5 Facts to Know About Your 401(k)
Savers should know some basics about these vital retirement plans.
The way most Americans will fund their retirement is through an employer-sponsored 401(k) plan, now that few private-sector employers offer pensions.
"About 25 to 30 percent of people's (retirement) income is coming from a 401(k) source. It's a pretty important thing to have in place," says John Falk, division consulting manager with U.S. Bancorp Investments in Milwaukee.
Plan offerings differ from employer to employer, but the basic way the plans operate are similar. Given how vital these plans are for retirement, participants should know a few facts about them.
Enrollment might be automatic. Hattie Greenan, research director of the Chicago-based Plan Sponsor Council of America, says 52.4 percent of 401(k) plans offer automatic enrollment. Without the automatic enrollment, the Department of Labor says approximately 30 percent of eligible workers don't participate in their employer's 401(k)-type plan.
Justin Goldstein, director of wealth management at Bronfman E.L. Rothschild in Madison, Wisconsin, says automatic enrollment has helped to cut some of the barriers people have enrolling in these plans.
"The automatic feature turns inertia or procrastination into an ally in saving for retirement," he says.
Employees can opt-out of the auto-enrolled 401(k) plan, but that quit rate is 5.5 percent, Greenan says.
Generally, auto-enrollment plans will put in between 3 and 6 percent of an employee's salary, although the type of allocations will vary. Steve McCaffrey, board chairman at Plan Sponsor Council of America and senior counsel at New York-based National Grid, says their automatic enrollment puts employees in a target-date fund as a default.
Target-date funds have a mix of bonds and stocks. The asset allocation between the stocks and bonds are determined by the employee's age. The closer the person is to 65, the more bonds are in the mix to make the portfolio less prone to market swings.
"Target-date funds are a good investment for people who don't know what to do, or don't want to (set the allocation)," McCaffrey says.
Go beyond the employer match. Many employees will only put in enough money to get any company match, such as when a company matches 100 percent of an employee's first 6 percent of contributions. Goldstein says some people mistakenly believe that's all they need to save for a prosperous retirement.
"There are plenty of statistics out there that show you'll need to save 10 to 15 percent of your own dollars to support the lifestyle you've grown accustomed to when you remove that work income," he says.
Dean Hedeker, principal of Hedeker Wealth in Lincolnshire, Illinois, says because 401(k)s are pre-tax savings vehicles, the person's overall tax burden reduced, and it has an impact in savings.
"Depending on your tax bracket, say you're in the 30 percent bracket, for every $1,000 you put in, it only costs $700," he says.
Fill out the beneficiary form and keep it updated. People enrolled in a 401(k) plan need to name a beneficiary in case of their death, McCaffrey says. If there is no beneficiary named, the assets will default to the person's estate.
Hedeker says people should also periodically review who is listed as beneficiaries in case life circumstances have changed. "If you get a divorce and the ex-spouse is listed at the beneficiary and you die, who gets the money? Your ex- does," he says.
Also, if people remarry, under federal law their spouse is the automatic beneficiary, unless they name someone else. "If you have kids from a previous marriage, have a 401(k) and you die without a beneficiary, the spouse gets the money and the kids are cut out," he says.
Be careful when taking out a loan. Loans from 401(k)s are allowed and can be a short-term option for some people, but they can be problematic, says Marc V. McDowell, director of retirement plan services at Bronfman E.L. Rothschild in Madison, Wisconsin.
"The rates can be appealing and you do pay interest back to yourself. But that's where the benefits end. Now that money is out of the market; it's not growing or compounding," he says.
McCaffrey also says if the loan isn't put back in the 401(k), the person needs to pay taxes on it and perhaps a penalty for early withdrawal. Loans can be paid back via payroll deductions.
Working longer has its advantages. While some workers dream of an early retirement, others will work past the traditional retirement age of 65. And, they will be allowed to continue to contribute to their 401(k).
Additionally, if they are working past age 70.5, they won't be forced to take required minimum distributions from the 401(k), which they must do with
Falk says he's seeing more people thinking about working later in life, so this benefit can be worked into their retirement income and may reduce their tax burden.
"The low interest rate environment is not kicking out the interest income, so many will need to do some work in retirement to not take a step back in their lifestyle," he says. "You would only be required to take distributions once you physically retire from that plan."
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