For most Americans, 401k plans, qualified plans or defined contribution plans are the most popular savings vehicles for retirement. With most private companies doing away with pension plans and the uncertainty of Social Security, individuals need to make the most of their retirement plans because these plans may be their principal source of income in retirement. So how do you take advantage of growing your nest egg in preparation for retirement? Here are five tips to help make your 401k grow.
1. Start Early
For those of you in Generation Y and even Generation X who have not yet enrolled in your 401k, don’t delay any longer. If you have not initiated a savings strategy into your 401k, you need to start now. By getting into the routine of saving early on in your career, it will become a permanent practice. Additionally you will take advantage of the power of compounding which allows you to earn on your earnings. Many companies offer an employer match- provided that you invest a certain amount into your plan, they will also make a contribution. If you are not contributing at least the minimum amount required to get the matching funds, you are essentially throwing away free money.
2. Defer as Much as Possible
The bottom line is the more you save now, the more money you will have for retirement. It’s a simple premise, but many people like to think there is some magical way to build up their retirement accounts without making the proper contributions. I often hear that saving 10% of your salary is a good rule of thumb. While I generally agree with this rule for younger investors, 10% may not be enough for those mid-career or those nearing retirement that may have started accumulating for retirement later in life. So be sure to take into account other factors like age, years until retirement and current investment amounts when determining how much to save.
Another significant benefit of contributing to your 401k is the tax benefit you will receive. Money contributed to a 401k is pre-tax so it is excluded from your taxable income for the year. That means if you are in a 28% tax bracket, you get to defer paying taxes on 28 cents on every dollar you contribute. For those without many other allowable deductions, this may be their primary form of tax savings.
Finally, the Pension Protection Act of 2006 permanently increased many of the contribution limits in retirement plans such as the 401k in addition to adding a cost of living adjustment. In 2017, the maximum contribution to a 401k is $18,000 and increases to $24,000 for those age 50 and older. Maxing out contributions over time at those limits can add meaningful depth to your retirement portfolio.
3. Properly Allocate your Account
Your 401k needs to be properly allocated in order to attempt to maximize your return. Two factors most often considered in determining how much risk to take in your 401k is your age and how many years you have until retirement. The idea here is that while you are younger and have a longer time horizon it is probably in your best interest to invest more aggressively using more equity based investments. In comparison, as you near retirement you’ll want your investments to become more conservative in order to reduce potential risk to your 401k since you may need to begin drawing on the funds in the near future. If you have a financial advisor, they can help you choose a suitable allocation. Most employers now have some form of fiduciary duty to provide education on the investment choices available to employees. This may come in the form of literature about your investment options or representatives from your plan provider may hold sessions and provide counseling.
4. Don’t Take Withdrawals
Most 401k accounts do offer the participant the option of taking a loan against them. You should not view your 401k as a bank account. It should be viewed as money that will not be accessed until retirement except in extreme cases. Not only will withdrawing funds from your 401k in the form of a loan reduce your retirement savings, but in the event that you lose or leave your job and can’t afford to pay back the loan it will be considered a distribution subject to taxes and penalties if you are under age 59 ½.
5. Consolidate old 401ks
If, like most, you have worked for more than one employer in your life you may have 401k plans to which you no longer contribute. 401k plans will usually allow you to combine other 401k accounts into them. There is good reason to consider consolidating these old plans with your current one. First, some of these older plans get neglected when choosing investments and an allocation. If you have a plan which you started in your 20’s, it may not hold appropriate investments now that you are in your 50’s. By having all of your accounts consolidated into one you will have better control of the overall investment strategy.
Saving for retirement is a lifelong process that usually yields the best results when you start early and make it a standard practice. Taking advantage of salary deferrals into a 401k is an easy and consistent method of contributing to your retirement fund which will provide you benefits for years to come.
Chrissy Canapari, ChFC® serves as Senior Financial Advisor and Manager of Client Services at StrategicPoint Investment Advisors in Providence and East Greenwich. You can e-mail her at firstname.lastname@example.org.
This original post was authored in 2013 and content has been updated, where necessary, to reflect current financial data. We encourage you to contact us if you have any specific questions about the content of this article. The information contained in this post is not intended as investment, tax or legal advice. StrategicPoint Investment Advisors assumes no responsibility for any action or inaction resulting from the contents herein. Chrissy’s opinions and comments expressed on this site are her own and may not accurately reflect those of the firm. Third party content does not reflect the view of the firm and is not reviewed for completeness or accuracy. It is provided for ease of reference.