Planning for retirement is essential for everybody. Social security will cover 35-40% of your pre-retirement income. For higher-income individuals, that number is even lower. The rest of your retirement income will have to come from other sources. The best way to supplement your retirement income is by contributing to a tax-advantaged account like an employer-sponsored 401k plan. If you are part of the lucky group that gets access to a 401k through your employer, you should look closer at your plan. You could improve your retirement planning with some simple adjustments. Many people need to learn more details about their 401k.
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Retirement Account Statistics from the US Census Bureau
According to recent data collected by the US Census Bureau, nearly half of the adult working population does not have access to a retirement account. Only 18% have access to an IRA, while 35% have access to a 401k plan. That’s a lot of people who miss out on retirement planning!
With a 401k plan, you are generally stuck with your employer’s plans. The features of the plans can be wildly different. Because of that, it makes sense to learn more about that topic and not to let money on the table.
Vanguard Report – How America Saves 2023
Vanguard has published a very interesting report, “How America Saves 2023” (PDF-Version). They are not the only provider of 401k retirement plans, but their plans are widely used. That’s why the data from this report is reasonably representative of the overall situation.
According to this report, 95% of all employer plans offer some employer match. That’s good news because an employer match is free money for you! Even better is that 50% of those plans don’t require you to contribute anything to get the match. For the rest of them, you need to make some form of contribution to get that match. Plans utilize different formulas to calculate the employer match. The most widely used formula is you contribute 6% of your salary, and your employer matches with another 3%. The average matching rate across plans is 4.5% of your salary.
Can I borrow from my 401k?
The deal with 401k accounts is that you must leave them alone until you are 59 1/2 years old. If you want access to the money in your account before that, you should check your plan. 83% of plans allow you to borrow up to $50,000 or 50%, whichever is lower. Borrowing from your 401k works without applying. But you need to pay the money back in time as you’ll end up paying taxes and penalties if you are younger than 59 1/2. Check the details of your plan to see if it comes with that option. But remember that any money taken out of your account can mean an even more significant loss. It’s not only the money you lose but also the future growth it would have brought. Let’s assume an average increase of 7% annually, and you take out $25,000. Over 10 years, that money would have grown to $49,178.78!
Another widely available option to get that money is through hardship withdrawals. 95% of all plans offer some form of this option. Before using this option, check what is considered a hardship. If the plan provider does not accept your situation and you still withdraw money, you might have to pay taxes and a 10% penalty.
What is the best way to invest my 401k?
The money in your 401k plan is invested in different ways to grow over time. Since the account lifetime of retirement accounts is usually very long, it’s all the more important for you to invest it the right way. Most plans offer pre-defined Funds to choose from. These Funds are diversified portfolios of small/mid/large-cap companies, cash, bonds, and other Funds. The average number of Funds offered by plans is 17.4, while participants only use 2.4 on average.
20% of the 401k plans are even offering a self-directed brokerage account. With such an account, you can choose your portfolio manually. While this option offers a huge opportunity to boost your retirement income, only a few participants are making use of that option. If you have such an option in your plan, we recommend you check it out. It is by far the most flexible way to grow your retirement income.
The most widely used Fund type across all 401k plans is the Target Date Fund. This Fund type has a date attached to it – your retirement date. The allocation within the Fund is based on how far away that target date is. Target Date Funds aren’t a very good option, especially for younger workers. The Target Date Funds allocated for younger workers often come with 10-15% cash and bond investments. In our opinion, this is too conservative, with so many years still to go. You would be better off investing more, if not all, in stocks now.
You can read our investment guide “ETF vs Mutual Funds: Which is Right for You?“. Interested to read some great timeless investment books? We’ve got you covered! Check out our article “5 Must Read Books for Beginner Investors“.
How much should I save for retirement?
Let’s start with the goal: The recommended savings rate is 12-15% of your salary. According to the Vanguard Report, the median employee contribution is 6.4%, while the average is 7.2%. If you include the employer match, the median is ~10%. The most striking fact of the report is that only 69% of all plan participants with access to a match are taking full advantage of it. That’s a lot of money left on the table. Consider increasing your contributions to get the full match if you are among them. It makes a difference for you in the long term.
401k accounts have annual contribution limits in place. You can’t just put a large amount of money in them all in one go. Those limits can also change over time. For 2023, the 401k contribution limit for employees is $22,500, or $30,000 if you are age 50 or older.
Make sure to read “5 Easy Money Moves To Save More” and “10 Money Tips I wish I knew in my 20s“. These guides contain valuable information to help you save more of your money.
What happens to my 401k if I change my Employer?
If you change your employer and your new 401k plan is better than the one from before, you can use a rollover if allowed. The tax consequences of a rollover depend on the option you pick.
Cash-out
This is the most expensive option because you’ll have to pay ordinary income taxes on the full amount. If you are younger than 59 1/2, you also pay a 10% penalty for withdrawing the money early. But if you factor in the missed future growth of the money, the total cost of this option is much greater.
Leave it as is
This option is the simplest for you. No further action is necessary. When you leave your 401k with your old employer, you cannot make any new contributions. It will still be invested, and you can change the investments. There are no direct tax consequences.
Roll over to a new Plan
You can also roll over your old 401k into your new employer’s IRA or 401k plan. Make sure to do it directly from one plan to another without ever having access to the money. This is your way to avoid paying taxes and penalties. Your transaction is direct in such a case. This option is the most common one.
The money will usually be mailed as a check to you. You have 60 days to deposit that money into your new plan. Coordinate with the support of your new plan for next steps. If you fail to deposit within 60 days, the entire amount will be considered a distribution. You will have to pay taxes and possibly a penalty for an early withdrawal.
The best advice is to compare your plans and make an informed decision. For some, having multiple accounts from previous employers is hard to track. Bundling everything into a single account is much simpler in such a scenario.
Interested in retiring early? Check out our post “FIRE Movement: Ways to Retire Early” to get some guidance on that endeavor.
Final Thoughts on 401k
Looking at what features your 401k plan provides can help you discover new ways to boost your retirement income. Given that a 401k account grows over a long time, even minor adjustments can tremendously impact your savings.
We want to encourage every 401k participant to review their plans again. Check out the available investment options. See if you have access to a self-directed brokerage account. Maybe you have some old 401k accounts from previous employers. Look at them and evaluate if a rollover is a good choice for you. See how you can use that valuable benefit if your employer provides a match. Maybe you don’t have access to a 401k plan through your employer. You can ask them if providing such a benefit is an option.
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