The 401(k) plan has become the foundation for building wealth for retirement of working Americans. Unfortunately I find that too many people are either not participating in their company 401k plan at all or are under-utilizing it. This is a financial mistake and if you fall into this group, now is the time to put your finances back on track. Here are my five top strategies for supercharging your 401(k) plan.
- Max the match. Think of how you would answer this question, “How much would you invest if I guaranteed that you would double your money in the first year?” That’s exactly what many employers do by providing a matching contribution for employees who contribute to their company 401(k) plan. Many plans will match 25%, 50% or even 100% of the first 3%-6% of your compensation. It is true that you must be willing to ‘invest’ your money for the long term, but don’t lose sight of the power of a matching contribution. No other investment strategy will offer as much potential.
- Focus on stock mutual funds. In the short-term stock values can and do fluctuate significantly, but stocks truly offer the best opportunity for long-term retirement planning. Long-term historical returns for stocks are about 9% while bonds historically have returned about half of that amount. Particularly today, when bond interest rates are at historical lows, the five to ten year outlook for bond returns seems bleak. If you are ten years or more away from retirement, I would recommend at least an 80% allocation to stocks. If you are five years away from retirement, your allocation to stocks should be at least 60%. During retirement, you should have at least 50% of your investments in stocks.
- Repay loans. Many retirement plans allow you to borrow from your account. If you have borrowed money from your plan, make paying that loan off a priority. One of the most important features of a 401(k) plan is tax-deferred growth. Some people like the idea of borrowing from their 401(k) plan based on the idea that they are ‘borrowing from themselves’. You are not borrowing from yourself; you are “stealing” from yourself!
- Increase your contributions. Does it make sense to invest in your 401k plan above the matching limits? Absolutely. While you don’t get the benefits of additional matching contributions, you do continue to get a tax-deferred growth and avoid taxes on the contributions. Increasing your contributions is easier than you think. If you are in a 28% marginal tax bracket, a $1,000 contribution only costs you $720. The government pays the rest for you! One way to systematically increase your contribution is to commit one-half of all pay raises to your 401(k) plan. You’ll be surprised how fast this will add up.
- Stick with it. One study suggested that over 40% of people who changed jobs actually cashed in their 401(k) plan, which creates income taxes and often federal penalties as well. Make sure that you and your family understand the importance of your retirement plan. It is a gift to yourself of financial abundance during your elder years.