have other assets. There are times when you can maintain a higher withdrawal rate. If you retire at 70, your retirement is shorter, so you might be able to withdraw high. If you have a significant pension, you may be able to tap into your 401(k) at a higher rate. If you will work in retirement, have a part-time job, or own real estate and have rental income, you may be able to withdraw at a higher rate."
8. Have an emergency fund. This is "critical," says Thompson. "Everyone should have an emergency fund. She says people often ask how does an emergency fund relate to retirement. "When people need quick cash, many dip into their 401(k)," she says. "They are taking small amounts.
"It's important to start an emergency fund, even if you put in $10 or $20 a week. If the hot water heater breaks or you need new brakes, you have the money so you don't have to tap into your retirement."
Best ways to start that emergency fund: Thompson says work with you current financial institution and start a direct deposit. Make sure it is a separate account. And think of it like the old vacation club or Christmas club accounts banks used to offer.
"Part of the success is it goes from your check to your account," she says. "You get used to not having that money."