New rules for making your 401(k) easier to understand—and steps for maximizing your return
If you’re one of the 70 percent of workers in the United States who rely on defined-contribution plans like 401(k)s as your main retirement savings vehicle, there’s good news: You’ll now have a little more clarity and confidence when making investment decisions, thanks to some recent federal regulations.
To start, the IRS has upped the annual amount you can stash before taxes, from $16,500 to $17,000. (The catch-up contribution limit for people 50 and older stays at $5,500.) The new limit applies to all 401(k) type plans, including 403(b) plans and 457 plans.
Also in place is a rule that makes it easier for 401(k) plan providers to offer their own investment advice to you. Beforehand, an employer offering a 401(k) plan through, say, Charles Schwab or Fidelity, had to contract with a separate adviser to comply with regulations against conflict of interest. Now, your provider can offer advice, as long as that advice is based on an unbiased computer model and doesn’t affect the adviser’s compensation.
“That means employers who were reluctant to offer advice to workers because of regulations will find it easier to include advice as part of the 401(k) package,” says David Wray, president of the Plan Sponsor Council of America, a nonprofit advising employers on managing retirement plans. At most smaller companies (fewer than 100 employees), that advice will take the form of one-on-one counseling, while larger companies will tend to rely on Internet tools or hotlines.
Fees will also become less of a mystery. Starting July 1, mutual fund firms and other 401(k) administrators must disclose all of their fees in writing. Typically buried in the fine print and passed on indirectly to you, fees charged for recordkeeping, compliance, and advice will now be more visible in the fund paperwork. That’s important because, over time, a few points here and there really impact your savings. Your employer will be required to give you a new quarterly document disclosing the fees it’s paying out of your account.
“This rule now lets you compare fund options more easily,” says Roger Wohlner, a financial planner with Asset Strategy Consultants in Arlington Heights, Illinois, who advises on 401(k) investing. “It could be eye-opening to look at some fund choices and see how high their costs are.”
At the same time, companies are adding more plan features, like Roth 401(k) options and automatic contribution payments, to get employees excited about investing—and there’s definitely a need. According to a survey of 430 companies by Deloitte, 84 percent of them said only some or very few employees were financially prepared for retirement.
While you may dread reading plan paperwork and analyzing funds, remember this: Your 401(k) is a key component in your retirement strategy.
Use the following plan tips and tweaks to maximize your account, minimize financial risk, and build a big enough nest egg during your working years.
Aim for the full match
According to Jack VanDerhei, research director of the Employee Benefits Research Institute, the typical company match is half of an employee’s contribution, and up to 6 percent of pay. That 3 percent match is free money that equals a 50 percent return on your investment and compounds during your career. “Those in mid-career should try to max out contributions, especially if your compensation is rising,” says Wohlner. “Same with those nearing retirement, even if it’s during your kids’ college years. The best gift to give them is not to be a burden financially in your old age.”
Many companies offer automatic enrollment, and also increase your contribution level every year, making it easy for you to “set and forget.” Still, check that contribution rate annually to see if it could be increased, says Wohlner. “Sometimes it’s at a too-low rate, like 1 to 3 percent, when you could be saving double that.” If you’re a high-income earner, make sure you’re not reaching your limit too early. Say you make $200,000 and automatically put in 10 percent of every biweekly paycheck. You’ll reach the $17,000 limit by your 23rd pay period, and miss up to $700 of your employer’s match for the last three. Reduce your contributions to 8.75% per paycheck, and you’ll maximize the match year-round.
Get free advice
Employees who take advantage of their companies’ online or in-person 401(k) advice have returns 2 to 3 percentage points higher than those who don’t. “If your plan provider offers it for free, definitely take advantage, especially if you’re not comfortable investing on your own,” says VanDerhei. But first get advice about your overall retirement strategy before figuring out whether to invest in stocks or bonds. “It’s difficult to discuss asset allocation if you don’t know how much risk you’re comfortable with.”
Check those fees
You will probably receive your first fee-disclosure statement this fall. Read it to see how you can minimize costs with different fund choices. According to the Vanguard Group, a worker who saved $10,000 a year in a fund with a 1 percent fee would have $829,000, while one who paid only 0.5 percent would have $91,000 more. But don’t make the mistake of focusing just on expenses, says VanDerhei.
“If one fund has a lower expense fee than a similar one, that’s a good criterion, but it really should be about constructing the right portfolio mix.”
Allocate your assets in accordance with your retirement goals and risk tolerance. If your fund choices are lousy, try to choose the best two and focus contributions there. If you’re worried about government debt and global economic uncertainty, VanDerhei suggests checking out inflation-protected, or Treasury-Inflation Protected Securities (TIPS) mutual funds, which invest in bonds that are backed by the federal government. “Unlike pension plans that are adjusted for cost-of-living increases, 401(k) plan holders have to consider inflation rates along with the investment rate of their retirement funds, so consider looking for funds offering adequate protection against future inflation.”
Reduce your company stock
Many large companies offer stock as their 401(k) matches. That’s great if the stock is hitting market highs, but not so great if it’s on its way to becoming the next Enron. Another problem is there may be restrictions on your ability to sell or transfer it out of your 401(k). Wohler says that if company stock is more than 10 percent of your overall investment portfolio, it’s time to lower that number and diversify out of it.
Review a Roth 401(k)
This plan, now offered by more companies, has the same annual contribution limit as a regular 401(k). The difference is that contributions are made after taxes, and your returns, including investment gains, are tax-free at retirement. Wray says a Roth 401(k) is worth considering if you think you’ll be in a higher tax bracket during retirement, or you are young and have many years to invest. “But you should look at the value of a tax deferral now versus some unknown tax savings later,” he says. “You basically have to bet on whether tax rates will go up or not in the future.”
Evaluate that target-date fund
This fund type, which adjusts the level of your stock holdings as you get closer to your projected retirement date, is a popular choice in 401(k) plans. But don’t just default to the one with an ideal date.
“Different target-date funds can often have widely different allocations, fund qualities, and risk levels,” says Wohlner. Look under the hood to see how the funds invest and what they invest in. “It’s okay to use a fund with a closer date or one further into the future if that fund is more appropriate for your risk tolerance.”
Take advantage of these new 401(k) changes and, with just a bit of thought, you can boost your retirement savings. DW
Vanessa Richardson covers personal finance and small business for Bankrate, Entrepreneur, MSNBC.com, and Money.
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