As we roll through February a large number of individuals are starting their first job. They sit down with their Office Manager or Head of HR, get a huge packet of stuff to sign and head on their way. Often, buried in that packet are enrollment instructions for the company 401K. So now what? Here a few things to keep in mind.
- Should I enroll ? Yes…if you can. Graduates these days face new challenges that previous generations did not. Their student loans are the highest in history and purchasing homes, particularly on the coasts, will require a sizeable down payment. Often, my conversations with these new employees center around which goals should be attacked first. Building an emergency cash reserve along with a game plan to pay down/pay off student debt are the main priorities. Typically we will investigate whether the company offers a matching contribution. If they do, trying to maximize that or, at least, capture some of that is a goal. After all, free money is never a bad thing….and compounding of free money over the next 40 years is even a better thing. It’s easy for an advisor to say “do it all!” It’s just not realistic. Cost of living is increasing and the income we make is finite. Working with an advisor, prioritizing your goals and investigating various outcomes will help you decide how to allocate your dollars efficiently .
- Is there a ROTH option? If there is, look closely at that option for your contribution. If you are in your 20’s you are looking at probably 40 years before you are turning that 401K into income. 40 years of tax deferred growth coupled with tax free withdrawals can be a powerful tool for you. There’s a saying I often hear when I’m meeting with clients, “Well I’ll be in a lower tax bracket when I retire anyway.” Will you? How do you know that? I don’t plan for my clients to live on less income in retirement. It may happen, but that’s not the strategy. What about tax brackets? Who is to say that in 20, 30 or 40 years that less income won’t be taxed at the same bracket you are in during your working years? The reality is nobody knows what you’re tax bill will look like in retirement. So if you have the ability to add some tax free income to the plan, think about it.
- What the hell is a target date fund? I hate to use the term “set it and forget it ,” but I guess I’m using the term “set it and forget it.” A target date fund simply allows you to set a target year for retirement and select a fund whose allocation is designed around that target retirement year. Target date funds are typically diversified with various stocks and bond mutual funds, both domestic and international. The further out your projected retirement, the greater internal allocation you will have to stocks. As you get closer to retirement, the fund then adjusts on its own and gradually moves the allocation away from stocks and into bonds. One thing to keep in mind, these funds are not typically cheap on internal expenses. If your plan offers index options, you may be able to build your own portfolio that mirrors the diversification of the target date fund but for lower fees.
- Do beneficiaries matter? Yes! When I do reviews of my client’s retirement plans , one of the first things we look at is the beneficiary named on the account. Particularly for people who have worked at the same company for a long time, life has probably changed a great deal since you started. You were single, now you’re married. You didn’t have kids, now you have 3. You were married, now you’re divorced. The bottom line is life brings change. The important thing to remember is your will (Which you should have and we can review that in another post) does NOT trump a beneficiary designation. Be sure to update your beneficiary or beneficiaries as life changes.