Now that traditional pension plans are becoming a thing of the past, 401k’s are the most common way people save for retirement. Yet unlike the pension where there is little choice or attention required, the 401k requires our attention and care.
There are a couple of good reasons to contribute to these plans. First, the money comes out of your paycheck and is generally not taxed. You are allowed to save money and pay less income tax now. Second, the money grows tax deferred (meaning you pay no tax on growth or earnings of the account) until the money is withdrawn years in the future.
What you need to know:
1. You must be present to win, as they say in winning the raffle prize, meaning you need to participate. Some plans automatically enroll employees some do not. I came across a statistic suggesting that one in three people fail to participate in their company’s plan.
2. As far as the amount, or percentage of your salary to save, auto enroll plans tend to have a default contribution rate. It is lower than the amount you should be saving. And if there is an employer match it will be less than the amount needed to take maximum advantage of the employer match.
Find out if there is an employer match and save as much as necessary to maximize the amount the employer pays into your account. If you don’t, you’re leaving money on the table. According to an AonHewitt survey almost 30% of employees don’t take maximum advantage of the employer match.
3. Check your investment selections. Auto enroll plans tend to default into what is known as a target date fund. It is a fund that automatically invests according to your age and when you are likely to retire. It may be an acceptable way to get started but as you learn more about investing you may be better served with a carefully chosen selection of options.
A common mistake is putting all your 401k savings into the most conservative investment option. Your investment assets need to grow over time and they won’t grow nearly enough in the safest option. Don’t “set it and forget it.” Check the mix of investments each year.
4. Fees eat into the amount you keep. Like taxes, the less you pay the better. Look into the fees being charged by the 401k administrator as well as those charged by each fund you’re investing in. There are online fee analyzers to help with this.
5. Don’t borrow from your account. Just don’t! Think of some other option. It should be a last resort.
Don’t forget why you’re saving! People are living longer. You can’t realistically expect to save for 10 years, retire for 30, and maintain the lifestyle you had when working. Start saving early and often because it takes time for your money to grow. The 401k is a useful tool for that.