You’ve got a 401(k), and you (mostly) know how to use it.
You’re aware that it’s a retirement plan set up through your workplace, where you can stash away money for your golden years. If you’re savvy, you may even understand the tax benefits as compared to saving and investing in a brokerage account. Good for you! The best kind of 401(k) is one that is used.
Still, a thorough understanding of 401(k) accounts and how they fit into your overall financial picture may take some additional digging.
Understanding the nuances of this all-important savings vehicle may help catapult you into full-blown investing expert territory. And that’s a pretty good place to be.
#1. Taking Advantage of Your Employer Match
Okay, so this tip is admittedly basic, but understanding your employer match is elemental to making the most of your 401(k).
Also called a company match, an employer match is a contribution made to your 401(k) by your employer, but only when you contribute to your account first.
An example match program might be an employer matching 3% when you contribute 6%. Your employer may do something different, so be sure to find out.
Even if you cannot contribute the maximum allowable amount to your 401(k), you still may want to take advantage of your match.
An employer match is sometimes referred to as “free money,” as in, “don’t leave this free money on the table.” While that may be a playful way to think about it, an employer match is money that is part of your compensation and benefits package. It’s yours, so claiming it could be your first step in wealth building.
#2. Considering Your Circumstances Before Contributing the Max
A lot of 401(k) advice revolves around getting people to try to contribute the maximum allowed each year. And that can make sense for a lot of people, particularly if contributing the max isn’t a huge financial stretch.
But if you’re spending every last dime trying to reach that maximum contribution number, it may not be the best use of your money.
First, you may want to think about whether you’re going to need any of those funds prior to retirement-ish age (currently 61). Withdrawing money early from a 401(k) can result in a hefty penalty.
There are some exceptions. For example, qualified first-time home buyers may be exempt from the early distribution penalty. But for the most part, if you know you need to save for some big pre-retirement expenses, it may be better to do so in a non-qualified account.
Another consideration is whether you should be putting all of your eggs in your 401(k) basket. Of course, these accounts can offer big benefits in terms of tax deferral and may come with a matching contribution from your employer as well.
But if you’re eligible to contribute to a Roth IRA, you may want to consider splitting your contributions between the two.
While 401(k) contributions are made with pre-tax dollars (taxes are paid when you make a withdrawal), Roth IRA contributions are the opposite—taxed on the way in but not on the way out, with some exceptions.
If you’re concerned about taxes going up or being in a higher tax bracket at retirement, then a Roth IRA can make sense as a complement to your 401(k). The caveat is that these accounts are only available to people below a certain income level.
#3. Understanding Your 401(k) Investment Options
The first step is contributing to a 401(k); the second, investing that money. Typically, you’ll be able to choose from a list of mutual funds to invest in for the long-term. Some 401(k) plans may give participants the option of a lifecycle fund or a retirement target-date fund.
To pick the right mutual funds, you may want to consider what is being held inside those mutual funds. For example, a mutual fund that is invested in stocks means that you are now invested in the stock market.
Does this underlying investment make sense for your goals and risk tolerance? Are you prepared to stay the course in the event of a stock market correction?
You may also want to consider the fees charged by your mutual fund options. When analyzing your options, look for what is called the expense ratio—that’s the annual management fee. Any management fee will be subtracted from your potential future returns.
#4. Staying the Course
Many investors will have at least a part of their 401(k) money invested in the stock market, whether through mutual funds or by holding individual stocks.
If you are not used to investing, it can be tempting to panic over small losses. This is also known as “the day-trader mentality,” and it is one of the worst things you can do—especially with a 401(k). Remember, investing in the stock market is generally considered for the long haul.
Getting spooked by a dip (or even a crash like the one in 2008 ) and pulling your money out of the market is generally a poor strategy, because you are locking in what could possibly amount to be “paper” or temporary losses.
It may help you to remember that although stock market crashes are disappointing, they are a normal and natural part of the growth cycle.
Do what you can to avoid getting caught up in the day-to-day—just try to keep focused on the bigger, long-term picture. Remember, the goal is to be patient and let the stock market do its thing.
You may even find it helpful to only check your balance occasionally—not obsessing about it—and instead, keep piling money in.
#5. Using Student Loan Refinancing or Other Avenues to Get Liquid—Not Your 401(k)
It can be tempting to raid a 401(k), especially if you have a more immediate financial need or goal for which you would like to use the money.
But the surprising fact is, if you add up the early withdrawal penalties, potential missed returns, and compound interest, even a slight withdrawal could be costly you. If at all possible, you may want to consider leaving your 401(k) untouched.
If you would like to buy a car or a house, or want to pay off debt, there may be other options available to you. You may want to consider your accounts that don’t have an early withdrawal penalty, such as contributions to a Roth IRA—as long as the contributions have met the 5-taxable-year rule—and brokerage accounts.
If you have student loans, one potential avenue for freeing up more cashflow is to refinance your student loans at a lower interest rate through a lender like SoFi. With a lower rate, you’ll typically pay less interest over the life of the loan Refinancing your student loans may give you the freedom to make purchases—or even just live above water—without dipping into your precious 401(k) funds.
#6. A 401(k) Might Not Be Your Only Investing Option
If you have a 401(k) through your employer, you may want to consider taking advantage of it. Not only may you have a company match, but automatic contributions taken directly from your paycheck and deposited into your 401(k) may keep you from forgetting to contribute.
That said, a 401(k) is not your only option for saving and investing money for the long-term. If your employer does not have a 401(k) program or you don’t like your 401(k) program’s investing options, then you can look at options for opening your own account.
One such option is a Roth IRA. While there are income limitations to who can use a Roth IRA, these accounts also tend to have a bit more flexibility when withdrawing funds than 401(k) plans. If you don’t qualify for a Roth IRA, ask your tax professional for additional guidance.
Another option is to open an investment account that is not tied to an employer-sponsored retirement plan, even though an investor might intend to use the funds in retirement. Sometimes called a brokerage or after-tax account, these accounts don’t have the special tax treatment of retirement-specific accounts.
Still, it might be an option for those who have maxed out their 401(k) contributions or are looking for an alternative to investing within a tax-deferred retirement account.
SoFi Invest® offers the option to invest within a variety of accounts, including after-tax accounts like a Roth IRA. There’s no minimum to get started, and accounts have no annual account maintenance or other hidden fees.
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