Most of us will depend on defined contribution plans, such as 401(k) or 403(b) plans, to fund much of our retirement. If this includes you, it’s important to understand how to make the most of the money you’re saving — both short- and long-term. Here are some tips.
Stay on Top of Matching Contributions
Many organizations match at least some of their employees’ contributions. A common formula is to match 50% of employees’ contributions up to 6% of their salary. Say you earn $50,000 and contribute 6% annually, or $3,000. Your employer kicks in another $1,500. At a return of 5%, your employer’s annual contributions will grow to more than $135,000 in 35 years, not considering fees. That’s on top of your own savings, and doesn’t take into account increases in your salary.
Consider Increasing Contributions
Boost your annual contributions if they fall below the legal maximum. For 2017, this was $18,000 for 401(k) and 403(b) plans, while those 50 years of age or older could contribute another $6,000. To ease the hit, increase the amount you contribute by 1% now, and by another 1% in six months, and so on, until you reach the limit.
Further, when you get a raise, increase your contributions so you’re still living on what you used to make. Allocate a portion of bonuses and other windfalls to your retirement accounts.
Be Aware of the Vesting Schedule and Look Into After-Tax Vehicles
The vesting schedule shows the time frame over which you become owner of the monies your employer contributes to your retirement account. (You always own the money you contribute.) After you’re vested, the funds belong to you even if you leave the company. For instance, some employers increase the amount by which you’re vested by 20% annually, until you reach 100%.
It’s true that you probably can’t change the vesting schedule. But you’ll want to take it into account if you’re thinking of leaving. If you’re close to a vesting threshold, it may make sense to hold off switching jobs until you reach it.
If you’re already saving as much as you can in an after-tax account, check whether your employer offers a Roth 401(k) or other plan that allows you to save on an after-tax basis. Qualified withdrawals from Roth 401(k) accounts aren’t taxed. Having both taxable and tax-free withdrawals in retirement can offer greater flexibility.
Review Your Investments in the Plan and Monitor Fees
Other funds may carry lower fees, or investments that better fit your current risk profile. If that’s the case, check with your plan administrator about switching. Many plans allow this.
Administrative, investment, sales and other fees can have a significant impact on retirement savings. A 2013 report from the U.S. Department of Labor, A Look at 401(k) Plan Fees, found that an employee with $25,000 in a 401(k) account would have $227,000 after 35 years, assuming investment returns averaging 7% and fees of 0.5%, even with no further contributions. If fees rose to 1.5%, that amount dropped to $163,000.
According to the research firm Morningstar, the asset-weighted average expense ratio across funds in different asset classes (excluding money market funds and funds of funds) was 0.57% in 2016. If the mutual funds within your 401(k) plan average more than this, consider bringing it to your employer’s attention. Understand that riskier asset classes tend to have higher expense ratios in mutual funds than lower-risk asset class funds. Reducing these fees benefits everyone who contributes to the plan.
Increase Your Financial Security
By making the most of your defined contribution plan, you’ll boost your ability to retire financially secure. Your accounting professional can help you review your plan and suggest steps to make the most of it.