Understanding your 401k may seem like a daunting task, and rightly so. These retirement websites and HR portals seem to speak a foreign language when it comes to retirement with terms like Asset Class, YTD, annualized and cumulative returns. Just researching the terms can take hours upon hours that many of us don’t have. So naturally, what do we do when we are inundated with a lot of information and options? We freeze or put off making a big decision which causes us to not act at all. Barry Schwartz calls this the paradox of choice, when too many choices lead to indecision because there are in fact too many choices!
Unfortunately, unless things change sometime soon, your 401k will not get any less complex. The good news is that things can get a lot easier for you to understand, once you direct your focus to a few key pieces of information that are easy to digest, one bite at a time.
Here are 5 things to know and consider when it comes to your 401K –
1.) What is a 401(k)?
401ks came into existence after Congress passed the Revenue Act of 1978. Named after a section in the Internal Revenue Code, a 401k plan, as defined by the IRS, is a contribution plan where an employee can make contributions from his or her paycheck either before or after-tax, depending on the options offered in the plan. The contributions go into a 401(k) account, with the employee often choosing the investments based on options provided under the plan. In some plans, the employer also makes contributions such as matching the employee’s contributions up to a certain percentage.
In short, a 401K plan is an employer sponsored retirement savings plan that an employee can opt in to. Check to see kinds of retirement programs your employer offers – 401K, pension, Roth 401ks, 403(b), etc.
2.) How much should I be saving?
Before you begin to worry about saving for retirement, make sure you are eliminating debt and not acquiring anymore along the way. Paying down debt as fast as possible is an easy way to free up cash in the future which will ultimately help you catch up on any time you’ve lost not investing.
The general rule of thumb for savings is that you should be putting anywhere between 10% – 15% of your income towards retirement or if you’re able to, max out your 401k (if that is in fact, a good option for you). However, the reality of saving 10 – 15% may be more easier said than done when 66% Americans don’t even have $1,000 dollars saved to cover a small emergencies let alone be able to put money towards their retirement.
So if you aren’t in the position to save 15% or max out your 401K, have no fear, start where you are with what you have. If you have a ton of debt but you are feeling anxious about not investing, invest up to what your employer will match so you aren’t missing out on free money. Then get on a written budget and furiously attack your debt with every extra penny you can find until your debt is gone. Once you’re debt free and you’ve got an emergency fund in place (3-6 months of expenses), you can revisit your retirement contribution. Increasing your contribution amount or percentage to whatever works best for you and your future needs.
If you are in good position financially but feel like 15%/maxing out is too much for you to go all in at once, start small and slowly increase your percentage as you go along. Perhaps you can start at your employers match percentage (dependent upon your employer but some offer 3%, 6% or no matching at all) then increase 1-2% every month until you hit 15%.
3.) What should I invest in?
What you invest in will be largely dependent on your risk appetite and what your employer offers. Since everyone’s situation is so unique here are just a few things you may want to look into or consider-
- Target Funds – You may hear them be called “Life-cycle funds”, “age-based funds”, “target-date funds” etc. These are relatively start forward investment vehicles, essentially you pick a fund with your retirement year and put all of your money into that one fund until you retire. For example, your employer may offer a list of funds that looks like “TRP Retire 2055 A” or “Vanguard Target Retirement 2045” etc. The number at the end signifies the year in which you plan to retire. Each fund is very different in nature depending on what your employer offers and your target retirement age; the portion of equity holdings (domestic, foreign stocks etc) vs fixed income holdings (bonds etc.) will differ. Based on what Target funds your employer offers, if any at all, keep an eye on the fees as they can also be relatively expensive. According to data published by Morningstar, the average expense ratio (aka FEES!) for all target-date funds in 2015 was .73%! Which will add up over time, ultimately eating into the funds you actually retire with. If you don’t mind the high fees associated with some of the target funds out in the market and don’t have much time to research, a target fund may be something to consider.
- Index Funds – In May 2017, during an interview on CNBC’s On The Money, Warren Buffett said that index funds make the best retirement sense ‘practically all the time’. Who better to learn from than the investment Guru himself! As defined by Investopedia, an Index fund is “a type of mutual fund with a portfolio constructed to match or track the components of a market index, such as the Standard & Poor’s 500 Index (S&P 500). An index mutual fund is said to provide broad market exposure, low operating expenses and low portfolio turnover.” Index funds are not actively managed funds, this allows for low operational fee which equates to keeping more of the money you’ve saved in your pocket. If your company offers index funds as a 401k investment choice, it wouldn’t hurt to check these out. Paying attention to the fees and types of investments, while keeping your risk tolerance in mind, index funds may be something you should consider. A majority of the major players offer Index Funds such as Vanguard and Fidelity. Generally, these options will include the word “index” in them, which will help you identify if what you are looking at is in fact an index fund. However, when in doubt, google it.
- Asset Mix – Your asset mix is also something to keep in mind. The term refers to how you are investing your savings across different asset classes for example: stocks, fixed income, and short term-investments (aka your portfolio diversification). Your asset mix is important because if you are close to retirement, you may want to consider less riskier investments to keep your nest egg safe vs. being 40 years out from retirement which may allow you to take on a little more risk.
4.) 401k Fees
If you didn’t know or you are one of the many people who don’t pay attention to nitty gritty details of your 401k, there are fees associated with your account. Like my old finance professor used to say, “There are no free lunches,” you are eventually going to have to pay. A great starting point for you to explore is what fees are associated with your account by finding out what your overall annual expense ratio (depending on your investments). Once you look into your annual expense ratio, you can dive into other fees that may be associated with your account like record keeping fees, investment advisory fees, service fees etc. At the end of the day, your fees will add up which will ultimately effect how much money goes into your pocket vs some rich fund managers.
Things to keep in mind-
- The cheapest fees don’t necessarily mean the best investments
- Checking your “expense ratio” is a great place to start
- You can find this information via your HR portal, prospectus, or online just look for “expense ratio”
Personal Capital also offers an awesome comprehensive buy isotretinoin canada pharmacy Fee Analyzer tool for free. It will show you what fees are costing you over the long run based on your current investments.
5.) 401k Retirement Contribution Limits*
The IRS is responsible for setting the limit on how much you can contribute to your 401k annually.
*Table from Fidelity “Stay Informed: 2017 IRS limits” article.
Catch-up contributions for those age 50 and over– If permitted by the 401(k) plan, participants who are age 50 or over at the end of the calendar year can also make catch-up contributions. The additional elective deferrals you may contribute is: $6,000 in 2015 – 2017 to traditional and safe harbor 401(k) plans
More information about 401k contribution limits can also be found on the IRS website.
Don’t be a victim of the paradox of choice, start piecing the puzzle together one piece at a time and eventually, you will have the full picture.
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