Retirement is something most people dream of, but surprisingly few people take steps to reach. U.S. Census bureau researchers estimate that about 79 percent of Americans have access to a workplace 401(k) or equivalent plan, but only 32 percent of employed Americans are investing in them.[1] This is troubling at a time when individuals are increasingly responsible for funding their own retirement.
Whether you’re new to the workforce or have not yet contributed to a 401(k), Celandra Deane-Bess, senior vice president and market wealth director with PNC Wealth Management®, shares the basics you need to know about using a 401(k) to save for your retirement.
Q: What is a 401(k) plan?
Deane-Bess: A 401(k) plan is employer-sponsored retirement plan thatallows you to invest part of your paycheck before taxes. It’s an easy way to help you consistently set aside money for retirement. Your contributions typically go straight from your paycheck into your 401(k) account, so you won’t be tempted to spend the money. You don’t pay taxes (for now) on the money you put into your 401(k) account or the investment earnings on your contributions until you take it out, and because of that, you can only contribute a certain amount each year. For 2018, if you’re under age 50, you can contribute up to $18,500.
Some 401(k) plans also allow you to make Roth 401(k) contributions. Roth 401(k) contributions are subject to tax when you make them, but investment earnings accumulate tax-free and qualified distributions are not taxed.
A 401(k) plan is meant to be part of a long-term strategy to help you set aside money for your future self, so the best thing you can do today is start contributing as soon as possible. This helps you maximize compound interest, where the money you make on your investments is reinvested and can continue to grow.
Q: What is a 401(k) match?
Deane-Bess: Many employers will help you build your nest egg by matching a portion of your contributions to your 401(k) plan, usually up to a certain percentage. For example, if you invest 4 percent of your pay in your employer’s plan, they may contribute an additional 4 percent to your account under the plan.
One of the biggest mistakes young employees make is they don’t pay enough attention to 401(k) benefits available to them from their employer and end up leaving money on the table. The match is essentially free money, so find out about your employer’s match policy and take advantage of it if available.
Q: What is an asset allocation and how do I choose one?
Deane-Bess: When you set up your account, you’ll likely need to choose how you want your money invested – that’s your asset allocation. Do you prefer low risk and low reward investments? Or are you comfortable investments that carry higher risk and potentially higher returns?
One easy, low maintenance option is a target date fund. You select the fund with a target date closest to your desired retirement date, and the fund will adjust how your money is invested to become more conservative as you get closer to retirement age.
You also can work with a financial advisor to tailor your asset allocation specifically to your financial situation and future goals.
Q: What does it mean to be vested?
Deane-Bess: If you’re fully vested in your 401(k) plan, it means that employer contributions made to the plan on your behalf are yours to keep. Most plans vest after 3-5 years. If you leave your employer before you’re fully vested, you can only take your own 401(k) contributions andthe vested percentage of your employer contributions . If you leave after you’re vested, you are entitled to keep all the money in the account.
Q: When can I access the money?
Deane-Bess: In most cases, when you’re 59 ½ years old. You may be able to withdraw the funds sooner under certain circumstances, but you likely will owe a 10-percent penalty plus regular income tax. In short: leave your money invested until you’re ready to retire to get the most out of your 401(k) plan.
Q: How often do I need to check on my 401(k)?
Deane-Bess: A good rule of thumb is to check your 401(k) performance and asset allocation on a yearly basis.
People make mistakes by changing their fund allocations too often. Keep your eyes on the long-term and don’t panic over market fluctuations.
Increasing your contributions by a small percentage once or twice a year is a great way to boost your investments. Some plans even allow you to automate this increase each year, which can help you gradually adjust to contributing more of your salary to your retirement.
Q: What should I do if I get a new job?
Deane-Bess: Most people will work for multiple companies before retirement. A new job often means a decision about your 401(k). By law, you have at least 30 days to decide what to do with your 401(k) when you change jobs.
You probably opened your account to help prepare for retirement, so keeping your money invested each time you change employers can help you reach that goal. Don’t be tempted to cash out an old plan before retirement simply because you now have access to it.
That being said, when you change jobs, you typically have four options for retirement accounts from previous employers:
- Leave the money in your former employer’s plan.
- Roll the money into your new employer’s plan.
- Roll the money into an individual retirement account (IRA).
- Take a lump-sum distribution.
If you have multiple 401(k) plans, it is generally better to consolidate them into one plan if you can achieve the same or better plan conditions.
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