How to Manage Your 401(k) for Retirement Success

How to Manage Your 401(k) for Retirement Success

October 06, 2022

To maximize your 401(k), you'll need to understand the types of investments offered, which are best suited for you, and how to manage the account going forward, among other strategies.

Ask older Americans what they regret in their retirement planning, and chances are, they’ll say they wish they had started saving for retirement earlier. According to a survey conducted by the Insured Retirement Institute, 44% of workers believe they will not have enough income to last throughout retirement. It’s never too early to start thinking about the future — and never too late to start catching up on saving.

A 401(k) plan is an employer-sponsored retirement savings account that allows you to make pre-tax contributions to your retirement fund. One of the biggest perks about having a 401(k) through your employer is that you can set up automatic payroll deductions so that money is taken from your paycheck and deposited into your account. Which makes it easier to maximize your savings potential.

401(k)s offer you a wide variety of investment options to choose from, including stocks and bonds. You can even invest in mutual funds made up of other investments or a combination of all three options.

However, there are also restrictions on how much you can contribute each year. Here's what you need to know about 401(k)s and how you can set them up for retirement in order to benefit you in the long run.

How They Work

There are two main options, each with distinct tax advantages. 

Traditional 401(k): With a traditional 401(k), employee contributions are deducted from gross income, meaning the money comes from the employee's payroll before income taxes have been deducted. As a result, the employee's taxable income is reduced by the total amount of contributions for the year and can be reported as a tax deduction for that tax year. No taxes are due on the money contributed or the investment earnings until the employee withdraws the money, usually in retirement.

Roth 401(k): With a Roth 401(k), contributions are deducted from the employee's after-tax income, meaning contributions come from the employee's pay after income taxes have been deducted. As a result, there is no tax deduction in the year of the contribution. When the money is withdrawn during retirement, no additional taxes are due on the employee's contribution or the investment earnings.

Now we understand how they work, it's time to discuss ways to maximize them. 

Consider Contributing the Max for Your Company Match

If you are still in the workforce and your company is matching the funds you contribute to a 401(k) savings account up to a certain point, contribute as much as you can until they stop matching the funds. Regardless of the quality of your 401(k) investment options, your company is giving you free money to participate in the program. Never say no to free money!

Once you reach the maximum contribution for the match, you might consider contributing to an Individual Retirement Account, also known as an IRA, to diversify your savings and have more investment choices. Just don't miss out on the match!

Learn the Basics of Investing

Investing (especially in a bear market) may seem complicated and even a little overwhelming. To help you understand the basics of investing, start by reading through your 401(k) plan; essentially you should know the ins and outs of your terms.

Evaluating different funds in your 401(k) plan can be confusing. If you don’t know what an expense ratio is, or 12B-1 fees, risk tolerance, etc, it’s easy to feel overwhelmed by the jargon and miss the point of the information you’re given.

You can usually find definitions and explanations anywhere online, and if you're still unsure then, it's probably best to set up a complimentary call with your financial advisor to clear up any confusion. And don't forget, you don’t have to pick just one fund. Instead, you could spread your money over several funds. How you divvy up your money—or your asset allocation—is your decision. However, there are some things you should consider before you invest. 

What to Consider Before Investing

The elephant in the 401(k) investing room is risk tolerance. If you have a long time horizon, it can be smart to get aggressive with your portfolio, but those closer to retirement should be careful, too. For those close to retirement, it may be time to shift into preserving your assets rather than trying to play catch-up. Only you and your Fiduciary advisor can say what is considered "risky" for you, so always consult together first to ensure you don't take on more risk than necessary. The least-risky investment in a 401(k) would be either money market funds or U.S. government bonds (known as Treasuries). However, these investments will typically offer a very low rate of return and may not keep up with inflation.

The risk tolerance equation also plays into your age - specifically how many years you are from retirement. The basic rule of thumb is that a younger person can invest a greater percentage in riskier stock funds. At best, the funds could pay off big. At worst, there is time to recoup losses since retirement is not imminent. 

Routine Maintenance of Your 401(k)

In life there are many things that need routine maintenance on, such as your car or home. Think of your 401(k) as just another asset that needs a check-up.

Why? As different assets move up or down in value, they become a smaller or larger percentage of your overall portfolio. If you don’t rebalance on a regular basis, try to make a habit of rebalancing once every six months. 

This is because the various positions in a portfolio grow at different rates, and over time the portfolio can deviate from its target allocation. Investors should look at their portfolios to see if they need to be rebalanced. Rebalancing returns the 401(k) from its current allocation to its target allocation.

Diversify, Diversify, Diversify

This is what good asset allocation is all about. Don't put all your eggs in one basket, or all your assets into one asset class. Spread them among different asset classes and investment styles. Doing so will spread your assets over an assortment of investments and should reduce your risk.

Over time, a diversified portfolio of stocks generally returns more than a typical bond portfolio. The Standard & Poor’s 500 index has gained an average of about 10 percent annually for decades. And with many retirees living longer than ever, they’re going to need to ensure their investments provide a high rate of return. An example here is a target-date fund...

Target Date Funds

When it comes to investing your 401(k) money, many people choose a target-date fund. Target-date funds are geared to evolve as you move closer to retirement. For example, if you’re planning to retire in 2035, you would invest in a target-date fund that matures in that year. The fund’s managers will continually re-balance the fund to maintain an appropriate allocation as the target date gets closer.

But there are also some reasons as to why this type of fund may not be the best choice. Firstly, funds use different allocation strategies, which may or may not be a good match with your goals. A target date fund’s performance is largely based on the fund managers. Since you probably don’t know the difference between a good manager from the bad, picking a fund will be difficult. 

Equally important, fees for these funds are often high, and novice investors don’t understand the golden rule of target-date funds: If you invest in one, don’t mix it with other investments. These funds have been notorious for being an “all or nothing investment”. Investing in it can throw off the allocation of your 401(k).

How Do I Start a 401(k)?

If you work for a company that offers a 401(k) plan, contact the human resources or payroll specialist responsible for employee benefits. You'll likely be asked to create a brokerage account through the brokerage firm your employee has selected to manage your funds. During the setup process, you'll get to choose how much you want to invest as well as which types of investments you want your 401(k) funds invested in.

How Agemy Can Help

Nothing is more central to your retirement plan than your 401(k). It represents the largest chunk of most retirement nest eggs. A comprehensive financial plan can help you make the right investment decisions and prepare for retirement.  

At Agemy Financial Strategies, our Fiduciary financial advisors are equipped with the tools to help you make the right investments and make the most out of your retirement savings. We are here to help you navigate any questions you have regarding investments, retirement savings and anything else that comes up during your retirement process.

As Fiduciary advisors, it's our duty to act on your behalf in finding the right solutions for your individual wants and needs. For more information on investing, retirement and financial planning services, contact us here today.