But it may help to think of it in these terms: By setting aside money in your 401(k), you'll get the money back years from now, when you may no longer have the ability to work. And even if you only have mediocre investments to choose from, tax-deferred compounding means you'll be able to take out far more than you put in.
The Department of Labor estimates that approximately 30% of eligible workers do not participate in their employers' 401(k)-type plans at all. It's hard to overstate the risk of not saving enough: The fact is, you can't take out a loan for retirement. And those who just assume they'll work well into their retirement years should know that's not always an option
. In such cases, the only option may be a painful lifestyle downgrade.
The maximum amount in pretax dollars that you can contribute to your 401(k) is $18,000 for 2017. (If you're over 50, you can contribute an additional $6,000 in so-called "catch-up" contributions, so $24,000 total.) Even if you can't afford to save the maximum, make sure you are contributing as much as you can afford to. And periodically revisit both your contribution rate and your portfolio's allocations to make sure your retirement plan is on track. Your (financially secure) future self will thank your younger self for sacrificing a small part of your paycheck.
Here's a checklist you can use to ensure you're getting the most out of your company retirement plan.
1. Does your employer's plan have autoenrollment, and if so, is the contribution rate high enough?
"Autoenrollment" means the company is withholding some of your pretax salary and investing it in a 401(k) plan for you. Often the assets are invested in a target-date fund, which is a mutual fund or collective investment trust made up of stocks, bonds, and cash equivalents whose asset mix gets more conservative as the target date approaches. (For instance, a target-date fund for an investor retiring in or around 2050 will be more equity-heavy than one retiring nearer to 2020.)
Not surprisingly, auto-enrollment helps increase employee participation in 401(k) plans: According to the Department of Labor, studies suggest that automatic enrollment plans could cut the rate of non-401(k)-contribution in half--from 30% to 15%.
A recent Vanguard report
agreed that autoenrollment did effectively increase participation rates, but it also found the deferral (or contribution) rate tends to be lower among employees who are autoenrolled. The takeaway: Make sure you're contributing as much as you can afford. If your company has autoenrollment, don't just assume you're saving enough for retirement and call it a day. Check the salary-deferral percentage. Understand that a low contribution rate--3% is common--won't cut it for most people. In fact, though 10% was an oft-cited contribution goal in the past, many financial planners now say 15% is a better target.
2. Can you "autoescalate" your contributions?
Along with autoenrollment, some plans offer "autoescalation," which is an automatic increase in the deferral rate--say, 1 percentage point per year. Check your plan--autoescalation is not a feature offered with all plans. In either case, it makes sense to revisit your contribution rate annually to make sure it still makes sense given your current circumstances. If you change jobs and your salary increases by 10%, for instance, you might be able to save a bigger percentage of your salary than in years past. And if you're eligible for catchup contributions, know that you can begin making those extra contributions on Jan. 1 of the year in which you turn 50; you don't need to wait until your birthday.
3. Does your company offer a match?
When deciding how much to contribute to a plan, determine whether your company provides a 401(k) match, and aim to contribute at least that much. For example, say your company will match up to 5% of your contribution at a rate of $0.50 for every dollar you contributed. Contributing less than 5% means you're effectively turning down some money that your employer is offering you.
4. Do you know what your funds cost?
401(k) plans can be attractive savings vehicles because they allow your pretax contributions to compound tax-free. But weak fund choices and high fees can make plans less attractive. Pay attention to how much the funds in the plan cost. Fund costs come right off the top of investment returns, so it makes sense to seek out reasonably priced options. (An increasing share of 401(k) plans are offering index mutual funds, which typically feature low costs relative to actively managed funds.)
You can research mutual fund fees on Morningstar.com. Simply type the ticker or name of a fund into the Quote search box at the top of the page, and then click the "Expense" tab on that fund's data report page to see our assessment of the fund's fee level.
If your plan features nothing but high-cost options, contribute enough to earn any employer matching contributions, then invest additional assets in an IRA, where you're free to select low-cost funds. If you've contributed enough to the 401(k) to earn matching contributions and contributed the max to an IRA, you can invest additional assets in the least-bad options inside your 401(k). And be sure to bring the high costs to the attention of your 401(k) administrator!
5. Are you saddled with high administrative costs?
In addition to fund expense ratios, company retirement plans may also charge administrative fees to plan participants. Plans can charge these fees in a number of ways; the employer can pay administrative costs itself, or it can pass them on to plan participants. In the latter case, the administrative costs may be deducted directly from plan assets, or they might be embedded in the underlying fund fees.
Because there are so many ways fees can be charged, there's no single location you can go to track down this information. In your plan's annual report (Form 5500) you may see administrative expenses expressed as a dollar amount; you can then divide that dollar amount by the total assets in the plan to arrive at a percentage. BrightScope.com
also provides some comparative information on 401(k) plan expenses.
Administrative-expense percentages will tend to vary based on employer size; therefore, it can be difficult to determine what a "high-cost" plan is. In general, though, if your plan's administrative costs edge above 0.5%--and certainly if they're more than 1%--that may be a red flag that you have a high-cost plan.
6. Has anything changed in your plan lately?
Every so often, retirement plans will get new options added to the fund lineup, or they might remove funds. It's worthwhile to see if anything has been recently added that might be a better fit for your portfolio. If a fund you own is swapped out with a new one, you should be informed of the change by your plan provider. Make sure you're comfortable with the new fund's costs and investment objective. If you're using Morningstar.com's Portfolio Manager
, remember to update your portfolio with the new fund and run it through the Portfolio X-Ray
tool to make sure you're still comfortable with your portfolio's allocations and exposures.
7. Have your allocations gotten out of whack?
The good thing about a diversified portfolio is that the asset classes don't always move in tandem; if one thing is in the dumps, maybe another is doing well. By using Morningstar's Portfolio X-Ray
tool, you can easily see if your allocations are still on track with your targets. (No targets? No problem--read this this article
While tinkering too much will probably lead to unnecessary trading, it might make sense to check your allocations once or twice a year. It could be just as simple as trimming a bit from the winners column and investing those assets in an underperforming asset class. The good thing about rebalancing within a 401(k) is that you don't have to pay any taxes to rebalance. (And investors who invest in a target-date fund exclusively will not need to rebalance at all.)
8. Are you making the right contribution type?
Some 401(k) plans offer only traditional contributions--that is, you put in pretax dollars and enjoy tax-deferred compounding, then pay ordinary income tax when you pull the money out in retirement. Increasingly, however, plans are offering participants the chance to make Roth 401(k) contributions: Aftertax dollars go in, but the money grows tax-free, and qualified withdrawals in retirement are also tax-free. This article discusses some of the factors to consider when deciding between traditional and Roth contributions.
In addition to the baseline contribution limits that apply to either Roth or traditional 401(k) contributions--$18,000 for investors under age 50 and $24,000 for those 50-plus--your plan may also offer what are called aftertax 401(k) contributions. Aftertax contributions can get you to a maximum of $54,000 for all 401(k) contributions in 2017.
The key virtue of making this type of contribution is that heavy savers will be able to roll over that money to a Roth IRA when they leave their employers. For more on this, see Christine Benz's article "Aftertax 401(k) vs. Taxable Account? Evaluating Options for High-Income Savers."
9. Are your beneficiary designations up to date?
Finally, review your beneficiary designations. Ideally you would want to do this on a regular schedule, maybe annually. At the very least, make sure you revisit your named beneficiaries after major life events, such as marriage, divorce, birth of a child, or death of a loved one. (Also make sure your beneficiary information carries over if your employer changes plan administrators.)
For more on beneficiary designations, see this article