As much as you may love what you do for a living, eventually you’ll want the ability to retire. And when you do, having a large, well-funded retirement plan is crucial. The best way to set yourself up for retirement is to start saving money as early in your career as possible.
While you can do this through a personal IRA, some employers offer tax-advantaged 401(k) programs as a benefit to their employees. These are great perks for an employee. But not everyone takes full advantage of it. Sometimes that’s for financial reasons, but often it’s a matter of not being fully informed.
If you are on the fence about investing in your 401(k), or even if you’re already investing, here are three ways you could be making the most of your employers’ retirement program.
1. Always contribute enough to earn the match
It’s become increasingly common for companies to match a percentage of what their employees contribute to their plans. This is done to help incentivize you to invest in your own future. The company benefits by attracting great employees with this benefit, without the expense of offering a full pension program. Sometimes the match is a percentage of your salary or of what you personally contribute. Either way, it’s free money.
At the bare minimum, you should be investing enough into your plan to fully cover the requirements for the match. Often times it’s a very low amount needed to trigger the match.
For example, let’s say your company offers a 100% match on contributions of up to 5% of your salary. If you have a salary of $50,000, that means annually your company will match you dollar-to-dollar up to $2500 (or $5000 combined).
As years go on that additional $2500 will start to compound and grow. That will result in you leaving a lot of money on the table. Take the match.
2. Take full advantage of the tax benefits
Assuming you’re already investing in a retirement plan, you should also be considering how much your contribution is impacting your taxes. If you are investing using a “traditional 401(k)”, every dollar you invest is considered to be pre-tax. This means that instead of paying taxes on that dollar right now, you’ll pay taxes on your investment and it’s growth later in life when you withdraw from your account. The benefit is you have less money taken out of your paycheck now as well as lowering your total taxable income.
If you chose to invest in a Roth 401(k), you’ll pay the taxes at the time you invest. That means you’ll have more money taken out of your paycheck for taxes, but then you don’t have to pay taxes on its growth once you’ve reached the age of 59 ½. If you believe you’ll be in a higher tax bracket when you retire, this could be a good option.
There isn’t a right answer for which type to use. The choice is driven by your own personal situation, and understanding the pros and cons of a traditional 401k vs. a Roth 401k. The important takeaway here is that you need to understand which is the most advantageous to you. Then you should take full advantage of it by investing up to your contribution limit, which per the IRS, increased to $19,000 a person for 2019.
3. Optimize your investments
Finally, you need to fully understand what funds you are investing in and how much those investments are costing you. Most funds have operating expenses associated with them that help covers the fees or operating costs of the firm managing the funds.
For example, let’s say a fund has an expense ratio of 2.5%. This means that every year, 2.5% of the funds’ assets will be used to cover costs. While that doesn’t sound like much money, if you take into consideration the lost growth you would have received due to compound interest, it adds up. While there isn’t anything wrong with those fees, you do want to be careful you aren’t paying to much.
You can do this by researching the expense ratios of each fund. An expense ratio shows you how much of every dollar invested goes towards buying assets and how much goes towards covering expenses. The goal is to find funds that provide the most value at the lowest cost. You can then look for funds with reasonable returns and low costs. Blooom has a great analysis tool that does this for you automatically with some great visuals that help teach you.
Not all companies offer an employer-sponsored investment program, so If your company has one make sure you recognize the full benefits of it. You can do this in three different ways.
First, always invest enough to earn the full match. Second, make sure you are investing in a plan that provides you the most tax benefit for your personal situation. And finally, look at the expense ratios of the funds you are invested in. The goal is to make sure aren’t paying to much for the value you receive.
Blooom does not provide tax advice. Consult a tax expert for tax-specific questions.