There are many ways you can maximize 401(k) contributions.  A 401(k) Retirement plan is a great way to invest tax- free dollars.  There are limitations on when you can withdraw the funds and the amount you can contribute.

Deciding whether or not you should participate in an employer-sponsored 401(k) is a confusing process, especially if it’s for the first time. If it is your first real job, you might not even be aware of what exactly a 401(k) is, or why you need it. A 401(k) is a type of account that is a long term savings tool, designed to help provide an alternative income source after retirement.  There are multiple different types of 401(k)s, which is what can make it a pretty confusing process. All types have different pros and cons to them, so research on the different types and how they fit into your life is a very important part of the process.

Since there are multiple different types of plans that all intertwine and become confusing, here are the most common types of 401(k).

Traditional 401(k)

With a Traditional plan a percentage of your income before taxes will be contributed to the retirement plan. The good thing about this type of plan, is that what you contribute is up to you. Usually you will pick a percentage of how much you want to come out of your paycheck, and then each month that percentage will go directly into your 401(k) plan. Although there are limits to how much you can contribute, contributing the max amount allowed would provide a larger end value. Another good thing about this plan is that you get to choose where you want your money invested. The younger you are the more aggressive you may potentially be.  The plan will have guidelines to help you choose investment options and many times you will have an opportunity to talk with a company representative about how their plans will help you work toward your goals.  All withdrawals from this type of 401k are taxed as they are withdrawn.  There is a potential for a 10% penalty tax if withdrawn before the age of 59 1/2.

Roth 401(k)

With Roth plans your contributions are made after taxes, therefore you will only pay taxes on your earnings from your contributions.  This plan could be more helpful to people who think they will be in a higher tax bracket in retirement.  (This is not as common.)

Employer Match to Maximize 401(k) Contributions

Many employers offer a dollar-for-dollar matching contribution.  What does that mean? FREE MONEY.  If your company matches 3% of your income, it may be wise to at least contribute that much to receive the match.  This is a great incentive which provides you a return on your contribution immediately, plus the interest earned.  Ideally, I recommend contributing 10% or even 15% of your income into a retirement account.  The max contribution for 2018 is $18,500.¹  If you reach the contribution limit you can also contribute to an IRA, or If a 401(k) isn’t offered thru your employer a IRA contribution is another option for potentially tax-free contributions.  401(k) accounts are not designed to be used for small purchases or an emergency because of the early withdrawal penalties.

Matching Options

Keep in mind the vesting schedule if its included in your plan.  If you leave your company will you be able to take all of the matching contributions with you or do you need to wait a certain time frame to leave.

Another great way to maximize your 401(k) is to increase your contribution each time you get a raise.  For example if you earn a 3% raise at your annual review, increase your contribution by half (1.5%), you will still notice an increase in your pay and you won’t miss the extra.

401(k) Interest Compounding

The younger you get a start investing in a 401(k) plan, the more time your money has to compound. If the % is taken from your paycheck automatically you will learn to live on the lower amount (You won’t miss it!)  Pay yourself first. If you have the ability to take advantage of a contribution plan, you should consider it. The compounding effect is something that we need to keep in mind to reiterate to younger generations.

Now lets look at a hypothetical example.

If you contributed 3% each year for 20 years with a matching 3% and we assume the account earns 5% interest, your account would grow to $86,000.

If we bumped up your contribution to 5%, using the same assumptions, the account would nearly double at $145,000!

A starting step could be to find out what your company offers and contribute enough money to get the match. Whatever investment options you choose, you can always tweak and adjust it down the road depending on your changing needs. Maximize 401(k) contributions by starting early and invest a higher percentage.  Review the investment choices annually.  This is a long-term investment which will ride with the market volatility.  As you near retirement (5-10 years away) you may feel more comfortable adjusting your investment choices towards a conservative model.

If you have any financial questions or would like more information to maximize 401(k) contributions, give our office a call at 417-882-1800 and make sure to tune into Bruce’s show next week, Tuesdays at 3pm on KOLR10.

Sources:

1- http://money.cnn.com/2017/10/19/retirement/401k-ira-contribution-limits-2018/index.html

https://www.thebalance.com/investing-through-your-401-k-357109

https://www.investopedia.com/articles/personal-finance/112315/how-401k-matching-works.asp

https://www.investopedia.com/terms/r/roth401k.asp

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The information contained in this material is believed to be reliable, but accuracy and completeness cannot be guaranteed; it is not intended to be used as the sole basis for financial decisions.   

We are not permitted to offer, and no statement contained herein shall constitute, tax or legal advice.  Individuals are encouraged to consult with a qualified professional before making any decisions about their personal situation.  Our firm is not affiliated with the U. S. government or any governmental agency.  Investment advisory services offered only by duly registered individuals through AE Wealth Management, LLC (AEWM).  AEWM and The Resource Center are not affiliated companies. AW05183065