Whether you just set up your 401(k) plan or you established one long ago, you may want to change the amount of your contributions — or even how they’re invested. Fortunately, changing your 401(k) contributions is usually straightforward, and you may be able to change your 401(k) contributions at any time (depending on your plan).
After all, the point of a 401(k) plan is to help you save a substantial amount for your retirement. So it’s important to keep an eye on your account and your investments within the account, to insure that you’re saving and investing according to your goals.
To understand how to maximize this investment opportunity and grow your nest egg, it’s important to start with the basics.
Purpose of a 401(k)
A 401(k) is a retirement account that a company may offer to its employees. In some cases, enrollment in the employer’s 401(k) is automatic; in some cases it’s not. Be sure to check, so that you can take advantage of this savings opportunity.
Employees may contribute a portion of their paycheck to the company’s 401(k) account, and employers might also contribute to each employee’s account (again, depending on the plan).
The employer’s portion is called the company’s “match” or matching funds. Typically, an employer might match up to a certain percentage of what the employee saves. One common matching plan is when a company matches 50 cents for every dollar saved, up to 6% of the employee’s total contributions. Terms vary, so it’s best to ask your Human Resources representative what the match is (if there is one).
The money a participant contributes to their 401(k) plan is technically called an “elective salary deferral” because it’s optional, not required, and those deductions are not included in an employee’s taxable income. That’s why 401(k) and similar accounts (like 403b and most IRAs) are often called tax-deferred accounts: You don’t pay taxes on the money you’ve saved until you withdraw the money in retirement.
This tax benefit can be significant. Every dollar you save reduces your taxable income, which can result in a lower tax bill in some cases.
Can You Change Your 401(k) Contribution at Any Time?
While the opportunity to make changes to some employee benefits, like health insurance, are generally only offered once a year during so-called open enrollment periods, many plans allow participants to change the amount of their 401(k) contributions at any point. According to Department of Labor guidelines, an employer must allow plan participants to change investments at least quarterly (sometimes more often, if company stock or other high-risk investments are offered by the plan).
The reasons for making changes to your 401(k) contributions may vary.
The Ability to Save More
You may have gotten a raise, or experienced a change in your financial circumstances, and wish to increase the percentage of your savings. Contributions to these plans are typically expressed as a percentage of your annual salary. For example, if you earn $75,000 per year, and your contribution rate is 10%, you would save a total of $7,500 per year. If you got a raise to $80,000 and now wish to contribute 12%, you would save a total of $9,600 per year.
To Get the Match
As discussed above, some 401(k) plans offer a savings match from the employer. In most cases, the match is a set percentage of the employee’s contribution. If you set up your 401(k) at a point when you couldn’t get the full match, you may want to increase your contributions to get the full employer match.
Rebalancing Your Asset Allocation
If you’ve held the account for a while, say a year or more, the original allocation of your investments — i.e. the balance between equities, cash, and fixed income investments — may have shifted. Restoring the original balance of your investments may be a priority, if your strategy and risk tolerance haven’t changed.
Changing Your Asset Allocation
You also might want to shift the allocation because your financial strategy has become more aggressive (i.e. tilting toward stocks) or more conservative (tilting toward cash and fixed income).
Setting Up Automatic Increases
Some plans offer participants the option of automatically increasing their contribution rate every year, typically up to a certain percentage (e.g. 15%), and not to exceed the maximum contribution levels. While some plans have different rules, the basic contribution limit for 401(k) plans for 2022 is $20,500 for participants under age 50. For those 50 and older, you can save an extra $6,500 in “catch-up contributions”, for a total of $27,000.
Setting up automatic increases allows you to save more each year without having to think about it; this can be beneficial for overcoming the inertia common among many savers.
How to Change 401(k) Contributions: 3 Steps
Again, the 401(k) plan provider will be able to advise participants on how often they can make changes to their contributions, and what the process will look like. For employees unsure of the plan provider, the company’s human resource department can point them in the right direction.
In some cases, participants can change their contributions directly through their plan provider’s website. Generally, the process of making changes to a 401(k) looks like this:
A participant, i.e. the employee, contacts their 401(k) provider to discuss how to change contributions for their particular 401(k) plan.
The employee considers how much of their paycheck they want to contribute to their 401(k) moving forward, taking their company’s 401(k) match into consideration, and ideally contributing at least that much. The employee might also change their asset allocation, depending on plan rules.
The participant fills out any forms (online or via paperwork) to confirm their new contribution.
Often, these steps can take just a few minutes, using your plan sponsor’s website.
Why Contribute to a 401(k)? 3 Good Reasons
Contributing to a 401(k) plan is an important way to save for retirement. The funds in a 401(k) are invested, generally in mutual funds, exchange-traded funds (ETFs), or target date funds — which can offer the potential for growth over time. Typically there are about 12 investment options in most 401(k) plans.
But perhaps the three best reasons to contribute to a 401(k) plan are the opportunity to save automatically, via regular payroll deductions; the potentially lower tax bill; the ability to get “free money” from your employer match, if it’s offered.
For many people, this type of investment is easy because you can choose how much of your salary to contribute each pay period, and deductions happen automatically. You don’t have to think about your savings, your contributions are taken directly from each paycheck, so it helps to build your nest egg over time.
Lower Taxable Income
Another benefit is the potential for savings during tax season. Since the contributions an employee makes to their 401(k) plan over the course of the year aren’t included in their taxable income, that can lower their overall taxable income. This, in turn, may result in an individual falling into a lower tax bracket and paying less income tax for that year.
And in the future, when they might likely be in a lower tax bracket due to retirement, they’ll pay lower taxes when they withdraw the money from their 401(k) account.
Note: Withdrawing money from a 401(k) account before retirement age may lead to early withdrawal penalties.
Another perk of enrolling in a 401(k) plan is the notion of “free money” from one’s employer. Some companies match a portion of their employees’ contributions—often around 50 cents to $1 for each dollar that an employee contributes.
Typically, an employer might set a maximum matching limit, such as 3% to 6% of the employee’s salary.
This matching contribution is often referred to as free money because the contribution effectively increases an employee’s income without increasing their current tax bill. It’s worth noting that an employer’s match generally vests over the course of three or four years—meaning that the employer-contributed money will accrue in the account, but an employee won’t be able to keep it if they switch jobs, unless they remain with the company for that set period of time.
Setting up Recurring Contributions
When it comes to setting up a 401(k), the process varies by workplace. Some companies offer automatic enrollment to employees, automatically reducing the employee’s wages by a certain amount and diverting that money to the employee’s 401(k) plan, unless the employee chooses not to have their wages contributed.
Or, an employee can choose to enroll, but to contribute a custom amount. This type of contribution is referred to as an elective deferral.
In companies that don’t offer automatic enrollment as an option, employees will need to work with their HR department and retirement plan provider to get their 401(k) set up.
Participants need to decide how much they want to contribute, may need to choose their investments, can opt to take advantage of autopilot settings, and can roll over a 401(k) from a past job into their new one.
How Much to Save for Retirement
The Department of Labor (DOL) outlined a few best practices for investing in order to save for retirement.
It’s estimated that most Americans will need 70% to 90% of their preretirement income saved by retirement, in order to maintain their current standard of living. Doing that math can give plan participants an idea of how much they should be contributing to their 401(k).
Participants might also consider a few basic investment principles, such as diversifying retirement investments to reduce risk and improve return. These investment choices may evolve overtime depending on someone’s age, goals, and financial situation.
The DOL recommends that employees contribute all they can to their employer-sponsored 401(k) plan to take advantage of benefits like lower taxes, company contributions, and tax deferrals.
Adding Alternative Investments to a 401(k)
Some savers may find themselves interested in pursuing alternative investments when saving for retirement. An alternative investment takes place outside of the traditional markets of stocks, fixed-income, and cash. This method may appeal to those looking for portfolio diversification. Popular examples of alternative investments are private equity, venture capital, hedge funds, real estate, and commodities.
Self-directed 401(k)s allow participants to add alternate investments to their 401(k) portfolio. With a self-directed 401(k), the investor chooses a custodian such as a brokerage or investment firm to hold the amount of assets and execute the purchase or sale of investments on the participant’s behalf. If an employer offers a self-directed 401(k), the custodian will likely be the plan administrator.
For employees looking to change 401(k) contributions, the process is often as simple as reaching out to your plan provider and confirming that you’re allowed to make a change at this time.
Some companies have rules around when and how often employees can make changes to their contributions. Once you have the go-ahead to make the change, and have considered what works best for your current financial situation and your future goals, it’s generally straightforward.
A company-sponsored 401(k) plan offers many benefits — including the “free money” that comes with an employer-matching program (as long as you stay at the company until you’re fully vested; vesting schedules vary). But there are also other ways to save for retirement, including your own investment account, which you can set up today with SoFi Invest®. Investors can get started with as little as $1 and can trade stocks and ETFs with no SoFi management fees. And for those who want more guidance, SoFi can help you build a portfolio with the SoFi automated investing feature. Even better, SoFi Members have access to complimentary advice from professionals.
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