Ten Steps to 401(k) Success
ANNAPOLIS, MD – 6/29/2021 – The 401(k) plan is becoming the single largest sourceof retirement savings for a majority of American workers. According to the Society ofProfessional Administrators and Recordkeepers (SPARK), over 55 million peopleparticipate in 401(k) plans. If you participate in a 401(k) plan, the good news is that youhave more control over your retirement money. The bad news is that you have morecontrol over your retirement money.
For people who do not have the time or the financial knowledge, properly managingyour 401(k) plan can be a daunting task. Moreover, if you do not manage it properly, the401(k) can become, at best, a savings account and, at worst, a high-risk gamble withyour retirement money.
Members 1st Credit Union, a 401(k) advice and asset management company,recommends ten steps that have helped thousands of corporate employees succeedwith their 401(k). If you lack the time or inclination to manage your own account, theywill actively manage it for you. However, if you are the do-it-yourself type, these tensteps will help.
1. ParticipateThe dollars in your 401(k) plan may represent 20-80% of your income at retirement. Thegovernment, and by extension, your employer, are giving you the opportunity to takeadvantage of two very powerful financial concepts: the ability to save money on a pre-tax basis, and the tax-deferred, compounded growth of those dollars. A 401(k) mayenable you to build a better nest egg than anything else you can do on your ownbecause of that tax-deferred growth. Saving money before it is included in your taxableincome reduces your annual tax bill. In addition, the earnings can grow on a tax-deferred basis, meaning you can earn money on your earnings! If your company offersa 401(k) plan, you need to be contributing, as soon as you can, and as much as youcan. It is the first step in taking charge of your financial future.In order to help you increase the size of your nest egg, as well as to encouragereluctant employees to save for retirement, many employers offer matching funds. Theaverage employer offers a match of 50% of the amount you contribute up to 6% of youreligible salary. In the complex world of finances, we call this free money. If youremployer is willing to give you money, you need to take it!Ten Steps to 401(k) Success
The only catch is that you must contribute some of your own money in order to receivethe company match. If your employer matches up to 6%, you should be contributing atleast 6%. The goal is to capture the entire company match (and then keep workingthere until you’re fully vested).
2. Determine your investor profileInvestor, know thyself! Every investor is different and knowing yourself is the first step toallocating your investments appropriately. Before you can determine your assetallocation strategy, you must first be able to clearly define your goals. Remember,401(k) money is retirement money and everybody has different dreams about what theirretirement will entail – traveling, boating, etc. Also, you may have some pre-retirementgoals for which you need to save some money. Each goal may represent a separatepool of money and there are different investment options available to you to help fundeach goal. Second, determine the time horizon for retirement. Is it more than 10 yearsaway? In general, the longer you have until you need the money, the more heavilyweighted you should be in stocks. You’ll have more time to recover any losses incurredduring a market downturn. The third consideration concerns how psychologicallycomfortable you are with those market downturns. Will you really be able to tolerate theinevitable ups and downs that the stock market delivers?
3. Allocate appropriatelyAsset allocation is the principle of deciding how to spread your investments acrossvarious asset classes, such as stocks, bonds, and cash. There are subcategories withineach class, such as small, medium and large cap stocks. The idea is to diversify yourholdings in order to potentially increase returns while diminishing risk. A variety offactors determines the appropriate allocation for each individual – When you need themoney (not automatically dictated by your retirement age), how much money you havenow and expect to need later, what kind of risks you’re willing to take, and what otherassets you have invested outside of your 401(k). Perhaps the most important factor isyour time horizon – the more time you have, the more aggressive you can be.
4. Limit exposure to company stockCompany stock can be a double-edged sword. On one hand, as a loyal employee whounderstands the business, you want to participate in the growth of the company bybeing a shareholder. On the other hand, it is risky to have too much of your portfolio inone stock. Having too much money in a single stock issue creates a non-diversifiedportfolio. Most investors are able to reduce volatility significantly by having a diversifiedportfolio. Besides, do you really want the fortunes of one company to control yoursalary, benefits, pension and your 401(k)?
5. Reallocate tacticallyWhile it is not advisable to move your money around daily (market timing in general hasnot proven to be an effective strategy over the long haul), it is advisable to look at whatyour investments are doing from time to time. If one segment of the market hasoutperformed other segments significantly, then your portfolio is likely to be significantlyout of balance. In other words, if you wanted to have 70% of your money in stocks, andit has grown to represent 80% of your portfolio, you need to rebalance your portfolio.You may also need to consider other strategic moves if your mutual fund suffers fromstyle drift, there’s a change in management, or if a similar fund with lower expensesbecomes available. Take a disciplined approach to monitoring your investmentportfolio.
6. Do not panicListening to the evening news, and hearing about the market changes on a daily basis,can cause even the most stalwart of investors to get nervous occasionally. Stocksfluctuate in value, it’s the nature of the beast. Just remember that you are investing inyour 401(k) for the long term. Although there are no guarantees that this will continue inthe future, the direction of the stock market over the long term has been up. There willcontinue to be downward dips and swings, which is why knowing how you’ll react tothose swings is a factor to consider in your overall asset allocation. Selling when yourinvestments are down is the best way to lock in your losses. Try to remember thatpatience is a virtue. Unless you believe that the investment cannot recover, it is usuallybetter to hold on for the ride. In fact, it might be a good opportunity to buy more!
7. Know your plan featuresEvery 401(k) plan has unique characteristics. To help maximize your plan, you need toknow all your options. Your plan documents, distributed by your benefits department,will outline options such hardship withdrawals, loans, vesting schedule, limitations tomoving money, and in-service withdrawals. Read this document carefully or have afinancial professional review it with you.Most plans allow for hardship withdrawals. There are several tax and penalty issuesassociated with hardship withdrawals, so make sure you read your plan documentscarefully and seek professional guidance. If you use the option for hardship withdrawal,you may be suspended from the plan for a specified period.The vesting schedule refers to the years of employment before the company matchmoney becomes yours. Vesting schedules either are graded, meaning you get apercentage of the money in successive years of employment; or cliff, meaning you getall the money at once after no more than five years. Keep the vesting schedule in mindif you are thinking about quitting your job.
If the plan does not meet your investment needs, and it allows for in-servicewithdrawals, you can move some of the money into other vehicles, such as anIndividual Retirement Account (IRA). An IRA gives you many options for investing yourmoney, thereby enhancing your diversification abilities.
8. Borrow judiciously – if at allEarly 401(k) plans had no provision for loans. Providers added most loan provisions asan incentive to encourage greater participation – participants would be more likely tosave for retirement if they could access the money before they retired. This does notmake loans an attractive feature! Many people believe (often erroneously) that if theinterest rate on the 401(k) loan is less than they would have to pay elsewhere, the401(k) loan is a good deal. That may be, but it does not take into consideration the realcost of the loan – the lost opportunity cost. The money in your plan cannot grow if it isnot there! If the investments in your plan are growing by 12%, that is what borrowingfrom the plan costs you, plus growth on that growth. Another consideration needs to bethe tax consequences of borrowing from your plan. While you do not pay any taxes onthe money when you borrow it, you do pay the loan back with after-tax dollars. Then,when you begin to take withdrawals at retirement, you pay taxes on those dollars again– you are paying taxes twice. If you do some calculations, you may find that borrowingfrom your plan is an extremely expensive option. Borrow only if you must.
9. Consider tax consequences of your actionsMost of the things we do in our financial lives have tax consequences. In the case ofthe 401(k), you can avoid several negative tax consequences. If you leave your currentemployer and want to take your 401(k) money with you, be sure to roll it over directly toan IRA or to another employer’s plan. You may leave it in your former employer's planonly if you have more than $5000 in your account. If you take a full distribution, you willpay federal and state taxes on the entire amount. If you are not yet 59 ½, you also willpay a 10% penalty. This could reduce your lump sum distribution to almost half itsoriginal value. It will not help your retirement nest egg. Do not take a lump sum atretirement, unless you need all the money at once. Take out only what you need, so thebulk of the portfolio can continue to grow tax-deferred. If you are over 72, you mustfollow the Required Minimum Distribution rules. Rolling your money from your 401(k) toan IRA may make sense for a variety of reasons, and fortunately, an IRA rollover is nota taxable event.
10. At retirement, balance your needs for income and growthMost people should disregard the notion that when you retire you should move all yourmoney into bonds and stay clear of the stock market. Inflation, even when it is undercontrol, has a nasty way of ensuring that a dollar in the future will not buy what a dollardoes today. You must ensure that your investment holdings have the potential tooutpace inflation, so that the income you receive from your investments can have thesame purchasing power when you’re 85 as it does when you’re 65. This means youshould have a portion of your money in investments that have the potential to outpaceinflation, such as stocks, regardless of your age.
Asset allocation, which is driven by complex mathematical models, should not be confused with the much simpler concept of diversification.
The return and principal value of bonds fluctuate with changes in market conditions. If bonds are not held to maturity, they may be worth more or less than their original value.
A diversified portfolio does not assure a profit or protect against loss in a declining market.
This communication is designed to provide accurate and authoritative information on the subjects covered. It is not, however, intended to provide specific legal, tax, or other professional advice. For specific professional assistance, the services of an appropriate professional should be sought.
The return and principal value of stocks fluctuate with changes in market conditions. Shares when sold may be worth more or less than their original cost.
All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful.
Investors should consider their financial ability to continue to purchase through periods of low price levels.
Distributions from traditional IRA's and employer sponsored retirement plans are taxed as ordinary income and, if taken prior to reaching age 59 ½, may be subject to an additional 10% IRS tax penalty.
Before deciding whether to retain assets in a 401(k) or roll over to an IRA, an investor should consider various factors including, but not limited to, investment options, fees and expenses, services, withdrawal penalties, protection from creditors and legal judgments, required minimum distributions and possession of employer stock. Please view the Investor Alerts section of the FINRA website for additional information.