Congratulations, you are enrolled in the new 401(k) at your company. Now what? Here’s how to make your 401(k) plan work for you.
Find Out if You Can Auto-Enroll: Hopefully your employer uses the auto-enrollment function. This allows all eligible employees to be enrolled, with a set payroll deduction amount and fund choice made by the employer. Employees can change investment options, deduction amounts and tax status, and can opt out at will. However, by enrolling automatically, the big hurdle of getting started is avoided.
Take the Free Money: If your employer is offering a matching contribution, take it. With a match, when you put in 3 percent, they put in 3 percent, for example. The employer will set the match amount annually. In addition, vesting of the employer’s money is set by the employer, which can go from immediate vesting — the money is yours when it hits the account — to five years out with 20 percent per year vesting.
Decide, Pre-Tax or Post-Tax? Now you have to choose which contribution type is best for you. Do you want to pay now, or pay later? With the pre-tax option, you don’t have to pay taxes on the amount of money you contribute to your retirement fund; you only have to pay taxes on your earnings that are not put into the fund. Once you’ve retired, you will pay taxes on the final amount as you withdraw it.
The other contribution type is the Roth — aka post-tax— option, which requires you to pay taxes on the contributions when you earn them. We know, it sounds much less appealing because money is coming out of your pocket up front, but stick with us for a minute. If you pay taxes on your earnings now, at retirement the contributions and earnings come out tax-free. Yes, you heard us right! No taxes due on the withdrawals at retirement, ever! That’s the deal Uncle Sam made with you, if you choose that option.
Leave the Money Alone: A 401(k) is like a bar of soap: The more you touch it, the smaller it gets. Most company-sponsored retirement plans offer broad-based options, which allow individuals to invest in a diversified mix of stock and bond funds according to risk and thereby maintain a more diversified portfolio. Pick a broad strategy and stick with it through rebalancing.
Robert Thomas is a member of the DailyWorth Connect program. Read more about the program here.