Build Retirement Savings in your 401(k) Account
Nobody is sure who the author of the quote “I'm retired - goodbye tension, hello pension!” is, but surely he or she must have been doing something right in building retirement savings.
It is a sad fact that most Americans are not prepared financially for retirement. According to the National Institute for Retirement Savings:
Over 100 million working age individuals (59.3%) do not own any retirement account assets, whether in an employer-sponsored 401(k) type plan or an IRA nor are they covered by defined benefit pensions.
Scary. Leaving yourself unprepared for retirement, relying only on Social Security for your income, is not good for your financial health.
Grow Your 401(k), Wisely
The most common form of retirement savings account, today, is the 401(k) plan. If you are one of the over 50 million American workers that are actively contributing to a 401(k) plan, you are counting on your nest egg to provide financial security your retirement years. To help you achieve this, here are four smart ways to make your 401(k) grow.
A key benefit of your 401(k) plan is the money you put in them lowers your taxable income. You don’t pay taxes on the money on your 401(k) contributions. A lower taxable income means you pay less income taxes. You don't escape the taxman, but the idea is that you will draw on the money, and pay taxes on it after you retire when you're earning a lower income. The lower income means lower taxes.
Make a Habit Out of Contributing to Your Retirement
The best way to grow your 401(k) is to put money in it. No surprise, but money doesn't magically appear in your 401(k). You have to choose to put it in. In some cases, you are automatically opted into contributing, and you have to choose not to contribute. Employers that put an automatic opt-in in place do so to encourage you to save. They know that people often choose the automatic option. If you have to make an effort to opt-out, you probably won't. Tricky, but for your own good.
The best way to have a strong retirement account ready for you when you retire is to put money into it from your first paycheck on. Find a way to contribute anything, 1%, 2%, 5% of your pay and then boost that if you are not feeling pinched by what you are contributing.
Get the Maximum Match
IRS rules place a cap on how much income you can contribute into your 401(k). Aim to maximize your 401(k) contributions, while balancing your other investment and savings goals. The more you put away and the longer it has to grow, the larger your account will be at retirement.
If your employers match your 401(k) contribution in any meaningful way, work hard to get the maximum match. It is free money you don't want to let slip away, if at all possible. For example, if your employer will give 50% of every dollar you give, up to a $5,000 maximum, try your best to contribute the $10,000 that will earn that $5,000 match.
There are penalties for withdrawing money from your 401(k) before you are 59 ½, so don’t put money into your 401(k) that you will need for some other purpose.
Consider a Roth 401(k), If You Think You Will Retire Well Off
Think that you will be in a higher tax bracket after retiring than you are in now? Then a 401(k) plan wouldn’t make too much sense, because all withdrawals will be taxed more heavily. In this case, a Roth 401(k) would make more sense. This retirement planning option allows you to make after-tax contributions so you won’t pay tax when you withdraw the money after you retire. Keep in mind that under the Roth 401(k) you need to hold the money in the plan for a minimum number of years after retirement.
Be realistic in your expectations for your investments and income, and protect yourself from financial shocks like long or short-term disability.
Limit 401(k) Withdrawals
Life happens. If you’re young, you may want to buy a house or not be overwhelmed with bills if you have children. If you’re older, you may want to help your kids with college expenses. Taking money out of your 401(k) to use as part of a down payment or to cover higher education expenses will trigger a 10% penalty and applicable income tax. As much as possible you should avoid making any withdrawals before you reach 59 1/2 years of age, when penalties no longer apply. To cover for those times that you really need to make a withdrawal due to hardship (unreimbursed medical bills) or other situations (first-time home buyer), set up separate savings accounts, or look at an IRA. Most IRA’s offer penalty-free withdrawals under special circumstances.
Don’t view your retirement accounts as an easy source of solutions. They are meant to provide income after you retire. Using them for other purposes eats away at the balance and leaves you with less in your retirement account, in the long run. Build other saving accounts for the different goals you have, such as the home purchase and college education expenses.
Don't Get Burnt When Changing Jobs
Avoid a common, careless mistake of making a bad 401(k) choice when you change jobs. The average American worker changes jobs between 10 to 15 times throughout their lives. If you change jobs take the time to understand your options and your responsibilities with your 401(k) holdings:
- If you meet the minimum balance for withdrawal, consider rolling over the 401(k) into an IRA.
- If you meet the minimum balance for withdrawal, consider rolling over the 401(k) into your new 401(k).
- Keep the monies where they are, if allowed to do so. Cashing out is a poor choice. You lose out on retirement income, and you have to pay taxes and penalties.
If you have a sizable amount in your 401(k), you could be hit with a double whammy. In addition to the taxes and penalties on the 401(k) monies, your increased income from the 401(k) disbursement could raise your tax bracket and cause you to owe more on the income you earn that year. If you planned for your withholding to cover taxes on your income, the higher bracket could result in a surprise tax deficit come filing time.
Each of the three options above has its pros and cons, all of which will depend on your unique situation at that time. The key thing is that you are aware of your choices and analyze them.
If your employer gives you the money from the 401(k), you have 60 days to put it in a new retirement account, like a rollover IRA, and avoid paying penalties and taxes on the entire amount. If you do nothing, you will be issued a 1099,
Your Retirement is Your Responsibility
You’re responsible for making the right investment choices if you have a 401(k) plan. Whether you’re an investment expert or don’t have a clue, it’s up to you. Find the right risk level for your age and pay attention to the fees you pay.
Trying to figure out the right investment choices can be intimidating. It's likely that your employer has resources available explaining your available choices. Don't be shy if you don't understand. Speak up and ask for help if you have questions. There is a ton of good information online, as long as you find the right sources.
If you want money tomorrow, start saving today.