Common 401(k) Plan Questions and Answers

Common 401(k) Plan Questions and Answers

Before we jump into common questions about your 401(k) plan, let’s get on the same page about what it is. A 401(k) plan is a defined-contribution retirement account, which allows you to save a portion of your pre-tax salary to the plan. Your contribution is automatically deducted from your paycheck prior to your paycheck being taxed.

There are several benefits to a 401(k) plan. One is that it makes it relatively easy for you to begin saving for retirement. However, we get several common questions regularly about 401(k) plans. Let’s discuss some questions you may have about your plan.

What should I do about my 401(k) plan if I change jobs?

You have a few options. 

  1. Keep the money where it is. 
  2. Roll it over into your new employer’s plan. 
  3. Roll it over to your own personal IRA.

There are benefits to each of these scenarios. If you’re not working with a financial advisor or if you’re not financially savvy yourself, you should consider leaving the money where it is or moving it to your new employer’s account. 

On the other hand, if you have an investment advisor or you are financially savvy yourself, it may bode well for you to move the money into your own personal IRA. Why? The investment options inside a 401(k) plan are usually limited in scope. So, if you move the money into your own personal IRA, you’ll have better diversification options. 

How much should I be putting into my 401(k) plan?

Most financial planners will tell you the ideal scenario is to max out your 401 (k) plan (especially if the employer matches it). There are exceptions, but for the most part that’s the advice. 

Getting as much money into your 401(k) plan is beneficial for the following reasons:

  1. It reduces your taxable income.
  2. It will grow tax-deferred until you take it out during your retirement years.

Employee 401(k) contributions for is $19,500. If you are older than 50, you are eligible for a catch-up contribution of an additional $6,500. This is considered a catch-up contribution. These numbers can change based on the economic environment. Check to make sure you know what the maximums are for you each tax year.

Should I be worried that someday my 401(k) plan may be taxed higher than it is right now?

No one can predict with certainty where tax rates will be in the future. All we can do is work with the theories that hold true now. And that is, during retirement, most people will likely be in a lower tax bracket than they are right now. The reason is because these individuals won’t be earning as much money. 

However, extremely wealthy people may fall under the highest marginal tax bracket (even during retirement) due to all of their assets. This scenario is one of the exceptions from the previous question. Because we know a higher tax situation is possible, financial advisors may advise wealthy individuals to put money into a Roth IRA inside of their 401(k) plan, when the opportunity arises. Why? Because Roth IRAs are funded with after-tax money.

In summary, unless you’re extremely wealthy, you most likely won’t have to worry about your tax rate being higher in the future. 

How often should you review your 401(k) plan and potentially rebalance the allocations?

The answer depends on your investment knowledge. If you have no investment knowledge, you should invest in the target date funds within your plan. These funds invest your money in a risk appropriate manner based on your target retirement date. In this scenario, you can potentially set it and forget it. You don’t need to rebalance because it’s inherent in the fund. You can just review occasionally to see how you’re doing. 

On the other hand if you’re knowledgeable about investments or you’re working with a financial advisor, you should be checking your account every three to six months. The last thing you want to do is look at it every day. That behavior can lead to anxiety and bad decision-making.

How do you best invest the money in your 401(k)?

As discussed in the previous answer, if you don’t know a lot about investing, you should put your money into the target date funds. However, as your money grows the best option would be to hire an advisor to help you. The target date funds are a one size fits all so as you gain more money, you’ll want specialization. The likely increased overall portfolio returns you’ll get from a professional’s knowledge is worth it. And there’s research to back this up. A recent study found a financial professional helps the average person increase returns by approximately three percent a year.

Should young adults put money into their 401(k) plan or should they wait until they’re making more money?

As we’ve already mentioned, in a perfect world the goal should be to max out the 401(k) contribution. So, the answer to this question is that yes they should put money into their 401(k) plan as young adults. And while it may not be realistic for them to max it out, they should put as much as they can into it. Why? Over time, the compounding effect of that money is significant. And this is especially true if there’s a company match. Because if there’s a match and you’re not taking advantage of it, it’s like throwing money out the window and no one wants to do that? Do the minimum to get at least up to the employer match.

401(k) plans are a valuable savings asset and you should take advantage of it whenever possible. To learn more, listen to our podcast for more details.

Common 401(k) Questions and Answers Part 1
Common 401(k) Questions and Answers Part 2