Now that you have your own 401(k) plan, what should you do about it? Well, it’s important to not remain complacent and always look to improve your situation. These 401(k) tips will help you maximize your retirement savings.
Develop an investing plan and then stick to it
Make a long-term investment plan, called asset allocation strategy, and choose a mix of low-cost mutual funds. Stick with your plan even when you see the market faltering. Over the long run it will pay off.
Consider a Roth 401(k)
In a Roth 401(k), which is similar to a Roth IRA, you will invest your money that’s been taxed already. Then, when you retire and withdraw your funds, that money will not be taxed. If you are starting your career, you are likely in a lower tax bracket than you will be at when it is time for retirement. Therefore it might be worth it to suck it up and take the tax hit now, which will free you from headaches later.
Then again, if you think your income is going to decline at retirement age, a regular 401(k) makes more sense. If you can manage it, then contribute to both types. That way, from a tax perspective, you are diversifying and hedging your bets. See if your company offers this.
Be careful of being charged fees for investment advice
Some employers offer investment advice to manage your account. If it’s free, make use of it. However, proceed with caution because often you will have to pay a percentage of your portfolio to get that guidance. If so, it’s generally not worth the cost for young investors that have limited assets. Some companies provide free online guidelines and calculators to help get you started.
Consider paying off high-interest debt with your 401(k) loans
Yes we did say not to use those funds. But if you are young and carrying high-interest credit card debt, it might be worth borrowing against your 401(k) to eliminate these debts. The loan comes from your own funds and essentially you are paying the interest back to yourself. However, only do this if you are strapped and can’t find different options.
If you use this option you need to be careful. Usually, you must repay the loan within a 5-year period, paying an interest rate that is prime + one percent. Should you lose your job (no matter the reason) or leave the company, then you must repay the loan very fast, generally within a 60 day period. If you do not, the IRS considers it a withdrawal and you will owe both early withdrawal fees and income taxes.
A final warning: you are not allowed to contribute to your 401(k) until you have repaid the loan, so you are slowing the progress you have already made with your work towards your retirement income.
You should never touch your 401(k) before you retire
You might feel the temptation to take money out of your growing retirement funds – after all you have a pool of money just waiting to be used, and there is a new HDTV model that you’d love to purchase (or whatever other major purchase it might be – car, down payment on a house, vacation). Don’t do it! You will land up paying extra fees and taxes, and you will lose out on compound returns, which is the one of the benefits of this kind of investment.
When you leave your 401(k) alone, your gains are reinvested and you land up earning more than you would if you were just investing a smaller amount of cash. Left alone, it has the potential to grow exponentially year after year. So instead, look to other cash sources and try not to raid your 401(k).
Roll over the funds if you leave your job
There is a temptation to ask your company to cut you a check, but it will cost you a lot in taxes and penalties. In the majority of cases, you can leave an old 401(k) account alone for any length of time you want, where it will stay with the brokerage firm that administers your account. If the previous company kicks you out of the plan, you have to find a new home for your funds.
The best option for you is to roll the funds into an IRA, or into a 401(k) at your new job. Take the time to have a conversation with your plan administrators and also with the new firm where you will put your money. This will ensure that you follow the rollover rules and that you avoid any possible penalties.
401(k) is a viable retirement savings option. If managed correctly, it can provide you with great returns and sufficient funds for comfortable retirement. All it takes is a sound judgment and some healthy spending restraint to fund your future.
Still looking for more? Feel free to check out our comprehensive personal finance guide to learn more about managing your budget and staying financially healthy.