“Your Retirement Plan and You”
Do you have a 401(k)- or similar retirement vehicle- plan available at work?
Do you truly understand how it works?
The 401(k) was created, almost by accident, in 1978 when Congress passed a provision allowing employees to avoid being taxed on deferred compensation (aka: your retirement savings). In 1980 a benefits consultant starting using this provision, coupled with an employer match, as an option for his company’s employees. In 1981 the IRS issued new rules allowing employees to fund their 401(k) through payroll deductions.
What is the incentive for your employer to offer a match? Contributions to the employer-sponsored retirement plan appear on the company’s balance sheet. This can help the company appear stronger than it really is, unless the viewer removes retirement plan balances from any calculations. Matches are also a way for the company to increase the perceived good will of the company toward its employees.
The median company matching contribution to employee 401(k) plans in 2019 is 3%, per the Plan Sponsor Council of America. That means that if you contribute 1% of your gross salary to the plan, the company will contribute 1%. If you contribute 3%, the company will contribute 3%. If you contribute anything in excess of 3% (4%, 5%, 10%, 15%, etc) the company will contribute 3%.
Now, here’s the catch:Because the government almost never gives you something for nothing, once you make that pre-tax contribution to your retirement plan, the government feels it has the power to tell you when you can start making withdraws from your own money and even goes so far as to tell you when you have to start withdrawing. Failure to do what the government has decided is in your best interest results in penalties.
So, what is the best way to maximize this tool?
1. Make contributions equal to your employer’s match. This will immediately double your money. Anything more will have diminishing returns. If your employer has a 5% match and you contribute 10% you are only increasing your contribution by 50%.
2. Choose your fund wisely. Most plans offer funds that are high risk, medium risk, low risk, based on retirement date, and index funds. While past results are not an indicator of future performance (something they love to use as a disclaimer), the more active the broker has to be in trying to beat the market, the more it is going to cost you. Take a look at the plan cost. Index funds (which just match the market) can be around 0.02%, whereas retirement date funds, which have a combination of stocks and bonds with a ratio based on how long you have until retirement, can be around 0.05%, and I have seen some funds that are much higher. Remember, the broker gets paid whether your investment increases or decreases. Unless you have a strong reason for choosing a specific fund, opt for the lowest fees possible. This will keep more of your money in your pocket.
3. Invest anything in addition to this amount into a different investment tool, such as a stocks, index fund, real estate, options, a money market account, or whatever you feel comfortable with. Even though you will pay tax on the dollars you are investing, chances are your tax bracket will never be higher than it is right now. And, you have no idea what the tax brackets- or tax code- will look like in your retirement years. Plus, this way there are no penalties. You can do what you want without government interference.
Here is your homework:
1. Take a look at your retirement plan. Most companies have online access. And, you should receive quarterly reports. If not, your HR Director can provide you with the name of the broker who handles your account.
2. Take a look at which fund your contributions are being allocated to. What is the fee? Do you understand what the fund includes?
3. What is your company match? Are you maximizing your dollars? Your HR department will have a form if you want to make changes.
4. Ask questions. It is the job of HR and your broker to ensure you understand what you are investing in. HR may not understand the specifics of each fund, but they can explain the company match.
5. Keep asking questions until you understand. Educate yourself. No one else is going to care as much about your future as you.