Most Americans have access to a 401k plan through their work, but very few truly understand the ins and outs of that plan. Here are a few basic 401k concepts that everyone should know:
- Does my employer match my contribution? If they do, you should be taking advantage of this since it’s free money! A typical match option is 50 percent of your contribution up to six percent of your salary. So if you make $65,000 a year and contribute $3,900 toward your retirement, your employer will give you an additional $1,950. When you see this as a guaranteed 50 percent return on your investment there is no excuse for passing it up.
- When will I be fully vested? When you are fully vested, it means that the money your employer has donated to your plan is entirely yours. There is typically a timed schedule in which the vesting takes place. For example: 20 percent after one year, 40 percent after two years, 60 percent after three years, 80 percent after four years, and fully vested or 100 percent after five years. If you are thinking about changing jobs or retiring, you need to be aware of this schedule because a few days could mean thousands of dollars!
- What are my investment choices? Some plans have as few as 10 investment choices and some have over 60, depending on what type of plan your employer chose. When it comes to choosing investment options you will want to keep your age and risk tolerance in mind. A lot of modern 401k’s actually include a risk profiler to assist participants in making better decisions, but they still leave a lot to be desired. If you have questions about choosing investment options, our advisors are always ready to assist. Since this is probably a large source of funding for your retirement, make sure you get it right.
- How much am I paying in fees? All of the investment choices in your 401k will have fees associated with them, typically called the expense ratio. You should be able to find these fees online under the description of the investment and they will also be available in the investments prospectus. You should pay close attention to these because sometimes you can get close to the same investment at half the cost. Also, the plan administrator may charge you fees if they are not covered by your employer.
- Should I borrow from my 401k? Almost 90 percent of 401k plans offer the loan option of borrowing 50 percent of your account up to $50,000. But that doesn’t mean it’s the right choice. When you borrow money from your 401k it could be subject to a 10 percent penalty and earned income taxes. Also money that is borrowed has to be repaid with post tax money. But in some situations it could be the right or only choice. Our advisors are always happy to discuss this decision with you.
- I am separating from my company what do I do now? The answer to this question could be different based on a few factors such as age and reason for separation. No matter the answer, there are three choices to pick from. First is to take a taxable lump sum withdraw, but this is almost always a bad idea. Second would be to transfer your 401k to your new employer. Depending on your new employer’s plan, this may be a good option because it keeps your money growing tax deferred. Lastly, you could rollover your 401k into an IRA. Typically, this is your best option as you avoid taxes and penalties and have many more investment options inside an IRA.
Whether this is your first job or you are about to retire, understanding your plan is critical to making the right decisions. Your human resources department should provide you with all the information you need about your plan. If you are confused or afraid, you are not making the right choices. Seek a financial advisor before you miss an opportunity. Davis Capital advisors are always happy to sit down with you free of charge and make sure you are making the right moves for your retirement.