Your 401k graciously provided to you by your employer is likely one of the most powerful retirement saving devices currently available to you. Addressing common questions such as how much should I contribute, what investments should I choose, and how do I intermittently check up on my account could make the difference between retiring in a luxurious beachside condo in Kauai or a windowless studio apartment in Kauai (personally I’d take either).
Exactly How Much Should I Contribute?
Well now that depends on your specific financial situation and if you can afford to contribute to the plan. However if you’re financially able to you most definitely, unequivocally should contribute enough to the 401k to obtain the full company match. Let me reemphasize; at least contribute enough to obtain your full company match!
By contributing to receive the full match, you ensure that you obtain the maximum amount of free money your employer is willing to give you; and come on, who in their right mind would turn down free money?
That being said, if you are a high-roller and able to contribute more to the 401k then the match by all means do so. Saving more now helps ensure a more comfortable retirement in the future. Also keep in mind that in a Traditional 401k all your contributions are pre-tax which in turn may lower your taxable income for the year thus potentially reducing the amount of taxes you pay for the current year. Pretty sweet right?
Choosing the Right Investments
Many employer plans provide you, the participant, with a plethora of investments options ranging from Mutual Funds, Index Funds, Bonds, and Money Market Instruments. The key takeaway here is to ensure that whatever investment blend you choose falls in line with your long-term retirement savings goals.
For example, if you’re a younger employee far away from retirement, more aggressive investment selections mainly comprised of stocks may be the appropriate choice for maximum potential growth. On the other hand, an older employee might want to choose more conservative investments to preserve their account balance in their 401k as they near retirement.
One more thing to note, your company’s 401k is simply one piece of your overall investment portfolio. It may be wise to consult with a financial planner to see how your 401k fits with your other retirement accounts (IRAs), regular brokerage accounts, insurance, and any other assets you may have.
The Annual Checkup
Our physical health is reviewed once a year so why should our financial health be any different? Is your investment allocation still consistent with your current savings plan? Sometimes when one investment outperforms the others your original investment allocation can become skewed toward that one outperformer. It’s important to make sure to check up on your investment allocation annually to see if any rebalancing is necessary.
Are you still contributing at a rate that’s appropriate for your financial situation? Perhaps your beater of a car broke down or you had a family emergency; you might have to temporarily contribute less to your 401k. Or maybe your salary increased this year; you may want to contribute more to your company’s plan to reflect that increase.
Lastly, if you are looking to contribute the maximum amount to your 401k be sure to know the maximum annual limits as they can change slightly from year to year ($18,000 in 2016).
There are three simple takeaways for your 401k if you are to truly maximize this great retirement savings resource:
- Find out how much you can contribute to the plan in the first place and contribute at least the amount to receive your full company match
- Choose the right investments and allocations that are appropriate for your financial time horizon to retirement
- Check in regularly with your 401k; reallocate investments if necessary, adjust the amount of your contributions, and check this year’s 401k contribution limits if you contribute the maximum amount
401(k) plans are long-term retirement savings vehicles. Withdrawals of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59 ½, may be subject to a 10% federal tax penalty. Investing involves risk and investors may incur a profit or a loss. Diversification and asset allocation do not ensure a profit or protect against a loss. The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a state of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Jacob Dahlstrum and not necessarily those of Raymond James.