In the early 1980’s, a fresh alternative to the quickly fading company pension arrived on the scene. This new retirement supplement was called a 401k and enabled companies to help their employees save for retirement while concurrently reducing taxable income.
In essence, workers can choose to deposit part of their earnings into a 401k account, and by doing so, avoiding tax on income until the money is later withdrawn in retirement, all while building interest on this untaxed money prior to withdrawal.
A champion of simplicity and stability, 401k’s are an ideal supplement to your retirement, but if you do not plan accordingly, there is the possibility of falling short.
The early adopters of the 401k are now set to retire in the near future and a large portion of these individuals are not in as strong a position as they would like when it comes to retirement savings. In fact, according to an article in The Wall Street Journal, “the median household headed by a person aged 60 to 62 with a 401(k) account has less than one-quarter of what is needed in that account to maintain its standard of living in retirement.”
While this may seem worrisome, do not fret. Such shortfalls are commonly not an issue with 401k’s or the mechanics of this system, but rather employees themselves not taking advantage of the benefits. Now that we understand the underlying value of 401k’s, and their importance in wage earners retirement planning, let’s discuss how to get the most miles out of this investment vehicle.
How Much to Contribute?
This comes down to how much your employer will let you contribute. Currently, the annual limits are $15,500 for those under 50, with an increase of $5,500 on top of that if you are over 50 years old. So for those who have gotten off to a late start, you can ultimately contribute $22,000 per year.
Many employers also match these contributions up to a certain percentage. The importance of the employer contribution cannot be stressed enough. Take advantage of the full employer match, because it is basically free money for you to add to the retirement war chest.
Although it would be nice to max out your contributions, you do still need to plan for living expense and the such. So go ahead and plan your needs for the current year and see how much you can put aside for savings. It all comes down to how much money you can realistically do without. Use the countless budget calculators on the internet to get a basic idea of what you living expenses will be.
Where to Invest?
401k’s allow for autonomy when it comes to deciding where to invest the funds. If you are quite a ways from retirement, being overweight in stock mutual funds is usually the proper avenue. This allows for added growth over the long-term, without having to worry about the up and down fluctuations of the financial markets in the short-term. As you get older, the allocation should gravitate towards bond mutual funds and other fixed-income investments that focus more on preserving capital. But always remember to stay diversified in order for you to have the best odds of growth.
As a rule of thumb, look for larger gains in the early years, and then protect your wealth while letting it compound in the later years. But do yourself a favor and research what you are buying into and do not blindly allocate your hard earned money into funds that you do not think will perform well.
Given the generous tax-breaks that your 401k plan offers, there is no reason that you should not take advantage of this resource.
For more information on 401k’s or retirement, talk to the expert advisors at Karlan Tucker & Associates today.