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Make the Most of Your 401(k)

Nest eggAs members of the Baby Boomer generation, it’s likely we have children that are just beginning to contribute to their 401(k).  Help them by making sure they don’t make these mistakes.

Here are the stats as well as the good, the bad and the ugly on retirement plans. First, the Investment Company Institute reports that the 401(k) plan retirement system held $4.8 trillion in assets as of March 2016. That represents 52 million active participants, former employees, and retirees. Vanguard also recently reported that the average 401(k) balance reached a record high of $101,650.  However, 38 million working-age households (45%) don’t own any retirement account assets, either an employer-sponsored 401(k)-type plan or an IRA.

The employer-sponsored 401(k) plan started in 1978.  Therefore, it’s been available to millions of workers who are now 65-years-old and who could’ve been using it to save for retirement and save on their taxes. However,  only half of Baby Boomers have more than $100,000 in a 401(k) or another type of retirement plan.

The good news is that younger workers have much of their working lifetime to accumulate a retirement fund. They also have the advantage of participating in 401(k) plans that have become far more sophisticated. This means that it’s a little bit more complicated for participants to understand all of the plan choices. As a result, some will make mistakes. A good goal is to save $1 million over your career to allow you to withdraw $5,000/month for 30 years with a 6% annual investment return.

Here are some common mistakes that retirement plan participants make and what they should be doing to avoid them.

Not Saving Enough. Simple math, right? To accumulate $1 million in monthly increments, you need to defer about $1,000 per month, every month, for 30 years with a 6% annual return.

Starting Too Late. Time and the power of compound interest must be worked to your advantage. The more time you have to accumulate savings, the more time the returns will have to work in your favor. Start to save right out of college, even if it’s a small amount to make saving easier for you down the road.

Not Maxing Out. You need to “max out” your employer match. For example, if you make $75,000 per year and put away 3% ($2,250), and the employer matches, your total annual contribution is $4,500. That won’t even get you halfway to that $1 million. But on that same salary, if you defer 13% into the retirement plan ($9,750 or $812.50 per month), and your employer matches the first 3% of your contribution, that’s an additional $2,250, for a total of $12,000. The employer match is like getting a 23% return on your contribution!

Priorities. Many people don’t pay themselves first. Most 401(k) plans have an option to set an increase in your contribution rate annually until you’re making maximum contributions. If you’re a single taxpayer, a $9,750 contribution will save you at least $2,437 in federal income tax.

Taxes. There are tax savings that are possible. How about $200 per month? Your paycheck won’t go down quite as much as the entire contribution to the plan because there are fewer withholding taxes. In our example, we assume a conservative 6% annual return. Two factors affect returns in a retirement plan. They are fund selection and asset allocation.

Doing Nothing. This means not taking advantage of the plan’s available tools to develop an allocation plan. Spread your contributions over a variety of funds that represent a broad selection of asset classes. A high percentage of plan participants don’t even take the time to change their fund selections from the default fund the plan offers.

Monitoring. You should rebalance your plan to keep the risk profile of your retirement plan portfolio consistent, over time.

Now’s the best time to review your retirement plan options.

Reference: Kiplinger (July 2017) “The 7 Most Common 401(k) Mistakes to Avoid

 

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