Retirement financial planning can be complicated, balancing investment options with tax strategies and personal goals. So even though the 401(k) open enrollment period for most companies is near the end of the calendar year, towards the end of summer it’s already time to start planning. There are numerous other investment options, but here we’ll focus on 401(k) accounts.
Why and When
It’s wise to review and revise your employer retirement plans each year along with your health and dental insurance, including disability coverage and dependent care benefits. Otherwise you’ll be locked in to your current plans unless there’s some qualifying event such as a major life change. And that could mean forgoing important benefits for a full year.
The open enrollment season for 401(k) accounts and other employer retirement plans typically last for a month or two, most commonly November and December. Your employer should notify you of opening dates and enrollment deadlines, along with sending you an enrollment information package and forms. New employees may be offered an enrollment period shortly after their hire, or they may instead have to wait until the next regular period.
Automatic savings are one of the key ideas behind these plans. You’ll be able to set an amount to be withheld from your paychecks and invested into the account. That stays the same every month so you’ll need to think through your living expenses and maintaining an emergency fund as well as your retirement goals.
Deciding on the investments that are right for you is arguably a more difficult task, and one involving perhaps as much judgment as number crunching. Each employer sets their own investment “elections.” You’ll typically be choosing from a variety of mutual funds. Some emphasize low-risk investments such as bonds while others concentrate on a more aggressive portfolio of stocks. Still others may include various combinations of bonds, stocks, and other securities. Always keep in mind that aggressive high-growth options carry higher risk. Those early in their careers often go for a growth strategy, having many years to recover from any period of losses. But nearing retirement age it’s usually best to choose low-risk options for capital preservation. And don’t forget to consider fees — these can take a significant chunk out of your investments growth.
Taxes, Roth, and Roth 401(k)
But should you be considering a 401(k) plan in the first place?
Your 401(k) contributions grow on tax-deferred basis — taxes aren’t assessed and paid until you withdraw funds during retirement. (If you make a withdrawal before that there’s an additional 10% early withdrawal penalty.)
It’s a good choice when your tax rate during retirement is expected to be lower than your current rate. That’s commonly the case for higher-earners well along in their careers. You contributions are pre-tax, giving you a tax break and putting more dollars into the account.
Young investors may be better off with a Roth retirement account. Investments are post-tax, that is after income taxes have been deducted. The account then grows tax-free, and your distributions in retirement aren’t subject to tax. But it’s not an either-or situation. You can choose to put some of your annual contributions into a Roth account and others into a regular IRA. And/or choose a “Roth 401(k)”.
When an employer makes matching contributions to a plan it’s usually a no-brainer for you to contribute. Otherwise you’re leaving free and tax-free money on the table. That could mean thousands of dollars each year, with some generous matches doubling your money.
There are many other considerations. Each person’s situation is different, and changes over the years. For example it might be better to pay off high-interest debt before contributing to a retirement savings account. On the other hand, with an employer match it could well be better to invest up to that match amount.
It’s always good to educate yourself and know as much as you can. But better still to consult a financial adviser as well.