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Best practices for 401(k) savings

According to the Bureau of Labor statistics, 69% of private industry workers have access to some type of employer sponsored plan. The most common one, by far, is the 401(k). In this insight we explore the best practices for 401(k) savings.

It's important to understand how these powerful retirement savings vehicles work and to make sure you're saving as efficiently as possible in these tax advantaged accounts. Making well-informed decisions about contribution amounts, understanding employer matching, choosing the suitable investment options, and avoiding penalty-triggering actions are some of the most valuable factors to consider.

In This Insight

What is a 401(k) savings plan?

A 401(k) savings plan is a retirement savings account that allows you to contribute a portion of your pre-tax or after-tax salary into a qualified investment account.

Qualified accounts are generally a Traditional IRA or Roth IRA. The Traditional IRA allows for contirbutions on a pre-tax basis, reducing your taxable income in the current calendar year. Roth IRA accounts allow for contributions on an after-tax basis, and if managed properly, never pay taxes again.

Sponsored by employers, these savings plans are autonomous, meaning the employed individual decides how much to contribute subject to legal limits, and the employer often matches a portion of the holder's contributions. The management of a 401(k) savings plan involves deciding investing in a range of asset classes - typically, stocks, bonds, and money market investments. The performance of these investments will generate gains or losses, impacting the value of the account.

Furthermore, its tax-deferred nature means that taxes on gains aren't owed until funds are withdrawn from the account. This deferral of taxes allows for the potential compounding of earnings, an integral benefit for the growth of the investment. Interestingly, while the 401(k) savings plan is a widely-accepted retirement vehicle, it comes with regulations. Early withdrawals before the age of 59.5 often incur penalties. Withdrawals are also taxed as ordinary income upon retirement, making it beneficial to contribute when income and tax rates are higher, expecting lesser income and lower tax rates in the retirement years. It's important to strategically balance the contributions, withdrawals, and overall management to maximize one's benefits from a 401(k) savings plan.

A 401(k) savings plan allows for pre-tax or post-tax contributions, potential employer matching, and tax-deferred growth, but requires thoughtful management and strategic balancing to optimize benefits and navigate withdrawal rules.

What's the difference between a 401(k), 403(b), and other employer sponsored plans?

The 401(k) and 403(b) are both employer sponsored plans and the fundamental difference between the two is the type of entity sponsoring the plan. The 401(k) is offered by private sector for-profit employers, whereas the 403(b) is offered to public education employees, some non-profit employees, and certain ministers. Then there are employer-sponsored plans such as the Simplified Employee Pension (SEP) IRA, and the Savings Incentive Match Plan for Employees (SIMPLE) IRA and Employee Stock Ownership Plans (ESOP). SEP and SIMPLE IRAs are great options for small business owners and self-employed individuals because they offer higher contribution limits and are easy to establish.

ESOPs allow employees to become business owners, sharing in the company's success as they accumulate shares of company stock in their retirement account. Each of these plans carries its own unique set of rules, benefits, and potential drawbacks depending on the individual's circumstances, and understanding these differences can guide individuals towards the most beneficial choice.

The 401(k) and 403(b) are both employer sponsored plans. The primary difference is that 401(k) plans are offered by private sector employers, whereas 403(b) plans are offered by public sector and non-profit organizations.

Deciding How Much to Contribute

Determining the ideal amount to contribute to your 401(k) is an essential aspect of your financial planning process. The precise figure hinges on several factors, including your age, current income level, retirement objectives, and anticipated living expenses upon retirement.

It is suggested that a worker should aim to replace around 70%-80% of their pre-retirement income in retirement, and a substantial portion of this income can come from 401(k) savings. Therefore, to accomplish these objectives, it's recommended to set apart a considerable portion of your income towards 401(k) contributions. Your employer's match can serve as an excellent guide to decide how much to contribute to your 401(k). Many employers match employee contributions to a certain percentage, typically between 3%-6% of the worker's annual salary. To make the most of this opportunity, at a minimum, it's highly advised to contribute enough to your 401(k) to receive the full employer match. This employer match essentially equates to free money, and not taking full advantage of it is akin to leaving money on the table.

Learn More About 401(k)s and the Company Match

Deciding on how much to contribute to your 401(k) also requires taking into account the Internal Revenue Service (IRS) limits. For 2024, the IRS limits employee 401(k) contributions to $23,000 if you’re under 50. But if you're aged 50 or older, you are allowed to make additional catch-up contributions of $7,500, raising the total allowable contribution to $30,500. For optimal benefits, if it is financially feasible, strive to contribute up to the IRS limit each year. This strategy can substantially bolster your retirement savings and also provides tax advantages.

Determining the ideal contribution to your 401(k) requires considering factors such as age, income, retirement goals, living expenses at retirement, employer match, and the IRS contribution limits.

Getting the full company match

Taking full advantage of your employer's 401(k) match is an essential aspect of sensible financial planning. Essentially, a company match represents free money that will augment your retirement savings. Employers may contribute a certain percentage to match what you are investing up to a specific limit.

Typically, these rules might state that the employer will match 50% of the employee's contributions up to 6% of their salary. So, for instance, if you make $60,000 annually and contribute 6%, which is $3,600, your employer would contribute an additional $1,800. Some employers also offer a 100% match up to a certain percentage. It's essential to familiarize yourself with these particulars to ensure that you maximize your potential savings. The full company match might not be available to you immediately. The reason for this is that many companies implement a vesting schedule. A vesting schedule is a system wherein the employee gradually gains ownership of the employer-contributed funds over a specific period of time. Until you are fully vested, you would not be entitled to the entire amount of your employer match if you were to leave the company. Consequently, it's crucial to comprehend your company's vesting schedule to optimally strategize your 401(k) contributions.

Investment Strategies for 401(k) plans

There are a wide variety of investment options are available within 401(k) plans, such as stocks, mutual funds, bonds, and money market accounts. Individuals should consider their risk tolerance, financial goals, and the length of time until retirement to determine the best investment mix. For younger individuals with longer time horizons it's generally wise to invest in low-cost equity ETFs, such as the Vanguard S&P 500 Index Fund (VOO). These types of ETF funds are highly diversified and generally come with the lowest fees in the industry - helping to maximize your investment growth.

As you approach retirement age, it may make sense to rebalance your portfolio to an asset allocation that more closely matches your goals and objectives. It may be beneficial to consider the benefits of a target-date fund as a simpler investment strategy. A target-date fund automatically adjusts the asset mix of stocks and bonds based on a specific retirement date. As the target date approaches, the fund becomes increasingly conservative, moving towards more stable investments.

This type of strategy is particularly beneficial for individuals who prefer a hands-off approach to their retirement savings. However, it's crucial to note that returns are not guaranteed, and an individual should comprehensively understand the fund's fees and investment approach before opting for this strategy.

Maximizing 401(k) savings requires understanding diverse investment strategies, including careful asset allocation, consistent portfolio rebalancing, and considering target-date funds for a more hands-off approach.

How much will I have in my 401(k) at retirement?

When considering the question, "How much will I have in my 401(k) at retirement?" it's important to remember several influencing factors. For instance, how much you contribute to your 401(k) on a regular basis, the length of time of those contributions, any employer matches, and the rate of return on your investment. All these will significantly impact the ultimate size of your 401(k) at retirement. The more you contribute and the earlier those contributions begin, the greater the potential for compound interest to increase the value of your 401(k).

See our 401(k) calculator to learn more about how much you could potentially have saved come retirement.

Schedule a Free Consultation with Selective

Maximizing the value of your wealth is a complex task that requires expertise across a variety of disciplines. Schedule a free consultation with an advisor that provides comprehensive wealth management, which includes financial planning, investment management, tax strategies, estate planning, and insurance services. Schedule a free consultation today.

Final Thoughts

Understanding and actively participating in a 401(k) savings plan can play a valuable role in securing a financially stable retirement. The unique advantages of a 401(k), compared to other employer-sponsored plans like 403(b), offer opportunities to maximize contributions and capitalize on employer matches. It's essential to make informed decisions about contributions and investment strategies within these plans.

By employing best practices, such as taking full advantage of company matches and implementing effective investment strategies, you can project a more accurate estimate of your potential retirement savings and progress towards your retirement goals.


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