Having a 401(k) is one thing. Making the most of it is another. One of the best things you can do for your financial future is to ensure you're getting all that you can out of your employer-sponsored plan. Here, we'll look at five key levers you can pull -- with minimal effort -- to maximize the value of a 401(k).
It's common practice for employers to match 401(k) contributions up to a specified percentage of your salary. For instance, let's assume you earn $100,000, and your employer matches up to 4%. When you contribute $4,000 to your 401(k) over the course of a year, your employer will contribute another $4,000. This is the same as a 100% return on your money!
Remember that a 401(k) is an account type and not an investment unto itself. This means that when you contribute money to a 401(k), you're only halfway done -- you'll need to make sure that the money within your account is actually invested. You'll be provided with an investment menu, and it's up to you to choose from a list of options. A 401(k) sitting in cash won't do you much good in the long run, so be sure to take a proactive approach when investing your money.
Your employer's 401(k) plan will most likely offer a list of investment funds for you to choose from. Each of these funds will come with a cost, otherwise known as an expense ratio. In 2021, you shouldn't need to pay more than a minimal fee (0.10% or less) to access great fund options.
If your employer uses an expensive 401(k) provider, you might consider contributing to a Roth IRA before maxing out your 401(k) plan for the year.
Reading your employer's 401(k) plan document may feel like watching paint dry, but it's a worthwhile investment of time to do it at least once. Your employer's vesting schedule is one central reason: The moment your 401(k) money vests is the moment at which the money in the plan truly becomes yours. Some employers require one to five years of service before this happens. If you choose to leave your company before funds have vested, you may walk away with only a portion of what you think you have accrued in your account. Know the details!
Many plans offer two options: a "pre-tax" 401(k) or a "post-tax" 401(k), better known as a Roth 401(k). With a pre-tax 401(k), you receive a tax deduction today in exchange for tax-deferred growth in your retirement account. Funds are only taxed when you withdraw them in retirement.
On the other hand, a Roth 401(k) is funded with post-tax contributions. This means you elect to pay tax today on this money, and only then is it added to your retirement plan.
The major benefit here is that once this money has been taxed, it's not taxed again. You'll see Roth 401(k) money grow without any looming tax bite, even when you withdraw the money in retirement.
Simply taking the time to know a few details goes a very long way when it comes to retirement planning. There is no perfect answer to investing in a 401(k), but if you can get certain key considerations right, you will end up far better off in the long run. The beautiful thing is that many of these action items take little time but provide a huge payoff.