401(k) Plan Management
401(k) plan management is the ongoing process of monitoring your 401(k) balance and making changes when necessary.
There are many aspects of effective 401(k) plan management, and knowing the ins and outs of these plans can help you to get the most for your money from them over time.
Participating in your employer’s 401(k) plan may seem like a rather cut-and-dried affair, at least at first glance.
You fill out the enrollment paperwork, choose a selection of investments and then put it on automatic pilot.
But keeping your 401(k) plan healthy and growing is an ongoing process that will require your continued attention.
How to Manage a 401(k)
For example, if the markets are in a definite uptrend, then your stock funds or shares of stock should probably be going up too.
If they aren’t, that could signal a possible problem that needs to be addressed.
It helps if you have a basic knowledge of investments and the different asset classes, because then you can see more clearly whether your plan is growing the way it should relative to the markets at large.
Another key factor that many employees overlook is contributing enough to take advantage of all of the employer’s matching contributions.
While some plans will match the first few percent of employee contributions, other plans offer a partial match on every dollar that is contributed into the plan.
So if your employer offers a 50% match on every dollar that you contribute to the plan, then you will have to make the maximum allowable contribution each year in order to get all of your matching contributions.
Annual 401(k) Fees
Other things to consider when you make your investment allocations are the annual fees that your investments are charging you.
Mutual funds have 12b-1 fees to cover the costs of managing the fund, unless it’s an index fund that simply holds all of the stocks in an index such as the S&P 500 Index.
401(k) Risk Management
Target date funds may seem like a tempting alternative, but these funds follow their own glide-path from aggressive to conservative asset allocations and this may not match your own risk tolerance or time horizon.
Furthermore, you will not only pay the fees charged by each fund within the fund, but you may be charged an additional fee on top of those by the target date fund itself.
Annuities are often a popular investment in 401(k) plans because of the insurance protection, and this can be invaluable during corrections and bear markets.
But most variable annuities charge at least 2-3 percent per year in annual fees, so make sure that you’re getting your money’s worth from this type of investment if this is what you choose.
If you take out a loan from your 401(k), be sure to get it paid off in full before you leave your current employer.
Any unpaid loan balance will be coded as a normal distribution if you fail to repay the outstanding balance within 90 days of your termination date.
If you have bought shares of your employer’s stock in your 401(k) plan, then when you retire, you can spin those shares off and sell them separately in a special single transaction under the Net Unrealized Appreciation Rule (NUA).
This will allow your sale to receive capital gains treatment instead of being taxed as ordinary income.
When the time comes to leave your employer, you have several options to choose from regarding your plan balance.
You can leave it with your former employer and let it grow, or you can roll it into an IRA.
If your new employer also offers a 401(k) plan, then you may also be able to roll your old plan into the new one.
Just make sure that your new employer’s plan offers a decent selection of investment options and doesn’t charge excessively high fees.
If this is the case, then rolling your plan into a self-directed IRA is probably the best option.
There are very few restrictions on how you can invest your money, and you can keep this type of account with the same custodian for the rest of your life if you want.
401(k) Plan Management FAQs
What is a 401(k) Plan?
The 401(k) retirement savings account got its name from the Revenue Act of 1978, where an addition to the Internal Revenue Services (IRS) code was added in section 401(k).
Consequently, 401(k) does not stand for anything except for the section of IRS tax code it was created in.
Traditional 401(k) vs Roth 401(k)
The traditional 401(k), named after the relevant section of the IRS code, has been around since 1978.
With this plan, any contributions you make to the 401(k) account will reduce your income taxes for that year and will be taxed when they are withdrawn.
Roth 401(k)s, named after former senator William Roth of Delaware, were introduced in 2006.
Unlike a traditional 401(k), all contributions are made with after-tax dollars and the funds in the Roth 401(k) account accrue tax free.
Typically, employees can take advantage of both plans at the same time, which is recommended among financial advisors to maximize retirement savings.
Because of the way the contribution limits work, it is possible to invest different amounts into each account, even year-to-year, so long as the total contribution does not exceed the set limit.
Contributing to Your 401(k) Retirement Plan
Contributing to a 401(k) plan is traditionally done through one’s employer.
Typically, the employer will automatically enroll you in a 401(k) that you may contribute to at your discretion.
If you are self-employed, you may enroll in a 401(k) plan through an online broker, such as TD Ameritrade.
If your employer offers both types of 401(k) accounts, then you will most likely be able to contribute to either or both at your discretion.
To reiterate, with a traditional 401(k), making a contribution reduces your income taxes for that year, saving you money in the short term, but the funds will be taxed when they are withdrawn.
With a Roth 401(k), your contributions can be made only after taxation, which costs more in the short term, but the funds will be tax free when you withdraw them.
Because of this, deciding which plan will benefit you more involves figuring out in what tax bracket you will be when you retire.
If you expect to be in a lower tax bracket upon retirement, then a traditional 401(k) may help you more in the long term.
You will be able to take advantage of the immediate tax break while your taxes are higher, while minimizing the portion taken out of your withdrawal once you move to a lower tax bracket.
On the other hand, a Roth 401(k) may be more advantageous if you expect the opposite to be true.
In that case, you can opt to bite the bullet on heavy taxation today, but avoid a higher tax burden if your tax bracket moves up.
Check out this article from Forbes to see the IRS tax rate tables for 2020, but remember that they are subject to change.
A smart move may be to hedge your bets and divide your contributions between the two types of IRAs.
If your employer allows you to add funds to both a traditional and Roth 401(k), then doing so reduces the potential risks of each.
In this case, you will also have the ability to decide what proportion of your income goes into each account, meaning that as you near retirement and have a clearer idea of what position you will be in, you can put more into one or the other.
When you do decide which avenue to take, make sure to thoroughly evaluate your decision.
Moving funds from one account to another, such as from a traditional to a Roth 401(k), is time consuming and expensive, if even possible.
Likewise, transferring a 401(k) from one employer to another in the event of a job change is also tricky.
You want to make sure that when you put money into your plan, it will be able to sit undisturbed for a very long time.
Pension vs 401(k)
Pensions are similar to a 401(k), but are a liability to a company.
If an employer offers an employee a pension, it means that they are promising to pay out a set amount of money to the employee at the time of their retirement.
There is typically no option to grow this amount, but it also does not require any financial investment from the employee.
Pensions, also referred to as defined-benefit plans, are becoming increasingly rare because it puts the financial burden of offering a retirement fund for employees entirely on the employer.
401(k)s, which are also called defined-contribution plans, take some of the financial pressure off of an employer, while also allowing employees to potentially earn a larger retirement package than they would have with a pension.
How Much Should I Contribute To My 401(k)?
Most financial experts say you should contribute around 10%-15% of your monthly gross income to a retirement savings account, including but not limited to a 401(k).
There are limits on how much you can contribute to it that are outlined in detail below.
There are two methods of contributing funds to your 401(k).
The main way of adding new funds to your account is to contribute a portion of your own income directly.
This is usually done through automatic payroll withholding (i.e. the amount that you wish to contribute, counting all adjustments for taxation, is simply withheld when receiving payment and automatically put into a 401(k)).
The system mandates that the majority of direct financial contributions will come from your own pocket.
It is essential that, when making contributions, you consider the trajectory of the specific investments you are making to increase the likelihood of a positive return.
The second method comes from deposits that an employer matches.
Usually employers will match a deposit based on a set formula, such as 50 cents per dollar contributed by the employee.
However, employers are only able to contribute to a traditional 401(k), not a Roth 401(k) plan.
This is especially important to keep in mind if you want to utilize both types of plans.
A key variable to keep in mind is that there are set limits for how much you can add to a 401(k) in a single year.
For employees under 50 years of age, this amount is $19,500, as of 2020. For employees over 50 years of age, the amount is $25,000.
If you have a traditional 401(k), you can also elect to make non-deductible after-tax contributions.
The absolute limit, counting this choice and all employer contributions, is $57,000 for employees under 50, and $63,000 for those over 50 as of 2019.