Why You Need to Start Looking at Your 401K
The strategy of never looking at your account is now costing you big time
41% of people don’t set any money aside for their retirement, according to a report published by Best Money Moves.
Don’t worry; this is not another piece telling you to save more and spend less.
This article will make you familiar with what the 401K is, and some strategies financial advisors won’t tell you.
If you think you are too young to be thinking about retirement, here is a quote by Dave Ramsey that might get your attention.
“Saving only $100 per month from age 25 to age 65 at 12% growth = $1,176,000. Everyone should retire a millionaire!” Dave Ramsey
Why Saving for Retirement is a New Thing
The employee-sponsored 401K is arguably one of the greatest wealth-generating tools in our society, and most people have no idea what it is or how to use it.
Whenever I talk to most people, they usually say, “Yeah, I contribute to the company match.”
I think people know so little is that saving for retirement is a relatively new phenomenon. Depending on how old your parents are, they might not have even talked to you about retirement savings because they might have personally been relying on an employer-sponsored pension.
If you aren’t sure what a pension is, it is a retirement plan that employers offered their employees, which paid them a certain percentage of their final salary during retirement. The percentage increasing the longer you stayed with company.
That is why our parent’s generation was loyal to the first company that hired them. If they stayed their 30 years they could be making sometimes as much as 60% of their final salary without even working.
Most companies now do NOT offer pensions, so saving retirement falls on the employee. To replace the pension, the IRS gave employers the ability to provide a 401K to its employees instead.
If you dream of a relaxing retirement, you need to understand and be able to take full advantage of this account. Unless you make uncomfortable amounts of money, it is your only hope for that rosy retirement.
What is a 401K
A 401K is a tax-advantaged retirement plan that employers offer to help their employees fund their retirements.
The most significant advantage of a 401K is it can help you avoid paying taxes. All of the money you contribute to a traditional 401K goes in pre-tax. This means the federal and state governments do not get to tax this money before it goes into your account.
**A Roth 401K is different and for this post, I am only talking about a traditional 401K**
If you are making over $40,000, your marginal federal tax rate is 22%. Meaning every dollar over $40,000 you earn, you only get to keep $0.78.
Another great benefit is you do not have to pay capital gains tax. The money you invest in a 401K generally defaults into a predetermined mutual fund. Over time these mutual funds typically grow in value. If you decided to cash-out on that growth in any other investment account (except IRA, Roth IRA, Roth 401K), you would have to pay taxes on that profit.
The current long-term capital gains tax rate is 15%.
The only caveat to the 401K is you can’t access the money until you are 59 ½, a good practice of delayed gratification.
There are circumstances where you can access the money, but that is an article all to itself.
The most common 401K investing strategy is to contribute and then never look at your account.
This strategy doesn’t surprise me because most people are pretty wary of stocks. According to a survey conducted by Ally Financial, “61 percent of adults say they find investing in the stock market to be "scary or intimidating."
Because of this, most people I know only contribute enough to meet their company’s matching policy. Meaning the company will match your contribution up to a certain amount of your yearly salary.
According to Fidelity, the average company match is 4.7%. If most people are only contributing to meet the match because of a fear of the stock market, it should be no surprise that most Americans are ill-prepared financially for retirement.
Before I dive into these strategies, I want to let people know that this article is only for informational and educational purposes. It should not be considered Financial or Legal Advice. Consult a financial professional before making any significant financial decisions.
Increase the Amount You are Putting In
The maximum amount an individual can put into a 401K per year is $19,000. If you can max out your 401K each year and you make over $60,000, you are avoiding $4,000 in taxes alone!
Also, the more you can contribute to this account when you are younger, the more ability this money has to grow over time. This is called compounding. Meaning you are earning money on earned money.
Being able to max out a 401K is not accessible for everyone, but I would encourage you to see if you could potentially put more than just the 5% that most people are doing. Retired, you will be very thankful that you did.
Remember, you can always raise or lower your contribution rate. When I bought my house I dropped mine to make sure I had enough cash to pay for unexpected expenses.
** Check with your companies 401K provider about changing your contribution rate. Retirement contributions are not like health benefits that you have to declare at the beginning of the year and can’t change.
Cashing-Out on Winnings
Selling funds within my 401K is one of my more controversial takes. I suggest that you sometimes cash out on your winnings. When I say winnings, I am talking about investments that have increased in value.
New investors tend to miss that you don’t make money in the stock market until you sell. The inverse is also true; you don’t lose money until you sell either.
In 2019, I sold 20% of my stake in an S&P 500 Mutual Fund when the S&P 500 was at 3,000. My coworkers laughed at me as the index moved up to 3,300. When the entire market took a dump in March, I was able to buy back in at 2,200.
That is a 33% swing.
The index has again gone back to those levels. Guess what I did? That’s right. I sold a little of my position to make sure I locked in those profits and have ample cash to buy back in again during a correction or a crash.
Most 401K companies limit the amount of trading you can do to keep their fees low, so that is something to consider. I am not recommending people become day traders in their 401Ks. In my example, I made two trades in 12 months.
** Be sure to check with your company to see if they have fees or waiting periods before trading
Becoming wealthy takes time. By starting when you are young, you increase your odds dramatically.
The Big Takeaways from this article
Retirement Savings is a relatively new thing
401K is a tax-advantaged retirement account offered by your employer
You can increase and decrease your contribution at any time
You can cash-in on market moves
I know this was a lot of concepts, and some of them probably flew over your head. If you want me to expand on any of the topics that I covered in this article, comment or email me directly (email@example.com), and I will write a separate article covering those topics in more detail.
This article is for informational purposes only. If you have specific questions around your financial situation, be sure to reach out to a financial professional.