The 401(k) plan: It’s the most popular employer-sponsored retirement account in the U.S., with nearly 90,000 participants nationwide, managing a total of nearly 640,000 plans that hold a whopping $3.8 trillion in total assets, according to the American Benefits Association.
So if you’re working for a company that offers this retirement savings account, there’s a good chance you have one.
However, when was the last time you thought about the account or explored the need to make any changes? Of course, as with any retirement savings account, the 401(k) has a long-term investment horizon, which allows you to “set it and forget it”—at least for a good while. But there comes a point when a regular check-in is necessary so you can ensure you’re maximizing every penny that you’re saving.
These four simple steps will quickly and seamlessly put you on the path to saving more.
1. Reevaluate your contributions.
If you’re stuck at one of the common default settings, you could be saving as little as 3 percent. Or you might have forgotten the contribution rate you chose last year—or two, three or five years ago. Ideally, you want to be contributing about 15 percent, but given your longevity and likely medical expenses as you age, contributing 20 percent would be even better.
What to do now: Check your contribution rate and aim to save enough at least to get the company match if there is one. Some companies will add, for instance, 50 cents to every dollar you save, up to 6 percent of your paycheck.
And remember, 401(k) contributions are capped at $17,500 for 2014, or $23,000—including the catch-up provision of $5,500—if you’re 50 or older, so you can likely save more than you are.
“Check to see if your plan offers auto-increases,” says Alex Benke, Betterment’s certified financial planner. That can make saving painless.
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If you’re not sure whether a, say, 1 percent increase would make you feel strapped, Benke advises doing a quick back-of-the-napkin calculation. For example, if you earn $100,000 per year and are in the 28 percent federal and 5 percent state tax brackets, your extra 1 percent contribution will be only $27.92 per paycheck if you’re paid twice monthly. (That’s 100,000/24×0.01 (1-.33)]
2. Reduce your costs.
Thanks to disclosure rules from the Department of Labor, investors have more transparency around the fees in their retirement plans. You may have noticed changes in your own last few statements.
If your statement isn’t 100 percent clear, speak to a plan representative to clarify the costs associated with the funds you currently have, plus any 401(k) maintenance charges. Your “all-in” costs should be no more than 1 percent per year of your total balance—and, ideally, less.
What to do now: If you’re not invested in them already, you can switch to low-cost index funds, exchange-traded funds or even a target-date fund. If these aren’t offered by your plan, ask your employer why.
“Many people don’t realize that their employer has a choice in what they can offer,” Benke said.
“Target date, or lifecycle, funds have flaws, but choosing any vehicle that gets you saving is better than waiting ‘to learn more’ and losing out on potential market returns.”
If you’re not sure which funds are best for you, you could do a lot worse than choosing a broad stock market fund—such as an S&P index fund—and a bond index fund, if available. Or, consider shifting your money into a target date fund, which rebalances a selection of investments geared toward your retirement date. Just make sure it’s cheap, ideally less than 0.50 percent.
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Target-date, or lifecycle, funds have flaws, but choosing any vehicle that gets you saving is better than waiting “to learn more” and losing out on potential market returns.
3. Rebalance to keep risk in check.
Wherever you set the asset allocation for your 401(k) account, it’s going to shift as the market moves. (Many people use the formula of 120 minus their age to determine the percentage of equities versus fixed income.)
Maybe you’re 40 years old and started with a 60-40 allocation of stocks versus bonds and cash, but there’s been a runup in stocks, and now you’re at 70-30. (Over the long term, stocks generally outperform bonds, so this is likely to happen eventually).
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What to do now: Is that bad? Not necessarily, because market movements are normal. But the changes may mean you are taking more or less risk than you intended. Rebalancing, by selling the outperforming funds and buying the underperforming ones, will keep risk in check by bringing you back to your ideal asset allocation.
These changes are tax-free in a 401(k). Also remember, Benke cautions that some companies have two settings: one for how new money is invested, and one for current funds. “Make sure these are both set to your desired asset allocation,” he said.
4. Don’t leave a 401(k) behind.
If you have a 401(k) from a previous job that’s hanging out somewhere in “retirement land” and you can’t remember where it is or what’s in it—tackle that old account stat. You don’t want to keep your money in an account that might be expensive, hard to access or, worse—see steps 1 through 3 above—not set up to your benefit.
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One option is to roll over an old 401(k) into an individual retirement account, which can save you money in fees in the long term. To give you an idea of how much you could save, consider this example:
- Starting investment amount: $100,000
- Number of years invested: 30
- Average return: 7 percent
- 401(k) fee: 0.80 percent = $607,764.74 future value, net of fee
- IRA fee: 0.30 percent = $699,733.37 future value, net of fee
- Difference: $91,968.62 saved in fees by rolling over into the IRA, or 13.14 percent less spent in fees
—By Jon Stein, special to CNBC.com. Stein is founder and CEO of Betterment, which ranked 45th on the 2014 CNBC Disruptor 50 list. The firm offers Web-based money-management services.