Make the Most of Your 401k

The new year is a perfect time to get organized, and your finances are a great place to start. One area that merits attention is the powerful retirement saving tool most people have access to: that’s your 401(k) plan. It is common to spend time setting the account up initially, but often it goes on auto-pilot later. While that’s great to ensure consistent savings, it’s also easy to forget about the account. That’s why it’s wise to check in at least annually as part of your regular financial planning to make sure you are making the most of your 401(k).

How to Keep Your 401(k) Working For You

With rising inflation and continued talk of higher future tax rates, it is increasingly important to keep a tight rein on your retirement investments. To do that, here are a few tips to make sure you’re maximizing your 401(k). 

Get Your Full Employer Match

Many employers will match your initial contributions up to a certain percentage every year. At the very minimum, you should maximize this since it is essentially free money. 

So your first step is to double-check that you are contributing enough to get the full match every year.

Up Your 401(k) Contribution Rate for 2022

One bit of good news: recently, the IRS announced increased 401(k) contribution rates. Starting in 2022, you can put an additional $1,000 per year away in your 401(k).[i] For most people, that means you can now shelter $20,500 in earnings in your retirement account this coming year. So now is a great time to increase your contribution accordingly. 

Don’t Forget About the 401(k) Catch-Up Contribution

There’s not always benefits to getting older…but there are when it comes to retirement savings. Once you turn 50, you’re eligible to make “catch up” contributions over and above the standard contribution amount. This currently is $6,500 per year, unchanged from last year. So if you’re 50 or older, you can put a total of $27,000 per year away starting 2022. If you’re not capturing this benefit, consider upping your contribution this year. 

Consider a Roth 401(k) If Available to You

You’ve probably heard of Roth IRAs, which allow you to forgo immediate tax savings and instead contribute after-tax dollars. By paying taxes now, your “Roth” money becomes completely tax-free as long as you wait until retirement to tap into it. 

Some workplaces are now offering Roth 401(k)s in addition to the traditional plans. You can even split them up in some plans and have some of your money contributed to each. With congress eyeing more tax increases and government spending still accelerating, contributing to a Roth 401(k) can be smart. 

One key here is that, unlike Roth IRAs, Roth 401(k) s are not phased out for high-income people. So you can contribute to a Roth 401(k) no matter how much you earn. [ii] 

We believe the sooner you start a Roth 401(k), the better! Especially for younger folks, decades of putting away after-tax dollars combined with tax-free growth is an opportunity not to be missed, especially when one cannot predict future tax rates.

Don’t Forget to Rebalance

Next, it’s time to evaluate what you’re holding in your 401(k). As you know, investment prices are determined by the market and change over time. If you originally started with a specific “asset allocation,” which means the split between different investments, your holdings have probably shifted with time. With stocks having had another strong year, your stock funds have likely increased in value while your bond or fixed-income funds may have dropped in value.

While holding on to the bigger stock position sounds good in theory, here’s the problem: you may end up with far too much of one type of holding. In this case, stocks. When the market cycle changes, that can mean potentially more significant losses, simply because your investment allocation had grown more aggressive due to price changes. That means you may be taking far more risk than you realize.

The answer? Something called rebalancing. Rebalancing is a process you do periodically. To rebalance, you sell some of your winners (take profits) and then plow that money back into the areas where values dropped (buying what is cheaper today). 

You’ve probably heard the old adage “buy low and sell high.” With rebalancing, that is exactly what you are doing! This is a disciplined way to manage your money and avoid buying or selling out of fear or greed. Rebalancing helps you naturally buy shares when they are cheap and sell some when they are expensive. More importantly, it helps keep your risk in check. 

Evaluate the Fees you are Paying

Finally, one last area to check is fees. Most of the time, you’ll have different 401(k) funds to choose from in your plan. Most plans have a mix of “actively” managed funds as well as more passive funds. 

While there’s usually room for both, most actively managed funds have significantly higher fees than passive funds, such as index funds. 

Since fees directly impact your earnings, it’s wise to make sure you’re not overdoing the higher-fee funds. If possible, always see if you can achieve your goals with a lower fee option.

Financial Planning Can Help You Stay on Track

Bottom line…if you’re going to save in a 401(k), you might as well get the maximum benefit out of that account. So either do these tasks yourself or check in with your financial advisor to make sure they are being handled for you. (At Emerald, we include an annual review of your employer or business retirement plan to help you with these tasks.) Whatever you do, remember to periodically check up on your 401(k) to ensure that it’s setting you up for a great retirement.

Want to Make Sure You’re Maximizing Your 401(k)? 

If you’re an existing client, book an appointment with us, and we’d be pleased to sit down and review your options and your holdings. Or, if you’re looking for help with your financial planning and investing, contact us to see if Emerald can help you achieve your goals. 

[i] https://www.irs.gov/newsroom/irs-announces-changes-to-retirement-plans-for-2022

[ii] https://www.investopedia.com/articles/personal-finance/071315/comparing-contribution-limits-roth-401k-vs-roth-ira.asp