Today is National 401k Day. To celebrate, we asked a selection of financial experts about their best practices on how to ‘hack’ a 401k.
Most people know the importance of maximizing their contributions and taking advantage of employer’s matching, as it’s basically free money.
However, employees who rely on their 401k as their sole means of saving for retirement need to know more. I asked these experts to only share their most unique tips and tricks that you may not have heard elsewhere. These tips, if utilized properly, can save you time and money and might even allow you to retire earlier than you may have thought possible.
David Bach, co-founder of AE Wealth Management, author of The Automatic Millionaire and Smart Women Finish Rich
Nothing you will do in your lifetime financially equals the importance of signing up for your 401k plan at work and using it correctly. Sign up day one of employment and save at least an hour per day of your income (that’s 12.5% of your gross income). Use a target-date mutual fund. Then leave it alone and never borrow from it.
David Bickerton, President, MDH Investment Management, East Liverpool, Ohio
Everyone should take a moment to review their 401k plan documents in regards to in-service distributions. Your employer should explicitly state whether employees are eligible to take an in-service distribution or 401k rollover while currently employed. Many investors are familiar with rolling over 401ks from former employers into IRAs, but rolling over a portion of your current 401k may be a great option.
If you are frustrated with the lack of investment options available to you in your 401k plan, an in-service distribution would enable you to roll funds into an IRA in your name where you have more control and more investment options. By taking an in-service distribution, you may find a wider range of investment options or the potential to work with a great money manager whose strategy you are comfortable with.
Tom Zgainer, CEO, America’s Best 401k
If the government created a new additional 10% income tax, we would all complain but we would pay for it. We must think about our future self in the same way. We tax ourselves today to have financial freedom tomorrow.
Begin at whatever percentage of your paycheck you can afford (i.e. 4%) and sign up for ‘auto-escalation’ so that each year, it will go up by 1%. This ‘save more tomorrow’ technique has shown to dramatically increase savings over time.
Cutting your fees in half can double your future retirement income (depending on the time frame, assumed growth and contribution). This bull market has disguised insanely high fees as account balances rise. The better question is how much was left on the table.
Patrick McDowell, Investment Analyst, Arbor Wealth Management, Miramar Beach, FL
Use your 401k to enable a backdoor Roth IRA contribution transaction.
You can’t make a non-deductible IRA contribution and then convert just that amount into a Roth IRA if you have other traditional IRA assets outstanding.
But, if you have a 401k that allows roll-ins, you can roll your IRA into your 401k and then execute the backdoor Roth IRA transaction.
It’s a lot of work to get $5,500 or $6,500 into a Roth IRA and it somewhat limits your investment flexibility but if you have a great 401k plan it can be worthwhile.
The other hack is doing what’s often called a self-directed 401k where you can invest in individual securities rather than just the standard fund options available.
Parker Babbe, Partner, Commonwealth Financial Group, Boston, MA
One of the most overlooked 401k hacks is the ability to make voluntary after-tax contributions to your 401k above the $18,500 limit (2018) and receive TAX-FREE growth on said contributions.
The true limit is $53k, which includes all employee and employer contributions to a defined contribution 401k. This allows you to save more, yes, but more importantly there is a way to turn a portion of these contributions into Roth dollars!
The IRS allows you to separate your voluntary after-tax contributions into two buckets. Bucket #1 is the contribution itself, while Bucket #2 is the growth on that contribution. When you retire or change employers, you can roll Bucket #1 into a Roth IRA, regardless of your income level! This is huge for high-income earners. Bucket #2 can then be rolled into a Traditional IRA.
Alexander Lowry, Professor of Finance at Gordon College, Wenham, MA
Take a careful look at your target funds. The theory behind target date funds is that younger investors can afford to take more risks than older investors. These funds, sold as single-fund answers to retirement investment questions, mix a multitude of investments into a single fund, with the allocation pegged to the risk profile of the age group it is aimed at.
But they are complex instruments. Some target-date funds have higher fees than other funds because they are essentially funds of funds. Some may be too conservative (putting too much money into bonds, for example) and some too risky (making big bets on stocks) for the tastes and situations of individual investors. And they may be insufficiently diversified as well.
If you like the offering in your 401k plan but think it is too risky or not risky enough for you, you can switch to a fund with a different target date — aiming younger or older than you actually are— until you get the risk profile right.
Ian Atkins, CFO, fitsmallbusiness.com
Solopreneurs and gig economy participants can get the same $55,000 contribution threshold from a Solo 401k and a SEP IRA (though a SEP limits your maximum contribution to 25% of your income). SEP IRA’s and Solo 401k’s are easy to set up, they’re provided by many of the same name brands you would entrust an IRA or brokerage account to and the fee structures are comparable to a normal 401k plan.
Billy Lanter, Fiduciary Investment Advisor, Unified Trust, Lexington, KY
Participants should see if their employer offers a Roth 401k option and weigh the potential benefits of contributing to a Roth 401k versus the traditional tax-deferred option.
This is of particular interest to those who may not otherwise be able to contribute to a Roth IRA directly because their income is too high. While Roth IRA contributions are limited (or disallowed altogether) based on an individual’s income, there are no income restrictions on Roth 401k contributions.
The cherry on the cake here is that you can stash away more money inside a Roth 401k vs. a Roth IRA ($18,500 vs. $5,500 for individuals under age 50 for 2018).
Matthew Gaffey, Senior Wealth Manager, Corbett Road Wealth Management, McLean, VA
One way to ‘hack your 401k’ for early retirees is to take advantage of the ‘Rule of 55’. If you severed ties with your employer after the age of 55, but you have not quite reached the age of 59.5 years old, you still have the ability to take withdrawals from your 401k penalty-free.
In order to take advantage of this, the money needs to remain in your 401k plan, as you will lose this ability if you roll all of the money into an IRA. This only applies to a 4.5-year window of time, but if it makes sense for your particular situation, it certainly makes it easier to fund your essential expenses.
Ryan Repko, Financial Advisor, Ruedi Wealth Management, Champaign, Illinois
Most people pick the funds in their 401k based on the past performance of the fund, even though the disclaimer clearly states past performance is not indicative of future results.
One of the best indicators for the return of the fund is the expense ratio. It’s very simple: the higher the expense ratio, the lower the return you receive in your 401k. Many people incorrectly assume that paying for a more expensive fund will deliver better results, but this is not always the case.
If you want to squeeze as much return out of your 401k as possible, keep a keen eye on the cost of the funds. Over several decades of investing, picking funds with lower expense ratios translates to more money in your 401k that compounds several times over to produce higher balances in retirement.
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