How to Maximize Your 401k - Top Strategies - Retirement Planning

A 401(k) is an employer-sponsored retirement plan that offers tax benefits to its investors. If your benefits package includes a 401(k), you may choose to contribute a portion of your salary to the account. The specialty of this plan is that your employer may even match your payments up to a certain limit which helps grow your retirement fund. Your savings are invested in various assets providing you with a source of income in retirement. If you wish to understand and learn about 401(k) contribution limits, tax benefits, withdrawal restrictions, and more, reach out to a professional financial advisor who can guide you on the same.

What is a 401(k), and how does it work?

A 401(k) is one of the most popular retirement plans in America wherein the employer can choose to match their employee’s contribution to their retirement account. The standard matching ratio is 50 cents for every dollar but can go up to $1 for every dollar invested. There are two kinds of 401(k)s wherein you can invest your savings: Traditional 401(k)s and Roth 401(k)s.

In a traditional 401(k), employee contributions are deducted from their paycheck before taxes are calculated. This means that contributions directly reduce the employee’s taxable income for the year and can be reported for tax deduction during the corresponding tax year. The money is put into various investible assets and allowed to grow over time to benefit from the power of compounding. When you withdraw money from your account during retirement, the withdrawals are taxed as per the prevalent tax rate at the time.

Alternatively, in Roth 401(k)s, you contribute after-tax dollars to your account. Since your contributions have already been taxed, you can make tax-free withdrawals in retirement provided you meet certain conditions set by the Internal Revenue Service (IRS). The IRS stipulates that you must have held ownership of the account for at least 5 years and be 59.5 years of age or older to qualify for tax-free withdrawals.

[See: Tax-Saving Withdrawal Strategy for Retirement Income]

Understanding the nuances of this important retirement vehicle might help investors maximize their 401(k) balances. Individuals may also choose an aggressive 401(k) strategy to build a larger retirement corpus should their risk profile afford them the aggressive stance.

Let us discuss certain strategies that you can employ to maximize your 401(k) balance:

How to maximize your 401(k) balance

Let us find out certain strategies that you may use to maximize your 401(k) balance:

1. Matching your employer’s contribution

To get the most out of your 401(k), you must first understand the concept of an employer’s match. An employer’s match, also known as a business match, is a contribution to your 401(k) by your employer, provided you contribute to your account first. “Free money” is a term used to describe an employer’s match. Even if you are unable to contribute the maximum limit allowed for 401(k), you may still wish to make the most of your employer’s match. For instance, if your maximum contribution ceiling is 10% and you don’t expect to meet the same, it would make sense to contribute at least 8% so that your company contributes an additional 4%. An employer’s match is money that is included in your pay and benefits package. You are entitled to the same and claiming it can be beneficial for optimizing your 401(k) savings.

[See: What Happens When My Employer Suspends Its 401(k) Program?]

2. Assess your financial situation

A lot of 401(k) advice focuses on encouraging people to at least match their contribution limits each year. However, if doing so stretches you to your absolute limit, it might not be the smartest use of your money.

First and foremost, you may need to consider if you’ll require any of those funds prior to retirement. Early withdrawals from a 401(k) portfolio might result in severe penalties. Depending on how the withdrawn cash will be used, there are various exceptions. Qualified first-time homebuyers, for example, could be excluded from the early distribution penalty. However, if you need to save for some significant pre-retirement needs, a non-qualified account may be a better option.

In that sense, being aware of your financial circumstances and having a financial roadmap can help you take better advantage of retirement savings accounts like 401(k) and maximize the benefits of the same.

3. Studying various 401(k) investment options comprehensively

It is important for you to research and carry out an in-depth study of various 401(k) plans available in the market. For example, 401(k) participants can contribute before-tax dollars allowing them to save more money in the present that they can use for investment in the stock market, purchase a home, or spend on travelling. However, they do not have access to a wide range of investment options. That is not the case with an Individual Retirement Account or IRA. People who invest in IRAs have a wider pool of investment vehicles available to choose from and can make tax-free withdrawals in retirement on fulfillment of certain conditions. Learn about the benefits and unique offerings of each retirement account before selecting one.

For each choice, you may want to consider the following few questions – Is the underlying investment appropriate for your goals and risk appetite? In the event of a stock market crash, are you willing to still remain invested? Are mutual fund charges viable to you? etc.

4. Be patient and don’t withdraw funds during times of market volatility

401(k)s invest in stock markets that are well known for their volatility and risks. In cases of market downturns, it may be difficult to push away the thought of withdrawing but you must exercise caution and not make a hasty decision. Remember that you are investing with a long-term vision in mind and should act with caution rather than panic.

While stock market crashes are largely unavoidable, they’re a part of the growth cycle. It’s important to remember that the goal is to be patient and let the stock markets work for you. But, a majority of the individuals in such scenarios do choose to withdraw money.

However, you can maximize your 401(k) balance by patiently riding through periods of market fluctuations.

5. Modify your investment strategy with a change in your life stage

Every individual has a unique set of financial goals that they wish to achieve. Their risk appetite, their dreams, their health, whether they are married or divorced, with kids or without, plays an important role in how they approach their investment strategy and save for retirement. One golden rule is that as you get closer to retirement, you should consider shifting your investment mix away from more risky, potentially higher-growth assets like stocks, etc., toward less-riskier instruments like bonds, etc. Some investors may opt to make these changes themselves as part of a quarterly or annual rebalance.

While you may want to change your 401(k) investment strategy over time, you should have a particular goal in mind with regards to returns. Your targets and goals for asset allocation can change over the course of your investment. Hence, you should adjust and rebalance your portfolio at specific intervals of time to maximize your 401(k) balance.

6. Diversify your asset allocation

There are various ways to diversify a 401(k), and understanding how diversification works for asset classes is one of the most critical 401(k) decisions. While the circumstances of each individual may be different, having a mix of equities and fixed-income assets, such as bonds, is usually beneficial. For instance, rather than buying shares in a single American blue-chip company, or a single smaller company, you might be better off buying diversified funds in each of these categories, giving you exposure to the entire sector with effective risk mitigation and diversification.

7. Seeking professional guidance from a financial expert

You should seek expert guidance on how to expand your present portfolio and protect it from risk when nearing retirement. If you’re over 55 and want to get the most out of your 401(k), we recommend consulting with a third-party professional who can assist you in reallocating your investments based on your risk tolerance and time left till retirement.

To summarize

401(k) is a qualified employer-sponsored retirement plan wherein investors contribute pre-tax dollars to fund their retirement corpus. If your employer offers a 401(k), you might want to consider contributing to it. The payments are deducted automatically from your paycheck. Not only does this help you accumulate a considerable retirement corpus but also helps build investment discipline.

However, 401(k) plans have contribution limits that are revised by the IRS from time to time. For 2022, you can contribute $20,500 to your 401(k) plan and an additional $6,500 catch-up contribution if you are 50 years of age or older. Try and adopt the strategies discussed in the article to maximize your 401(k) balance, and save for a comfortable retirement

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