7 Tips for Maximizing Your 401(k)

A 401(k) is a retirement savings plan sponsored by your employer. It allows for pre-and post-tax dollars to be removed directly from your paycheck and deposited into investment accounts. These accounts are typically managed through a third-party investment firm, such as Vanguard or Fidelity.

These types of accounts are common methods for saving for retirement. Get seven tips below for maximizing your 401(k) savings to help cover your future lifestyle.

Does Having a 401(k) Help Your Credit Score?

Before we dive into the nitty-gritty, let’s answer a quick question: does having a 401(k) help your credit score? Quick answer: no. Because your 401(k) isn’t being reported to any of the credit bureaus and isn’t on your credit report, it won’t negatively or positively impact your credit score. 

Know How Much You Can Put into Your 401(k) in 2021

One of the best ways to maximize your 401(k) savings is by maxing out your annual deductions if you can. You can invest up to $19,500 in your 401(k) in 2021, plus an additional “catch-up” contribution of up to $6,500 if you’re age 50 or older. If you wish to invest more than this amount, you’ll have to consider other savings and post-tax options such as an IRA, mutual funds, CDs or other investment vehicles.

You’ll also want to understand what you can afford to put into your 401(k). Don’t invest in retirement at the expense of missing payments on your bills today, for example. That can hurt your credit and make it difficult to access financial tools in the future.

Maximize Employer Match

Many employers offer to match funds to encourage their employees to save for retirement. These employers offer up to a certain percentage of your salary as a match.

For example, you might put 10% of your paycheck into your 401(k) and your employer might offer matching funds up to 3%. That means you’ll receive the full 3% from your employer as an investment into your 401(k). However, if you’re only contributing 2% of your salary, your employer will match only that 2%. That’s why it’s important to know what your employer’s matching amount is so you can take full advantage of these additional retirement funds.

Know When You’re Vested

Vested means you own the plan or contributions to it. You’re immediately 100% vested in the contributions you make yourself. But it can take up to six years to become 100% vested in the contributions your employer makes. 

When you become vested depends on the type of vesting your employer uses. With Graded Vesting, for example, you’re 20% more vested for each year of service you complete after the first. If you leave the company after three years, you’re only 40% vested. That means you only get to keep 40% of the employer’s contributions to your 401(k).

Knowing when you become fully vested can help you plan career moves to protect your retirement. If you only have one year to go, for example, you might wait to make a move depending on how much employer contribution you stand to gain.

Understand the Tax Advantages

The money you contribute to your 401(k) up to the IRS allowed amount each year is pre-tax. That means it’s taken out of your paycheck before taxes are calculated and withheld. Since taxes are only calculated on the lower amount, you pay fewer taxes than you would if you weren’t contributing to your 401(k).

Yes, you’ll eventually pay taxes on the money in your 401(k) when you withdraw it as income during retirement. But with the tax savings today, you can work toward even greater financial stability in the future by paying off debt or making other positive financial decisions with the money you might otherwise have paid in taxes.

Don’t Borrow or Withdraw the Money Early

It’s easy to see a 401(k) savings as a savings account. But that’s far from the truth. When you withdraw from your 401(k) early, you may pay a 10% penalty tax on top of any other taxes owed on the withdrawal. 

In some cases, you can borrow from the plan via a loan that you pay back with interest. However, that means the money isn’t in your 401(k) investment account earning interest—usually at a higher rate than you’re paying back. So, even borrowing the money can negatively impact your future retirement savings.

Instead of relying on your 401(k) as an emergency savings account, consider budgeting to build an emergency savings instead. That way, you don’t have to dip into your retirement account if something comes up. 

Plan Rollovers Carefully

Since 401(k) accounts are employer-sponsored, you can’t typically keep them as-is when you change employers. But you can plan a rollover that allows you to maintain your retirement funds and tax-deferred savings status. 

If you’re moving to a new employment opportunity immediately, you might consider rolling an old 401(k) into one offered by your new employer. If not, you may be able to roll your savings into an IRA. Talk to both HR departments involved or a financial analyst about your options. 

Have a 401(k) Investment Strategy

Don’t just set and forget your 401(k). Educate yourself about the markets so you can choose a strategy that’s right for you or work with a retirement planning analyst. It’s a good idea to know when you should switch from risky investments to more stable ones, for example. Risky investments when you’re younger may be okay because you have time to recover funds, but as you approach retirement, you may want to play it safe with what you have.

Having a strategy can help you weather issues and market forces, too. For example, the COVID-19 pandemic caused a lot of upheaval in markets. That did impact people’s 401(k) investments, and some people panicked with actions such as early withdrawals. Having a 401(k) strategy can help you hang on through market upheaval by understanding the big picture of your investment goals.

It’s Never Too Early to Start

There’s never a bad time to start learning more about and saving for retirement. In fact, if you have kids, you may want to start teaching them about retirement investing so they can get a head start on the process. 

Whether you’re starting early or not, understanding what you need for retirement and how to maximize your savings now is a great place to begin.

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