Wish you could wave a magic wand and optimize your 401(k) ? These 7 surprisingly simple 401(k) tips come pretty close.
As a Certified Financial Planner™, I’ve come across my share of 401(k) mistakes. The good news — most of these mistakes are easy to overcome (even if you know very little about investing).
To help you with that, here’s 7 simple tips to optimize your 401(k) right now.
# 1 – Optimize Your Investments
Besides your savings rate, what determines how fast your 401(k) can grow are the investments you choose. Choose the right mix of funds and knock years off your working life. The wrong choice can have the complete opposite impact, leaving you working longer and with less money.
What’s unfortunate is that choosing the right mix of funds to maximize returns is hard. So hard in fact, one study found a professionally managed 401(k) can grow twice as fast as one that isn’t.
Instead of going out and hiring a financial adviser to evaluate your 401(k) — you can give your 401(k) a FREE analysis in just a few minutes with Blooom.
If you haven’t heard of Blooom, they’re an SEC-registered investment advisory firm that optimizes and monitors your 401(k) for you.
Blooom gives you an initial 401(k) checkup for free. This can tell you whether you have selected the optimal mix of stocks and bonds.
To get your free analysis, all you have to do is enter your name, birthday, and estimated retirement date. Then, let Blooom link up to your 401(k).
You’re free analysis can then be boiled down to one simple image.
After that, Blooom costs just $10 a month to continue to optimize your account no matter the size.
# 2 – Increase Your Savings Rate In Increments
Fidelity Investments recently finished a large study1 of 401(k) millionaires. What they found was that the typical investor contributes 8% of their pay to their 401(k). The savings rate for the average 401(k) millionaire was 16%.
If you’re not at 16% today — there’ no need to panic. Getting there isn’t as hard as many think. Here’s one tip that has been powerful for myself — increase your savings rate by 1% at a time.
For example, say you’re saving 0% of your paycheck today. Start today by saving 1%. In three months, increase another 1%.
By increasing your savings rate 1% at a time, you’ll barely notice the difference. Then, a few years go by and you’ll be on pace to become a 401(k) millionaire yourself.
# 3 – Take Advantage of the Match
A report by the independent investment advisory2 firm Financial Engines found 1 in 4 employees are not taking full advantage of their employer match. By not maximizing their match, employees are leaving an estimated $24 billion on the table.
Taking full advantage of your 401(k) match is as close to free money as you’ll ever get. If you’re not currently taking advantage of your match, make the changes you need to make to get there.
# 4 – Discover How Much Of Your Retirement Is Lost Due To Fees
High investment fees can literally add years to your working life. Today you’re going to discover how much of your retirement is lost to fees.
Do you have to work an extra 2 years? 5 years? 7 years?
Here’s a simple way to find out.
With employer sponsored plans, there are two layers of fees:
- Account management fees. This may be a flat fee or a fee based on a percentage of your account value.
- Mutual fund fees. These are fees charged for the specific mutual funds you choose.
Hidden fees are called hidden for a reason. Fortunately, a free tool called Personal Capital can help discover hidden fees in your 401(k) and across all your investments in just a few clicks.
Here’s how it works:
- Sign up with Personal Capital and link your 401k account. My 401k was with LT Trust, so I simply typed “LT Trust” in the search field, then linked my account.
- Once your 401(k) is linked, click the investing tab and select the “401(k) Fee Analyzer” tool.
- Use the tool to discover the impacts on your contribution rate, growth rate, and additional investment fees.
- Finally, link your other investment accounts that you’d like to analyze.
Personal Capital will then break down your 401(k) and other investment fees, to determine how much of your retirement is lost to fees.
- Keep track of your net worth. Personal Capital works with all of your financial accounts – from your 401(k) and other investments to checking, savings, mortgage and credit cards. So you get a complete picture of your net worth anytime.
- Give your portfolio a checkup. With the free “Investment Checkup” tool, you can learn whether your investments (401K, IRAs, taxable accounts) are optimized to the ideal target allocation designed to minimize risk and maximize return.
- Know exactly where you stand relative to your retirement goals. With the “Retirement Planner” tool, you discover how prepared you are for retirement based on your ideal target retirement date. Plus, learn the impact of life events – such as paying for college, buying/selling a home and adjusting your savings rate has on your retirement. .
# 5 – To Roth or not to Roth
Should you invest in a Traditional 401(k) or Roth 401(k)?
The most important factor to decide what account you should contribute to is a comparison of current versus future marginal tax rates.
And that’s why you hear the advice:
- If your tax rates today are lower than they will be at the time of withdrawal, choose a Roth 401(k)
- If your tax rates today are higher than they will be at the time of withdrawal, choose a Traditional 401(k)
But there’s actually a lot more to the equation then simply looking at your projected current vs. future marginal tax rates.
There are two other factors you want to consider:
The Impact of Required Minimum Distributions (RMDs)
RMD is a tax law which requires you to withdraw a certain amount of your Traditional 401(k) each year.
While Roth 401(k)s do have RMDs, you can avoid RMDs from a Roth 401(k) by rolling the money over to a Roth IRA.
RMDs for Traditional accounts (such as 401Ks and IRAs) start at the age 70 1/2.
This is a disadvantage of Traditional accounts for those;
- Who plan to work past the age of 70 and thus will maintain a higher marginal tax rate
- Who want to pass on their 401(k) to a beneficiary
In 2018, Roth and Traditional 401(k)s have the same maximum contribution limits, which is $18,500 per year (up from $18,000 in 2017).
But keep in mind, $18,500 in a Roth has a greater value then $18,500 in a Traditional account.
In a Traditional 401(k) part of your account belongs to the IRS. For example, if you expect to pay 28% tax on your withdrawals, 28% belongs to the IRS.
In a Roth 401(k), while the contributions are made after-tax, 100% is yours to keep.
The contribution limit is therefore higher for Roth 401(k). This comes into play for those wanting to max out their 401(k) but still have money in taxable investment accounts. All things being equal, it’s better to invest 100% in a Roth 401(k), then say 85% in a Traditional and 15% in a taxable account.
This is an advantage for Roth 401(k).
# 6 – Rollover 401(k)s The Easy Way
Why does it make sense to rollover your 401(k) to an IRA? After all, switching can be quite the pain.
But as previously mentioned, 401(k) fees are quite high. The ICI reports3 that the average person pays 1.29% in fees to invest in their 401(k). For smaller businesses, the news is even worse. Plans with less than $2 million in assets averaged 2.22% in fees.
It’s not uncommon to have a few old 401(k)s lying around. By rolling over your 401(k) to an IRA, you can reduce your fees and have better investment options.
Furthermore, there are more advanced financial planning tactics one can take advantage of when moving to an IRA. One tactic being the IRA conversion ladder. As Jeremy Biberdorf of Modest Money explains in his guide on IRA Conversion Ladders, “You may have the opportunity to access your retirement funds prior to age 59 ½ without be penalized by utilizing a conversion ladder technique to move retirement funds from a Traditional IRA to a Roth IRA.”
You’ll also be happy to know that a 401(k) rollover doesn’t have to be such a pain. While some investment brokerages make the process labor intensive, Betterment makes it simple.
Instead of having you select which funds to invest in, Betterment first has you complete a goal questionnaire. Betterment then designs an ideal asset allocation for you based off of your goals.
Their goal questionnaire, which only takes 2-5 minutes and doesn’t require a signup, allows you to see exactly the portfolio they’d put you in. If you want to then take their recommendation and use it to help you pick funds at your preferred broker, you can. Or you can simply just let Betterment manage your account. Their fees are just .25%, over 1% less than the average 401(k).
# 7 – Save That Bonus
Many investors stick to saving a certain percentage of their income. This is true even when a rare “windfall” occurs. For example, an inheritance, gift, or a bonus.
One last tip to help you retire rich is to save that windfall! When you find yourself with some unexpected cash, max out your 401(k) contribution then use the windfall for your living expenses.
For example, if you get a $4,000 gift, contribute an extra $4,000 that month to your 401(k). While this may require you to save say 50% of your income for the month — use the windfall to cover your living expenses.
Note:Investing 100% of your windfall IRA, if available, will have a similar impact.
And don’t forget: if you have questions that aren’t covered here, help is available. A qualified financial planner can help you evaluate your financial situation and build a sound strategy. Financial planning used to be only for the wealthy, but today there are many free (or very affordable) resources available. You can read more about them in my guide to low-cost financial planning services.
- Surge in 401(k) millionaires as balances hit highs
- Americans Likely Leaving $24 Billion in Unclaimed 401(k) Company Matching Contributions on the Table Annually, Financial Engines Finds
- Study Finds Small Business 401(k) Fees Average 2.22%
- Most People Will Ultimately Pay About $279,000 Of Interest On Their Loans
*I’m a customer myself, as well as recommend to others tools like Blooom, Personal Capital, and Betterment. If you to decide to use these tools you help support this blog and its mission of helping Americans connect the dots between their money and what makes them happy. Thank you!