401k Advice Tool: You CAN Do-It-Yourself!
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Why It's Important
401k
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Step One: If you are fortunate to have a 401k plan available through your employer, be sure you participate in it .
This is the single most important piece of 401k advice that can be given.
Do you participate in a 401k plan?
Reason: Only about half of all workers participate in any type of employer-sponsored retirement plan at any given time.
According to the Government Accountability Office, 62 percent of workers are offered a retirement plan by their employer. About 13 percent of the full-time workforce with access to employer-sponsored plans does not participate in such plans.
Workers have a role to participate and save in 401k plans when they are given the opportunity to do so. Failure to participate almost certainly will guarantee an outcome of inadequate savings at retirement.
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Step Two: Make sure you take full advantage of any matching 401k contributions offered by your employer.
This is the second most important piece of 401k advice that can be given. You would not turn your back on free money from any other source, so don't lose out on free money offered by your employer.
Let's see how you're doing. From the options below, select one that best describes your current 401k contribution habit:
Reason: Think of the employer match as an immediate, risk-free return on your investment (ROI). Regardless of the level of your plan's match, you should always contribute enough to get the maximum possible match. The higher the maximum employer matching contribution, the greater the opportunity you have to leverage contributions and build a retirement nest egg. According to the Profit Sharing/401k Council of America, the average employer match is 3%.
a. I contribute more than enough to my 401k to ensure that I receive the maximum matching contribution from my employer.
b. I contribute an amount to my 401k that gets me between 50% to 99% of the full matching funds offered by my employer .
c. I contribute enough to get less than one-half of the full matching funds offered by my employer.
d. My employer doesn't match my 401k contributions.
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Step Three: Understand the dangers of 401k leakage and how it can wreak havoc on your 401k.
401k leakage occurs when participants tap into their accrued retirement savings prior to retirement. Leakage can occur in three ways - cashouts of account balances at job separation that are not rolled over into another retirement account, hardship withdrawals, and 401k loans. Cashouts are the most dangerous type of leakage, but all types of leakage can result in a permanent loss of retirement savings.
Answer the questions below to see how well you've been able to avoid 401k leakage?
Reason: Taking a cashout, hardship withdrawal, or loan can come with costs that can amplify the detrimental effect that leakage can have on a participant’s retirement savings. For example, early distributions from a 401(k) account, whether in the form of a cashout, hardship withdrawal, or defaulted loan, may be subject to a 10 percent tax penalty that must be paid in addition to the amount of the distribution.
a. When I left my last job, I rolled my full 401k balance into an IRA or my new employer's 401k.
b. When I left my last job, I cashed-out my 401k balance and used the money for other things.
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Step Four: Keep 401k investing simple, but do not be afraid to invest in the stock market.
Too many 401k participants invest only in money-market accounts and other investments they consider "safe". But, as a retirement account, your 401k has a time horizon that may extend several decades. Over such long periods, "safe" investments can actually be the most risky. These investments may protect against downside losses, but their upside potential for growth is very limited. Meanwhile inflation eats away at their value and can prevent the accumulation of healthy retirement nest egg.
It is essential that 401k account holders invest a sizable share of their holdings in equities (stocks). Although more volatile in the short-term, numerous studies show that equities are actually the "safer" investment for longer time horizons.
Of course, the investment time horizon shortens as you approach retirement. It is generally considered prudent to lessen stock investments as retirement nears. 401k plans now offer target date investment options that automatically re-balance your 401k investment holdings as you age. Target date funds (also called "life-cycle" funds)are an excellent option for many 401k participants too busy to get into the details of investing.
Reason: Target Date Funds(TDF)offer 401k investors a number of potential advantages. First, they relieve 401k participants of the burden of deciding how to allocate their retirement savings among equities, fixed income, and other investments. TDFs offer participants a professionally developed asset allocation based on their planned retirement date. TDFs thereby can help plan participants and other investors avoid common investment mistakes, such as a lack of diversification and a failure to periodically re-balance their assets.
Second, Target Date Funds are designed to strike a balance between an age-appropriate level of risk and potential investment return. Typically, a TDF will shift from primarily equities to fixed income investments as a participant approaches his or her retirement date, in the belief that fixed income investments generally pose lower risk. This shift can be represented graphically as a line commonly referred to as the glide path.
TDFs allocate a relatively large percentage of assets to equities early, when investors are relatively young, and a much lower percentage as the retirement date approaches. The asset allocation thus becomes more conservative over time, because an older plan participant has a shorter time horizon, fewer opportunities to make contributions to savings, and less ability to recover from downturns in the market.
a. My 401k has a target date fund (TDF) option which I use.
b. My 401k is strictly invested in safe instruments like money-market accounts.
c. I invest my 401k in stocks and other securities and periodically re-allocate investments.
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Step Five: Remember this one cardinal rule about 401k investing: Lower fees directly relate to higher returns.
As 401k plan participants accrue earnings on their investments, they also pay a number of fees, associated with 401k plans. Fees can significantly decrease participants’ retirement savings over the course of a career. For 401k participants, even a small fee deducted from a worker’s assets today could represent a large amount of money years later had it remained in the account to be reinvested. Over the course of the employee’s career, fees can significantly decrease retirement account balances.
401k participants are responsible for directing their investments among the choices offered by their 401k plans, but may not be aware of the different fees that they pay.
According to industry professionals, participants are often unaware that they pay any fees associated with their 401k plan. In fact, studies have shown that 401k participants often lack basic knowledge about the fees associated with their plan. In a recent nationwide survey, 83 percent of 401k participants reported not knowing how much they pay in fees.
Reason: Just a 1-percentage point difference in fees can significantly reduce the amount of money available for retirement. For example, A 45 year-old employee with 20 years until retirement changes employers and leaves $20,000 in a 401k account until retirement. If the average annual net return is 6.5 percent—a 7 percent investment return minus a 0.5 percent charge for fees—the $20,000 will grow to about $70,500 at retirement. However, if fees are instead 1.5 percent annually, the average net return is reduced to 5.5 percent, and the $20,000 will grow to only about $58,400. The additional 1 percent annual charge for fees would reduce the account balance at retirement by about 17 percent.
a. I know how much in fees I pay in my 401k.
b. I do not know how much in fees I pay in my 401k.
Results: Under 50 points: You need to re-examine several of your 401k habits and behaviors. Look over the information above and find areas to improve.50-70 points: You need to make changes if you hope to accumulate an adequate retirement nest egg.71-90 points: You are doing many things right, but there are some areas you can do better at.Over 90 points: You are doing a great job building towards your goal of an adequate retirement nest egg.
Total:
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