If your employer offers a 401(k) or similar plan, you’ve got a powerful retirement-savings tool at your disposal. And yet, how well you do with your 401(k) depends greatly on your choices and actions. What steps can you take to maximize the benefits of your plan?
For starters, be aware that your 401(k) may come with what might be called “standard” features, which you should review to determine their applicability to your situation. These features include the following:
Default deferral rate
When you take a job, your employer may automatically enroll you in the company’s 401(k) plan and assign a “default” contribution rate – the percentage of your salary you will put in to your 401(k). Many companies choose a default rate of 3%, although, in recent years, there has been a move toward higher rates, even up to 6%. Unfortunately, too many people don’t question their default rate, which could be a problem, especially if it’s at the lower end. If you want your 401(k) to ultimately provide you with as many financial resources as possible, you will likely need to contribute as much as you can afford. So, be aware of your default rate, and, if you can possibly afford it, increase that level. And every time your salary goes up, consider boosting your contributions.
Investment mix
When you’re automatically enrolled in your 401(k), the amount you might initially contribute isn’t the only “off the shelf” feature – you also might be assigned a default investment option. One common default investment is known as a target-date fund, which generally includes a mix of stocks, bonds and cash instruments. Your 401(k) plan provider, or your human resources area, will typically base this mix on your age and projected retirement date. Usually, this fund will grow more conservative over time, reflecting the need to reduce the portfolio’s risk as you get nearer to retirement. However, you may not be obligated to stick with the default option. Most 401(k) plans usually offer several options from which to choose. Ideally, you’d want to spread your investment dollars among a mix of these investments to give yourself the greatest growth potential, given your risk tolerance and time horizon. And always keep in mind that your 401(k) is a long-term vehicle, designed to help you prepare for a retirement that may be decades away. Consequently, try to discipline yourself to look past the inevitable short-term drops in your portfolio.
Matching contributions
If your employer offers a 401(k) matching contribution, you should certainly take advantage of it. Consider this: If you employer matches 50 cents for every dollar you contribute, up to 6 percent of your pay, and you contribute the full 6 percent, you would, in effect, be receiving a 3 percent pay raise (50 percent of 6 percent). That’s like a 50 percent rate of return even before you invest this added money.
Taking control of your 401(k) in the ways described above can help go a long way toward getting the most from your plan – and, as a result, may help get you closer to supporting the retirement lifestyle you’ve envisioned.