In today’s uncertain retirement environment, where most people do not have a pension to rely on, you need to take control of growing and protecting your nest egg. If your employer offers a 401(k), maximizing this retirement savings vehicle is critical for helping to ensure the retirement you envision.
Here are nine strategies to make the most of your 401(k) plan:
- Increase your savings rate. It is becoming increasingly common for new employees to be automatically enrolled in 401(k), most often at a rate of three percent of their pay before tax. This will likely not be enough for you to achieve the lifestyle you hope for in retirement. By looking at how much you need to support your current lifestyle, you can gain a better understanding of how much you can afford to save. At a minimum, try to contribute at least the amount that qualifies you for an employer match, if your company offers one.
- Take advantage of employer match. If your employer offers a 401(k) match, this is one of the easiest ways to increase your 401(k) balance. It’s common for employers to contribute just under 50 cents for each dollar contributed by the employee, up to six percent of your salary. But, keep in mind that in some cases, you may not be eligible to keep the 401(k) match until you are fully vested in the 401(k) plan. Some employers allow their employees to keep a portion of the match if they leave the company before they are fully vested, but others require their employees to forfeit the entire match.
- Maximize your tax benefits. Traditional 401(k) plans allow you to defer paying income tax until you withdraw the funds in retirement. The money in your 401(k) also grows tax-deferred, which means that as the investments earn investment income, you do not pay tax on the investment gains (if any) each year. To maximize your tax benefits, try to meet the contribution limit for your 401(k). In 2018, taxpayers under age 50 can contribute up to $18,500 of pre-tax income, and those age 50 and over can contribute $24,500.
- Avoid cashing out. It is extremely common to switch employers several times over the course of a career. When you change jobs, you need to decide what to do with the 401(k) at your former employer. One option is to cash out some or all of your savings. However, the amount you withdraw will be subject to a mandatory 20% federal income tax withholding, as well as possible state income tax and a 10% early withdrawal penalty tax if you withdraw that money before age 59½. In addition, if you cash out, you lose the power of compound interest on your 401(k) balance.
- Transfer your 401(k) balance directly. When you change employers, you can usually leave your 401(k) at your former company or roll it over to either an IRA or your new employer’s 401(k) plan. If you opt to roll over your balance, ask your former employer to transfer the balance directly to the new financial institution to help avoid taxes and penalties.
- Diversify. The investment options in your 401(k) comprise a variety of mutual funds which vary in risk and the types of stocks and bonds they invest in. Choose a mix of funds that is appropriate for your risk tolerance and investment horizon. You may need to rebalance your portfolio periodically to maintain your target allocation, or to adapt to changing priorities or evolving life circumstances. Generally, people tend to shift toward less risky funds as they approach retirement.
- Read the fine print on fees. The investment options in your 401(k) may have different fees. Look for low-cost options that align with your tolerance for risk.
- Resist borrowing against your 401(k). Borrowing against 401(k) assets effectively eliminates the tax benefits of this retirement savings plan. If you borrow from your 401(k), you will need to repay that loan in after-tax dollars and may need to pay additional fees. Because of these consequences and their potential impact on your retirement goals, this option should be a last resort.
- Don’t forget required minimum distributions. If you have a traditional 401(k), you are required to take minimum distributions each year after you reach age 70½. If you fail to do this, the penalty is half of the amount you should have withdrawn.
Saving early, often and automatically is the key to financial independence, and your 401(k) is the cornerstone of a sound retirement strategy. A professional financial advisor can help you understand your 401(k) options, as well as how this type of retirement savings plan fits into your overall wealth management plan. iBi
Cathy S. Butler, CFP, CRPC, is a vice president, financial advisor and portfolio management director at Morgan Stanley Wealth Management. She can be reached by email at Cathy.Butler@morganstanley.com or by telephone at (309) 671-2873.
The information contained in article is not a solicitation to purchase or sell investments. Any information presented is general in nature and not intended to provide individually tailored investment advice. The strategies and/or investments referenced may not be suitable for all investors as the appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives. Investing involves risks and there is always the potential of losing money when you invest. Morgan Stanley and its Financial Advisors do not provide tax or legal advice. Information contained herein has been obtained from sources considered to be reliable, but we do not guarantee their accuracy or completeness. The views expressed herein are those of the author and may not necessarily reflect the views of Morgan Stanley Wealth Management, or its affiliates. Morgan Stanley Smith Barney LLC, member SIPC.