The Most Common 401(k) Questions Answered
Understanding your 401(k) isn’t just smart – it’s essential to safeguarding your retirement lifestyle.
Whether you’re just getting started or looking to optimize your existing plan, it’s critical to ask the right questions so you’re not left in the dark about your investments.
Below, we’ve outlined 5 of the most frequently asked 401(k) questions and the answers you need to feel confident about your next move.
#1 What Type of Contributions Should I Make?
One of the first things to evaluate is how you want to contribute to your 401(k).
If your employer offers both a traditional and a Roth 401(k), it’s worth understanding the distinction.
The Roth plan option is a type of 401(k) you fund, just like a traditional 401(k), but it has different tax benefits.
The key difference is you receive a tax break today if you contribute to the traditional 401(k) each year.
With the Roth 401(k), you lose the opportunity of a tax break upfront since your contributions are made with after-tax dollars. But your earnings are tax-free in retirement.
With a Roth 401(k), you must wait until the future to enjoy tax benefits.
This is a personal decision.
Some people need a tax break today, while others aren’t concerned with it and would rather have their retirement totally tax-free.
[Related Read: Pros and Cons of a Roth 401(k): Key Differences and Tax Implications]
#2 What Are My Investment Choices?
A common concern among plan participants is the quality and variety of investment choices in their 401(k).
Many employers automatically enroll new hires into default investment options, most often a target date fund. While these funds are designed for convenience, they may not always align with your unique needs.
The issue with target date funds is that investors are grouped solely based on their expected retirement date, while other important traits, such as location, profession, salary, risk tolerance, goals, and objectives, are NOT taken into consideration.
Target date funds were created to take away the hassle of having to research mutual funds in your 401(k) and build and construct your own portfolio. They make investing easier.
But the reality is that target date funds may often underperform in good markets and may do a poor job of managing downside risk during down markets.
They do not take into consideration changes in the economy, tax policy, trade, earning reports, or investment trends – and may not make adjustments for any of these driving factors that affect investment performance.
If these adjustments are not made, you may not stay on course to reach your retirement goals. You’re not stuck, though. You do not have to stay with the default option.
Contact your plan representative or HR department and find out if you were automatically enrolled in a target date fund or not.
If you are, then your second step is to find out what other 401(k) investment options are available to you.
[Related Read: Why Relying Only On Target Date Funds May Hurt Future Retirement Account Performance]
#3 Should I Roll Over My Old 401(k)s or Not?
Another important 401(k) question investors have is what they should do with their 401(k) when changing jobs.
Should they just leave the 401(k) behind? No!
Here are the options for 401(k)s when you change jobs:
- Leave the money behind in the former employer’s 401(k) plan. We don’t recommend it, but it is an option.
- Roll over the 401(k) savings into an individual retirement account (IRA). This option allows you to consolidate more than one 401(k) account into an IRA.
- Roll over the old 401(k) into a new 401(k) account if permitted by your new employer. If you have at least $5,000 saved in your old 401(k), most companies allow you to roll the 401(k) over.
- Cash out your 401(k). While this is an option, you will face penalties and pay taxes for cashing out before age 59 1/2.
Each choice has its own set of considerations regarding taxes, investment options, and fees.
It’s critical to understand the rules before you make the move.
[Related Read: 401(k) Rollover Mistakes to Avoid]
#4 Is It a Bad Idea to Borrow from My 401(k)?
Borrowing from your 401(k) seems appealing because 401(k) loans require you to pay interest to yourself rather than a creditor.
With a 401(k) loan, you can borrow as much as your 401(k) plan allows as long as the funds are paid back within 5 years.
However, there are other considerations.
Some 401(k) plans do not allow you to contribute to your 401(k) plan while you have a 401(k) loan, which means you cannot grow your nest egg.
If you fail to pay back the 401(k) loan, the loan may go into default and be converted to an early withdrawal.
Early withdrawals are also costly.
Even if you are tempted to take an early withdrawal from your 401(k), consider the penalties.
[Related Read: 401(k) Early Withdrawals May Cost You More Than You Think]
The IRS requires automatic withholding of 20% of a 401(k) early withdrawal for taxes.
In addition to withholding taxes, the IRS will also penalize you with a 10% penalty on all funds withdrawn when you file your tax return if you’re under the age of 59½.
That’s not all.
The amount withdrawn is taxed as ordinary income for the year the money was taken out – which could push you into a higher tax bracket, and you’ll be forced to pay even more taxes.
Should you take money from your 401(k) early – whether it’s a 401(k) loan or withdrawal – you miss out on the compounding effect and the potential growth.
As a result, taking money from your 401(k) before retirement may significantly impact your retirement savings over time.
#5 Do I Really Need Help with My 401(k)?
It may be well worth your time to get third-party advice – especially when it comes to something as important as your retirement future.
David Blanchett, former Head of Retirement, CFP, CFA at Morningstar reported that participants that received expert guidance had as much as 40% more income during retirement versus those who received no help at all.¹
401(k) Maneuver provides professional account management with the goal to help you grow and protect your 401(k).
Our goal is to increase your account performance over time, manage downside risk to minimize losses, and reduce fees that harm your account performance.
There are no time-consuming in-person meetings and nothing new to learn, and you don’t have to move your account.
Simply connect your account to our secure platform, and we regularly review and rebalance your account for you, when necessary. Check here for more info on how it works.
Have questions or concerns about your 401(k) performance? Book a complimentary 15-minute 401(k) strategy session with one of our advisors.
Sources
- David Blanchet, Morningstar Analyst 2014, “The Impact of Expert Guidance on Participant Savings and Investment Behaviors”
