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The 411 on Your 401K

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We live in a world of options. Whether it’s what your next meal is going to be, where your next vacation destination is or what should you invest in – there are always options for you. Options are what make the world go ‘round.

Speaking of options, does your employer offer you a 401k account? Does it have a lot of investment options that leave you scratching your head? Ever wonder what happens to it if you leave your company?

Some important things to understand about your 401(k)

 

Your contributions are yours forever

Some people worry that they won’t be with their current employer all the way until retirement, and hold off on making contributions because they don’t want to lose that money if they switch jobs. But the money you put in out of your paycheck stays yours – you can roll it over from the 401k to an individual retirement account (an IRA) that you control when you leave.

You can double your money by taking advantage of your company’s match

Ever been to Costco and made a whole meal out of the amazing free samples that can be found as your browse up and down their aisles? Well, the money your employer offers as a match to your 401(k) contributions is like a free sample-your company is giving you free money! Take it!

401(k) plans usually have fewer investment options than a Traditional IRA account

While this is true, there are usually plenty of options available. Take a look at the options available to you and do some research on each fund to determine if it is something you’d like to. Most will have an option that is called something like “target date fund,” in which you select the fund with a date closest to the year you will likely retire. The investment mix will change gradually from more aggressive in the early years to more conservative in the later years when you are closer to retirement age. Sort of like a robo-advisor that you don’t have to pay an extra fee to.

There are likely fees assessed to your 401(k)

Do you know how much it cost to invest in your 401k last year? Don’t worry if you don’t – most people don’t. Turns out the fees you pay in your 401k can be awfully high, which ultimately means less money available for you in retirement. Think about it: if your expenses are approximately 2% and your returns are 5-7% then your returns are far less. Your 401(k) provider is required to send you a review of the plan fees on an annual basis.

There is power in both pre-tax and post-tax contributions

Many plans allow you to make contributions that are either pre-tax (meaning they take the contribution out of your paycheck before taxes are calculated, resulting in less taxes on that paycheck), or post-tax as a Roth contribution (meaning that you don’t receive an immediate tax deduction, but your earnings are tax-free when you withdraw them in retirement). It’s a good idea to allocate some money to both types of contributions in order to give you tax flexibility in the future when planning for retirement. Keep in mind that there are limits for how much you can contribute to either one, depending on your salary, age, and on your overall adjusted gross income.

Vesting schedules are different with different companies

While your own contributions are always yours, the same is not necessarily true for the amounts contributed by your employer. Your employer is allowed to hold back money from you depending on how long you stay with the company, under a system called “vesting.” How long it takes to vest varies. You may be subject to either a “graded vesting schedule,” in which a percentage of your employer’s contributions become yours each year over several years (6 max), or a “cliff vesting schedule” in which all of it becomes yours at once after several years (3 max). If you leave the company before you have fully vested, you forfeit the money that hasn’t been vested. It’s a good idea to check the vesting schedule for your plan before timing a job switch.

Finally, it’s important to understand that the quality of your 401k will affect the quality of your retirement. There is so much emphasis on the power of your 401k and how it can literally provide for you in retirement but the truth is it is just one piece of the puzzle. While I do advocate maximizing your 401(k) contributions if possible (if your company offers a match program, at the very least do the minimum in order to get the match), there are other vehicles that help provide for your post-65 needs. A traditional IRA, a Roth IRA and the very new Roth 401(k) are other great ways to stash away money now that will compound over time and provide for you in later years.

Want to learn more about saving for your future? If you are interested in learning more about planning your finances, consider taking the Mosaic Financial Fitness Challenge. In four weeks, you can cover the basics of setting financial goals, saving, paying down debt, and understanding investments.