Saving for retirement is a smart strategy to pursue financial security in retirement. Which 401k optimization strategies and tips can help you grow your savings and create a brighter future?
The Importance of Saving for Retirement
Saving for retirement is a key part of early career financial planning. The younger you begin to contribute toward retirement the longer your money has to grow. At whatever age you may find yourself asking “When should I start to save for retirement?” the answer is always, “Now”.
Understanding Your 401k
A 401k retirement account, named after that section of the IRS law, is an investment-based plan sponsored by an employer with tax deferral options. With a 401k, you can take advantage of the convenience of an already set up retirement plan offered through your employer that can automatically deduct a percentage of your salary and allocate it to your 401k account.
That’s convenient and you may find savings beyond what you could achieve on your own. Additionally, many employers offer a matching contribution, generally up to 3% of your salary, plus 50% of the next 2% of your contribution. That is, for every dollar you contribute up to 3% of your pay your employer may match your contribution. It’s a risk-free way to double your money and is the most valuable feature of an employer-sponsored retirement plan.
Nearly 90% of employers today offering a pretax 401k also offer an after-tax Roth 401k option. With a traditional (read: pretax) 401k, your contributions reduce your taxable income which reduces your corresponding tax liability. That helps to reduce the tax you pay today but you will need to pay income tax on your retirement money when you retire.
Tax Benefits and Considerations
How much income tax will you need to pay when you retire? It depends on what tax rates will be when you retire. Some people may not want that unknown risk so they choose to pay tax on their contributions when they are made. They won’t get the taxable income deduction today but they will get it in retirement because they money they withdraw from their 401k when they retire does not need to be reported as income—they already did that years before when they made the retirement account contribution.
That’s why so many employers now offer a Roth 401k option. It appeals to many employees who would rather pay income tax now on their retirement money and not have to worry about what they may have to pay when they retire. No doubt, the massive federal debt, now at $35 trillion dollars and rising fast, plays into their calculation. Will Americans face far higher income tax rates to help pay off that federal debt? Roth 401k participants choose not to have to deal with that—especially with federal income tax rates now at or near historic lows.
Both traditional and Roth 401k benefits include:
- Automatically contribute up to $23,000 (as of 2024) of your salary annually if you’re under 50
- Contribute up to $30,500 annually with catch-up contributions if you’re over 50
- Potentially benefit from employer-matched contributions
- Invest in retirement savings long-term with low cost and convenience
- Grow your savings with already vetted, diversified investments like mutual funds, money market funds, and stocks/bonds
You may be automatically enrolled in a 401k plan by your employer with a fixed percentage of your salary deferred to your account (you can adjust this amount or decline participation). That’s called autoenrollment. Autoenrollment has been helpful in including more employees in retirement plan participation and at least a nominal contribution rate than if they had to act on their own to sign up.
What Is Employer Matching?
Employers may offer to match your 401k contributions to help grow your savings faster. The contribution limits of an employer-sponsored 401k are much higher than the amount you can contribute using an individual IRA. That’s a built-in benefit of participating in your employer’s 401k (you can additionally contribute to your IRA).
But, offering a retirement plan isn’t enough today. With 92% of employers which offer a 401k offering a matching contribution today, any employer not offering a matching contribution is not offering a competitive retirement plan benefit. The matching contribution is table stakes these days.
Employers are required to match 100% of the first 3% and 50% of the next 2% of an employee’s contribution based on their salary to be exempted from IRS compliance tests, called a “safe harbor” exemption. That’s why employer contributions stop at this percentage.
How much you contribute toward your retirement is independent of and may need to be much higher than the contribution amount your employer offers to match. Depending upon your age and goals, you may need to contribute 10-20% of your income to reach your retirement goal at a desired retirement age.
Staying Engaged and Monitoring Performance
The most effective way to optimize your 401k performance is to stay engaged and continually monitor your account’s performance. Check on your asset allocation regularly, make habitual contributions that maximize employer contributions, and choose the 401k plan type that best suits your needs now and in retirement (traditional or Roth).
Your retirement nest egg is a significant factor in your career financial strategy. A reputable advisor can help you navigate investment and contribution strategies with personalized guidance to make the most of your money.
Ready to optimize your 401k with confidence? Trust a MyStages® consultant as your financial advisor/planner to maximize your retirement savings. Schedule a consultation today.
