With the traditional defined benefit pension essentially extinct for private-sector workers, 401(k) plans have become even more important for pre-retirees.
While stashing away money in a retirement plan like a 401(k) is a great start, there’s even more that savers can do to get the most bang for their buck. Here are 10 ways of potentially optimizing your return:
— Save more than your employer’s automatic savings rate.
— Get a 401(k) match.
— Stay until you are vested.
— Maximize your tax break.
— Diversify with a Roth 401(k).
— Don’t cash out early.
— Rollover without fees.
— Minimize fees.
— Diversify your assets.
— Remember required minimum distributions.
Contribute More Than Your Employer’s Default Rate
Automatic enrollment for new employees in a company’s 401(k) plan has become increasingly common in the past decade. The most common default contribution rate is 3%, although employers can set it as high as 10%.
“Check to see if your employer automatically enrolls you in the company’s 401(k) plan and set up a recurring contribution,” said Scott Schleicher, senior financial planner at retirement services provider Empower in Denver, in an email.
Schleicher said that if enrollment is not automatic, savers should enroll manually and try to contribute 10% to 15% of their pretax income each year.
“This will not only increase the probability of reaching your retirement goals, but it will also effectively reduce your taxable income, decreasing your tax bill,” he added.
[5 Ways to Minimize Taxes on Retirement Income]
Get a 401(k) Match
Some employers will put money in employees’ retirement accounts based on the amount the employee contributes. That’s called a 401(k) match.
According to brokerage Fidelity, “Match formulas vary, but a common setup is for employers to contribute $1 for every $1 an employee contributes up to 3% of their salary, then 50 cents on the dollar for the next 2% of an employee’s salary.”
“A 401(k) match is like free money, so don’t pass up the opportunity to take full advantage of this benefit,” said Michael Collins, a chartered financial analyst and CEO at WinCap Financial in Winchester, Massachusetts, in an email.
“It’s an easy way to boost your retirement savings and secure a better financial future,” Collins added. “For example, if your employer offers a match on contributions up to 6% of your salary, you should aim to contribute at least 6% of your salary to receive the full match.”
Stay Until You Are Vested
While taking advantage of a 401(k) match is something all savers should do, there’s a catch: In many cases, an employee must stay with a company for a specified period of time before that money fully belongs to the saver.
That’s known as vesting, and various employers have their own schedules for that process. If you have a 401(k) with a match, be sure to understand the vesting schedule if you’re considering leaving the company.
“People don’t realize that their 401(k) employer contributions could be rescinded,” said Gloria Garcia Cisneros, a certified financial planner and wealth manager at Lourd Murray in Los Angeles, in an email.
[Read: Is a 401(k) Worth It in 2024? Pros, Cons and Costs]
Maximize Your Tax Break
With a traditional 401(k) account, you’ll defer paying income tax on the money you save for retirement. In 2024, according to the Internal Revenue Service, “The contribution limit for employees who participate in 401(k), 403(b) and most 457 plans, as well as the federal government’s Thrift Savings Plan is increased to $23,000, up from $22,500.”
Retirement savers with low to moderate income can also take advantage of the saver’s tax credit. This provides a credit of up to $1,000 for an individual or up to $2,000 for a couple, based on retirement plan contributions.
Diversify With a Roth 401(k)
A growing number of employers are offering a Roth 401(k) plan which allows workers to salt away after-tax dollars. As with a Roth individual retirement account, withdrawals in retirement are tax-free, since the taxes have already been paid.
For younger workers and those with moderate income, a Roth 401(k) often makes sense, as those savers may be in a higher tax bracket in future years. However, older workers who want more flexibility and tax benefits may also want to consider the Roth 401(k).
“I recommend that almost everyone contribute 50% to a Roth 401(k) and 50% to their traditional 401(k), as having a diverse pool of assets in retirement provides the most flexibility when seeking to minimize taxes,” said Glenn Goland, a certified financial planner and senior wealth strategist at Arnerich Massena in Portland, Oregon, in an email.
Don’t Cash Out Early
When you change jobs, you have several options when deciding what to do with your old 401(k). You can roll it over to your new employer’s plan or roll it to an IRA without incurring a penalty or taxes. You may also be able to convert it to a Roth IRA or simply leave it with your former employer’s plan.
All those choices have pros and cons, but the remaining choice is generally a no-no: Cashing out your 401(k) before you have reached full retirement age.
“Cashing out early from your retirement account should be avoided at all costs,” Collins said. “Not only will you incur penalties and taxes, but you are also jeopardizing the long-term growth of your savings. Stay disciplined and leave your money invested for its intended purpose: retirement.”
[READ: How Much a 401(k) Early Withdrawal Costs]
Roll Over Without Fees
By transferring your 401(k) into a new employer’s 401(k) or an IRA, you’ll avoid penalties and fees. That’s called a rollover from one type of qualified account into another, and the IRS treats it differently from cashing out or making a withdrawal.
Savers considering a rollover should understand the fee structures of the outgoing and receiving accounts before transferring money, Schleicher noted.
Minimize Fees
Many investors overlook the fee structures of their various retirement accounts. While these may seem like small amounts, they can add up, taking money from your return and instead paying a fund manager.
While all investment accounts and funds have some type of management fee, savvy investors can minimize the amount they’re paying.
“Many 401(k) plans offer low-cost index investment options. Plan participants should utilize these index strategies and steer clear of active fund managers in 401(k) plans, as these managers often charge up to 1% in fund expenses and most have a really difficult time outperforming the market over time,” Goland said.
Diversify Your Assets
Broad asset-class diversification can smooth returns over time, potentially helping investors weather a downturn better than if their portfolio was more concentrated.
It can be frustrating to see one asset class, such as domestic large-cap tech stocks, take off for the races while another, such as fixed income, remains in the doldrums. However, many advisors recommend patience, which can pay off over the long haul.
“Investing is a bit like being stuck in a traffic jam, as it is tempting to constantly jump lanes to get into the one that is moving the fastest,” Goland said. “A properly diversified portfolio has a car in each lane, knowing that there is always going to be a leader and always going to be a laggard.”
Remember Required Minimum Distributions
Retirement savers must withdraw a specified amount from their traditional 401(k) or IRA every year, beginning in their early 70s. These withdrawals are known as required minimum distributions. RMDs are calculated by the IRS and determined by factoring in the account owner’s age and amount invested.
An investor who misses an RMD faces a penalty. The idea behind the RMD is that the account has grown tax-free for years, and the government finally wants to collect the tax owed.
“It’s important to stay on top of RMDs when you reach a certain age,” Collins said. “Failing to take these amounts out can result in penalties and taxes, so be sure to plan accordingly and don’t forget about them.”
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10 Strategies to Maximize Your 401(k) Balance originally appeared on usnews.com
Update 05/28/24: This story was published at an earlier date and has been updated with new information.
