Key Takeaways
Even if you’re maxing out your 401(k) contributions, you could still be leaving retirement money on the table. Lots of it.
Don’t be afraid to reach out to your plan administrator if you’re not satisfied with your 401(k) investment options or fees.
If you’re contributing the maximum $19,500 to your retirement account ($26,000 if over age 50) and getting a company match, that’s great. You’re doing better than most Americans. But you may only be saving a fraction of what you could be saving.
To take full advantage of your 401(k), you need to know all your options. So why don’t many successful professionals save more for retirement?
Analysis Paralysis
Mainly it’s due to confusion. At many companies, the 401(k) plan descriptions are filled with jargon and can run over 100-plus pages. Workers can feel overwhelmed by the sheer number of options or frustrated by the mediocre choices. They often aren’t sure about the difference between traditional or Roth accounts, as well as how to allocate their savings by contribution source, and how to coordinate with payroll/HR, etc. to manage the actual deferral amount.
I’ve seen many plans at well established companies in which there are only five stock investments to consider and three of them invest in the same area--U.S. large growth. So, employees think to themselves: “the company plan stinks. The costs are too high and the investments are too limited to build a diversified portfolio. So, I’ll just invest on my own.”
Keep it Simple
Don’t let poor 401(k) plan design or confusion prevent you from taking advantage of the high contribution limits offered by 401(k)s. Here are the most important considerations:
Does your plan offer the ability to make Roth 401(k) contributions?
Many workers aren’t aware that they may be able to contribute to a Roth 401(k) instead of to their traditional 401(k). As with a traditional 401(k), you can contribute $19,500 a year to a Roth 401(k) ($26,000 if over age 50). The difference with the Roth is that you pay the tax up front, but then the account grows tax-free the rest of your life. You can contribute to both a traditional and a Roth 401(k) as long as your total contributions don’t exceed the limits ($19,500 or $26,000 depending upon your age). This means that you might choose to allocate half to a traditional 401(k) and half to a Roth 401(k). You can always customize the right combination of contributions to fit your goals and your tax plan. But, if you are unsure about what to do, just contribute 100% to the account that best fits your tax plan.
A Roth 401(k) can make sense if your life circumstances change, such as having other sources of employment income from your spouse, or changing your overall goals as you get older since you have accumulated savings. Or perhaps your plans for gifting or leaving money to kids have changed. Does your plan offer the ability to make after tax contributions?
The ability to contribute after-tax deferrals is a very important and often overlooked benefit of 401(k)s. It is a great way for high income earners to save more money in a tax advantaged manner. Most people think $19,500/$26,000 is the contribution maximum for a 401(k), but that is not entirely true. The real contribution limit is $58,000 ($64,500 for those over 50) in 2021 when you factor in contributions from all potential sources, such as employee deferrals, employer match, profit sharing, pension, and after-tax contributions.
As the name implies, after-tax contributions provide no immediate tax benefits. However, any dividends and growth from these contributions grow tax deferred. The best part is that when you roll your 401(k) over to an IRA, you are able to send your after-tax contributions directly into a Roth IRA. This is a great way for high income earners to maximize their savings by earmarking more money for an account that will be tax free in retirement.
What are the investment options in your plan?
Ideally, your 401(k) plan will offer 10 to 12 low-cost investments that you can use to develop a globally diversified portfolio. The plan should also offer a full lineup of target retirement funds for those who are unsure about how to invest. If the investment options are expensive or non-diversified, or if there are too many options to choose from, then consider going with choosing the best option and then coordinate with your other investment accounts to create a portfolio. For example, you can put all of your 401(k) money into a U.S. large company stock fund and then use your traditional IRA to get exposure to international and emerging markets stocks. Real World Example Let’s say a 50-year-old executive earns a $200,000 salary and is planning to retire in 10 years. She is already contributing the maximum $26,000 to her traditional 401(k) because she wants to optimize the tax benefit. That still leaves her with plenty to support her lifestyle. With her $50,000 bonus, she’ll earn too much to contribute to a Roth IRA, so one option is to contribute to an individual account in her name. But, if her company offers the ability to make after-tax contributions and she doesn’t need access to the money until retirement, she could potentially contribute another $38,500 of additional savings into her 401(k) each year until she retires. After 10 years, she’ll be able to move $385,000 from her 401(k) to a new Roth IRA at retirement. All the dividends and growth from the $385,000 of after-tax contributions will grow tax deferred while in her 401(k) and also after she retires within her traditional IRA.
That’s a great way for high earning disciplined savers to shift an additional $385,000 of retirement savings into a tax-free account. Conclusion
Don’t be afraid to reach out to your plan administrator if investment options aren’t good (high cost, not enough options to create diversified portfolio). Plan administrators are fiduciaries (like us) and are required to act in your best interest by providing a quality fund lineup. For example, if your plan offers a passive index 500 fund with high expenses (i.e. 0.5% or more), that’s unacceptable today. That’s not acting in your best interest. Your plan should be offering better investment options that are more competitive. Don’t be afraid to speak up and advocate for yourself and your fellow employees. If you or someone close to you has concerns about their retirement readiness, or about how to develop a maximized retirement savings and investment plan, feel free to reach out to us for a complementary initial meeting.
RYAN M. VOGEL, CFP® is the CHIEF PLANNING OFFICER, PARTNER at Novi Wealth