50% of Americans have less than $10,000 saved for retirement, according to a new retirement savings survey. Why is this happening if we all know how important it is to save for retirement?
The search for “retirement calculator” on Google returns an astonishing 4,480,000 results, and the choices seem endless. You can calculate just about every factor of retirement that you would need to – how much should you have in total, how much should you save each month, what percentage of your income should you be saving, etc. The choices can be entirely overwhelming, not to mention trying to figure out which retirement account you should have: a 401(k) or an IRA.
If you work for a company, your first stop on the retirement roadmap is going to be with your 401(k). You don’t need to know all the ins and outs of 401(k)s before you start saving, however, what you do need to know are these five 401(k) tips that will help you supercharge your savings, so you can buy that villa in the South of France in 20 years if you wish.
Tip 1: Evaluate it
If you’re already saving for retirement, congrats, you are ahead of the game. However, you aren’t investing just for the hey of it. Wouldn’t you want to make sure your money is positioned properly, so you are making the most of the good years and avoiding the bad years as best as possible?
Just like checking your credit score every year, you should also set a reminder to evaluate your 401(k). The fund choices can be confusing, yes. However, there are so many articles online and research companies to help you demystify your options. If you’d rather leave it in the hands of a professional, for a super low monthly fee you can hire a company like Blooom http://www.blooom.com to help you fix and manage your 401(k) with all those complicated pie charts and line graphs.
Tip 2: Go up by 1%
Most people use the set-it-and-forget-it method when it comes to saving money in their 401(k). Are you guilty of using the same approach?
It’s easy to carry on knowing that you are saving money towards retirement, but the problem is that when your income increases, your savings should also increase. Of course, this happens naturally – if you’re saving 3% of your salary and you get a pay increase, conceptually you will be saving more. However, studies have shown that even increasing your retirement contribution percentage by as little as 1% can have a huge impact on your overall retirement balance.
The idea is to grow your retirement savings percentage steadily by 1% every year or every other year to get the most out of your savings. For the overachievers, a good recommendation is to increase your retirement savings percentage by half, or all, of your annual salary increase. For instance, if you get an annual bonus of 3% in pay, go ahead and bump up your retirement savings by 1.5% to keep pace.
Tip 3: Max it out!
One of the most glorious perks of a 401(k) is the ability to receive matching contributions. Matching contributions are like the pot of gold that you find at the end of the rainbow (well, at least that’s what the Leprechauns say).
Matching funds are essentially free money that your company is willing to contribute to your 401(k), provided you contribute a certain percentage of your own money each and every month as well. Most companies match up to 6% of contributions, but you should check with your Human Resources department to make sure you know the exact matching percentage. Your goal is to contribute enough to your 401(k) to max out the matching contributions–if your company matches up to 6%, you had better definitely be contributing no less than 6%.
If you think about a snowball, when it first starts rolling downhill, it is tiny. The longer it rolls, the bigger it gets. Well, your 401(k) account is very much like a snowball, but if you receive matching contributions then your snowball starts out big and only gets bigger. Most companies have what is called a vesting schedule, meaning you will need to stay at that company for a given amount of years to be fully vested in their contributions towards your retirement account.
For example, if a company has a six-year vesting schedule, it would look like this:
- Year 1: 0% vested
- Year 2: 20% vested
- Year 3: 40% vested
- Year 4: 60% vested
- Year 5: 80% vested
- Year 6: 100% vested
If you decided to leave for another job in year 6, you would walk away with your savings (you always get to take this amount) plus 100% of the matching funds from your company. If you left after year 5, however, you would take all of your money plus 80% of the matching funds from your company.
Tip 4: Call ROTH to the rescue
Saving in a 401(k) is great, but as we all know eventually you will need to pay taxes on the money you are saving. When you go to retire, you will owe taxes on however much you withdrawal in a given year at your current tax rate. This just doesn’t sit well with some people; maybe you’re one of them.
Along came the ROTH. No, this is not a crazy kind or rodent, but a close family member to the 401(k) and IRA. With a ROTH, you can save up to $5500 in 2016. However, your ROTH contributions are not tax deductible. Your money does grow tax deferred, just like the IRA and 401(k). And since you paid taxes when you invested the money, when you take your money out at retirement, you will not owe any tax on those funds. Therefore, a ROTH can be a nice balancing act to your 401(k) savings allowing you to have your cake and eat it too when it comes to taxes.
Tip 5: Have a 401(k) party
Raise your hand if you have multiple 401(k)s from previous employers just sitting right where you left them? This is a common mishap that many people make simply because they don’t know their options after they leave their job. Let’s break it down.
If you leave your company for a new job, you can either leave your 401(k) as is and your money will keep growing. However, you can’t contribute any more to that account.
Or, you can do a direct rollover (you want to avoid having access to the funds yourself) to an IRA set up at companies like Fidelity, Vanguard, T. Rowe Price, etc., where you will then have access to a wider range of investment choices and where you can continue to contribute money each year to this account.
If you have multiple old 401(k)s sitting around at old jobs, you can roll those all over into one giant IRA, and suddenly your retirement snowball will get even bigger.
Photo: Eugene Hu