Maximizing Your 401k

Retirement might seem like a long way off, especially if you are younger or early in your career. However, it's crucial to understand that the sooner you begin putting money away, the more financially secure and comfortable you will potentially be.

A 401(k) plan is one of the most effective tools available for retirement planning, offering significant advantages that can grow your savings over time.

The Importance of a 401(k)

As you likely know, 401(k) (or 457 or 403-b) plans are tax-advantaged retirement savings plans offered through your employer. These plans allow employees to contribute a portion of their salary into individual accounts, which are then invested and allowed to grow tax-deferred until retirement. Many employers offer matching contributions to 401(k) plans, which can help boost your retirement savings. Failing to take full advantage of an employer match is essentially leaving money on the table.

Maximizing the Benefit of Your 401(k)

When it comes to maximizing the value of your 401(k), consider investing for growth if your risk tolerance allows for it. Until you get closer to retirement, you should consider taking on more investment risk with the potential for higher returns. Here are some specific tips for you to get the most benefit from your plan:

1. Start Now: The earlier you begin contributing to your 401(k), the more time your investments have to grow. Starting early takes full advantage of compound interest, significantly boosting your retirement savings over the decades. Aim to contribute as much as possible to your 401(k), ideally up to the annual limit set by the IRS. If you are not currently at the maximum, gradually increase your contributions annually or whenever you receive a raise or bonus.
2. Investment Selection: Until you are closer to retirement, consider directing a larger portion or your contributions to growth-oriented investments. That means using the stock funds available in the plan, stock funds have historically offered higher returns over the long term despite being riskier investments. Another choice would be a target-date fund that matches your expected retirement time frame.
3. To Roth or Not to Roth: Your Employer’s plan may allow you to make your contributions using a Roth 401(k). With a Roth, contributions are made in after-tax dollars, meaning you will be paying taxes on the amount you are contributing prior to the deposit into your account. On the other hand, if you choose a traditional 401(k), the contributions you make are free of income tax. For example, if you are in a 25% tax bracket and contribute $1,000, you will save $250 in taxes this year! There is a big difference between the two at the end though: Withdraws made at retirement from a Roth are fully tax free, while withdraws from the traditional are fully taxed as they are taken out.* A financial advisor can help you select the best plan for your situation, but if you are in a low tax bracket now and expect to be in a higher one later, a Roth may be a good choice. If you have the opposite, sticking with the traditional is likely best.
4. Seek Guidance: A financial advisor can make a huge difference in your life by helping you find ways to put the most possible into your plan and guiding you into the investment choices available that best fit your needs. Not sure where to start? Read our blog How to Choose a Financial Advisor to get a better idea of how you can find the right fit for you.

Pitfalls to Avoid

While investing for growth and maximizing your contributions are essential, it's equally important to avoid common mistakes. For instance, cashing out your 401(k) savings prematurely can result in significant penalties and taxes, severely depleting your retirement funds. Loans against your 401(k) may cause you to lose as well. Some plans allow employees to take loans from their accounts under certain circumstances. Although that may seem like a good way to access cash, it means that the money that has been removed  may no longer provide the growth needed to hit your retirement goals. Another common mistake is being overly conservative or cautious with your investments as this can limit the ultimate value of your 401(k). This is likely to become one of your biggest investments so selecting the right investment allocation can make a big difference towards your retirement security.

Conclusion

In conclusion, a 401(k) is a powerful tool that plays a critical role in retirement planning. By starting early, selecting an investment allocation aligned to your retirement goals and risk tolerance, and maximizing contributions, you can build a substantial retirement nest egg over the years. Remember, the key to a comfortable retirement is proactive and strategic planning. Take charge of your 401(k) today, and your future self will thank you.

*You must reach the retirement age of 59 ½ and have had the Roth account for a minimum of 5 years in order to qualify for the tax-free withdrawals on earnings in a Roth account.

Note: Contribution limits are subject to change based on IRS regulations. This material is for informational purposes only and does not constitute tax advice. Investment advice is offered through OneDigital Investment Advisors LLC.

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