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Corporate pensions have been absent from the American workplace for decades. They have been largely replaced by 401(k) plans as the primary type of employer-sponsored retirement plan.
These accounts are an essential part of retirement planning for some 27 million American workers. So it's worth knowing a bit more about how they work and what you can do to maximize your returns.
What is a 401(k)?
Unlike a traditional defined benefit pension, a 401(k) is a defined contribution account.
Companies love these retirement plans because they cost less, but the defined contribution structure shifts most of the savings burden onto the employee, and financial planners worry Americans aren't saving enough
According to the Institute for Employee Benefits Research, the median 401(k) account balance was just $90,015 at the end of 2018.
According to experts, most Americans should save more than they actually earn. "One of the biggest mistakes a person can make with their 401(k) is simply not saving enough," says Robert Comfort, president of CUNA Brokerage Services Inc., a division of CUNA Mutual Group, based in Madison, Wisconsin. .
If you haven't already, take advantage of tax benefits and employer contributions to maximize your 401(k) annuity.
Advantages of a 401(k)
Applying for a 401(k) is easy. In fact, many companies are automatically enrolling new workers in their 401(k) plan, forcing those who don't want to participate to not actively participate.
A traditional 401(k) is a tax-deferred retirement plan . (The awkward name comes from the IRS law that defines it.) Pay pre-tax dollars out of your paycheck that you invest in mutual funds or, less commonly, in exchange-traded funds (ETFs) or individual stocks.
This money grows and is reinvested, tax-free. Your 401(k) money is not taxed until you withdraw at retirement. (A Roth 401(k) is the opposite: contribute money on an after-tax basis, then withdraw your funds tax-free at retirement.)
Young workers, in particular, should book where possible, says Kenny Polcari, managing partner of Boca Raton, Fla.-based Kace Capital Advisors.
"Start investing early to take advantage of compound interest," he says. "Hardening your decision to contribute to your employer's 401(k) plan can be costly over time."
Paying taxes on retirement withdrawals is better for most Americans because they will have less income, and therefore fall into a lower tax bracket, in retirement than during their careers.
Contributing pre-tax income also reduces your taxable income during your working years, which can reduce your overall tax burden.
One of the great benefits offered by many employers, especially the larger ones, is pre-tax consideration of up to a certain percentage of the employee's contributions.
According to Fidelity, this amount was 4.5% on average at the end of 2019. This means that your employer contributes an amount equal to 4.5% of your salary to your 401(k) if you contribute at least the same value. In these cases, 401(k)s act as contribution plans that receive funds from workers and employers.
Comfort recommends that you save 15% of your salary, but if this is too much, it is better to start below to receive company mail than to save nothing. "At the very least, start by putting yourself off long enough to get any corporate mail that may come up," he says.
Note: Before employer matching funds can be accessed, companies often require workers to be “invested”. In other words, you must stay with your current employer for a specified period of time before you have the matching funds in your 401(k).
How to Invest 401(k) Funds
The self-directed nature of 401(k) retirement plans means that although an employer or plan administrator may offer some advisory services to workers, choosing investments and determining asset allocations throughout your career is largely a DIY task.
Most 401(k) investment offerings are mutual funds, each made up of a basket of stocks or bonds.
Some 401(k) plans also offer workers the option to invest in ETFs. Although more liquid than mutual funds (because they trade throughout the day rather than just once at the end of the day), ETFs can also be more volatile.
Many 401(k) investment offerings are index funds, designed to track the performance of one of the major stock indices.
Experts say your asset allocation should include stocks and bonds. “In general, the younger you are, the more aggressive you can be about holding a larger percentage of your 401(k) balances in stocks,” says Comfort. Young adults can absorb more volatility than someone close to retirement, she says. "They have many years before retirement to weather the inevitable ups and downs of the market."
Financial experts will help you plan and manage your 401(k)
Online brokers like Betterment use asset allocation strategies to help keep you invested in your retirement goals.
Your asset allocation should become more conservative over time. “As you get closer to 60, you want to reallocate more money into bonds and big blue chip stocks, ETFs, or mutual funds that pay high dividends.
These types of stocks offer some growth, but also income through dividends," says Polcari. "As you get closer to retirement, you may not want to be as exposed to growth stocks, which can be more volatile, than dividend stocks, which are typically more stable."
If you don't want to handle these reallocations yourself, you can invest in maturity funds, which automatically adjust to be more conservative as you get closer to retirement.
The other important part of the equation is the amount of fees charged by a given fund. Competition among financial service providers has reduced mutual fund and ETF fees, but this does not mean fees have disappeared entirely.
“When it comes to investing in 401(k), consider the fees that each 401(k) fund has. Fees can erode investment returns over time,” says Polcari. plan, you can at least take into account the fees of each fund so that you can choose the cheapest options among them.
Contribution limits for a 401(k)
The maximum you can contribute to a 401(k) throughout the year is reviewed annually by the IRS. However, the contribution limit for 2021 is the same as this year: $19,500.
The IRS allows workers age 50 and older to contribute additional "catch-up" funds; for next year, this number also remains at the 2020 level of $6,500.
If you didn't contribute to your 401(k) as much as you should when you're younger, or if you realize you'll need more spending power in your later years, catch-up contributions can be a good way to plug this hole. .
How to withdraw money from a 401(k)
You can start taking penalty-free distributions from your 401(k) at age 59½. At age 72, you must withdraw required minimum distributions (RMDs) from your 401(k) account (although you may be exempt from withdrawing RMDs from your current 401(k) account if you are still working).
Your RMD value is calculated using the value of your account balance and actuarial estimates over your lifetime.
Outside of certain exemptions, if you withdraw money from your traditional 401(k) when you're under age 59.5, you'll trigger a 10% early withdrawal penalty and that money will be taxed as income.
Plus, you lose the ability to raise that money. For these reasons, financial advisors discourage people from withdrawing their 401(k) early.
How to pitch a 401(k)
If you change employers and your new employer has a 401(k) plan that you're eligible for, you can transfer your funds to the new plan.
It's best to do it as a direct funds transfer instead of ordering a check, because if you take more than 60 days to complete the transfer, the IRS will treat it as an early withdrawal subject to taxes and penalties.
When you retire, you'll need to decide whether you want to keep your money in your former employer's 401(k) or transfer it to an individual retirement account (IRA). "It's important to weigh this decision carefully, as each option can have pros and cons," says Comfort.
An IRA can offer more varied and flexible investment options, including access to alternative classes not typically well represented in 401(k) plans.
However, if you've worked for a large company, it may be worth sticking with a 401(k), where you'll likely have access to low-cost investment options.
If you've worked for multiple employers during your career and maintained each respective retirement account, consolidating them into a single IRA can solidify your financial planning and give you a better view of your financial health.
Make sure your 401(k) is where you want it to be
Get an online broker like Robinhood to streamline your fund selection and reach your retirement goals.
Can a 401(k) be started without an employer?
These are employer-sponsored accounts, so you can't open a 401(k) on your own. If you're in a job that doesn't offer a 401(k), open an IRA and contribute.
However, if you're self-employed, you may want to consider opening a one-party 401(k) plan, also known as a Solo 401(k).
About Roth 401(k)s
Roth 401(k)s are different from their conventional counterparts because they are funded with after-tax dollars rather than pre-tax dollars. So the money grows tax-free and you don't pay taxes on retirement withdrawals.
(However, the money your employer pays is taxable when they retire.) Experts say Roth 401(k)s may be a good solution for young workers, because young workers may not have reached their senior years. retirement be in a lower tax bracket than they will be later in life.
If you're considering refinancing your home loan, consider switching to a new mortgage lender.
"Lender loyalty can backfire if you don't do your research to see if there are better rates," says Heather McRae, loan officer at Chicago Financial Services. This is especially true in today's aftermarket, where lenders compete aggressively for customers.
According to a Black Knight report, creditor retention is at record lows. Mortgage servicers retained just 18% of the estimated 2.8 million homeowners who refinanced in the fourth quarter of 2020, the smallest share on record.
Take advantage of a competitive interest rate by refinancing your mortgage loan.
Advantage: You can get a better mortgage rate
Shopping never hurts, says David Mele, president of Homes.com. "Many borrowers stick with their lender when they refinance because they know them well, but you still want to compare quotes to make sure you're getting the best deal," says Mele:
"If your account is in good standing, you can get the lowest refinance rate with your current lender, but different lenders have different loan requirements."
However, it is not necessary to talk to every creditor in town. McRae suggests getting quotes from three lenders when he considers his options.
"I recently talked to [a refinancer] who talked to 11 different mortgage lenders and it's totally unnecessary," he says. "He won't get drastically different offers if he goes to a bunch of lenders."
If your current loan officer issues mortgage applications (some don't), McRae recommends getting an estimate, but be prepared to provide a ton of documents.
“Many people mistakenly believe that the application process is easier if they stay with their loan servicer, but in general, you will need to provide the same information and documents to your servicer that you would with a new lender,” he says. .
Disadvantage: You don't know how a new lender treats their customers
If you have developed a good relationship with your creditor, this is a big deal.
"Having someone you trust with your money is priceless, and your home is probably the biggest investment you have, so you want to make sure you trust the lender you're working with," says Todd Sheinin. , COO of Homespire Mortgage in Gaithersburg, Maryland.
Some lenders treat their customers better than others.
Think about your experience with your current lender. Sheinin recommends looking at questions like, "Have they told you everything that's going on with her mortgage?" Do you think you have the full attention of your loan officer? Do you have a good rate? Has your creditor kept in touch? »
Having a responsive lender is especially important when things go wrong, for example, if you need help applying for mortgage foreclosures (borrowers with government-supported FHA loans, VA loans, or USDA loans can sign up for forgiveness plans , which affect your mortgage payments) keep until June 30) or need a loan modification.
Advantage: You can get lower closing costs
Closing costs for refinancing are typically 2% to 5% of the value of your new loan, with a balance of $300,000, that's $6,000 to $15,000, as some lenders charge higher fees for home appraisals, title searches and other services.
Therefore, a different lender may offer lower closing costs than the original lender.
That said, some lenders "will be willing to offer a good current customer a discount on closing costs to keep them as a customer," says Sheinin. Depending on the lender, they may offer a reduction of several hundred dollars to about $1,000 in lower closing costs.
One caveat: "I always tell people to be careful when a lender offers 'credit' to cover some or all of your closing costs," McRae says. "It almost always means that a lower interest rate was available."
Do you want to reduce your mortgage payments? Refinancing can help you!
Take the first step toward refinancing your mortgage today by researching the invaluable information you'll need to navigate the process. For more information, click below.
Disadvantage: You can be hit with a prepayment penalty
Although prepayment penalties have become less common, some lenders still charge borrowers a fee for paying off their mortgage before the loan term expires.
Prepayment penalties can vary widely. Some lenders charge clients a percentage (typically 2% to 3%) of their outstanding principal, while others calculate prepayment charges based on the amount of interest the borrower would pay on the loan over a period of time. certain number of months (normally six months).
Look for the term "prepayment disclosure" in your mortgage contract to see if the lender charges a prepayment penalty and, if so, how much it costs.