Paces Ferry Wealth Advisors, LLC is a registered investment advisor with the U.S. Securities and Exchange Commission (“SEC”). This material is intended for informational purposes only. It should not be construed as legal or tax advice and is not intended to replace the advice of a qualified attorney or tax advisor.
401(k) 101: Six Things You Need to Know Before You’re 50
Considerations for Your 401(K) as You Approach Retirement Age
Contributing to your 401(k) is a habit you’ll want to start as soon as you enter the workforce. Likely, it will become a yearly or monthly contribution you don’t actively think about for the most part. However, as retirement approaches, it becomes even more imperative for you to understand your 401(k) and the best ways to access it. Here are six things to know about your 401(k) as you approach age 50.
1. How Much to Contribute
There are several widely accepted strategies for contributing to your 401(k). You can choose the method of simply contributing as much as possible, or you can contribute 10% of each paycheck. These methods, while common, are not always the best strategy for your contributions.
For example, in the case of contributing as much as you can, it may not be ideal depending on what other assets you are growing. There are also tax considerations, and it may make a difference if your company offers a matching program.
The rule of 10% is easy to remember but can end up being a bad fit for your retirement plans. Depending on your current budget, 10% may be too much. On the other side of the coin, high-income earners may find 10% will not be enough for their retirement needs. Reaching out to a financial advisor can make the job of correct allocation of funds a much easier prospect.
2. Your 401(k) Investment Strategy
Your retirement years will, ideally, be some of the most relaxing and secure years of your life. The care you take preparing for them is going to dictate how your finances look in retirement. Despite this fact, a survey found that the average American spends more time choosing a restaurant to eat at than they do choosing their retirement investments. These retirement funds are a long-term game, and it is a mistake to invest in high-yield or risky funds to catch-up at the end. Below are three 401(k) investment strategies to consider.
Model Portfolios: These are portfolios that are designed by investment advisors and have a curated mix of assets. The portfolios are separated into three categories to accommodate the different investment strategies— conservative, moderate, and aggressive.
Balanced Funds: These funds allocate your investments into a mix of both stocks and bonds, usually at a dispersal rate of 60% stocks and 40% bonds. The steady balance of bonds will decrease the possible risk associated with stocks.
Target-Date Funds: Set to the date you expect to retire, target-date funds will diversify your assets and frequently become more conservative as the planned date of retirement approaches.
3. Vesting and Why it Matters
Vesting is one of the first things you will want to check when changing companies or starting your retirement. Vesting, in this situation, refers to your employer’s contribution to your 401(k) that you are entitled to.
There are stipulations regarding vesting, and paying attention to them can maximize your 401(k) potential before you leave a company. The two types of vesting to be aware of are cliff vesting and graded vesting.
With cliff vesting, you may have a minimum number of years you must work for the company in order to receive any of the company contributions. With graded vesting, the percentage you’re allowed to take with you will increase the more years you spend there. You can see how, in a situation like cliff vesting, missing the cutoff requirement by a couple of days or months can turn into an all-or-nothing scenario, which should be avoided when possible.
4. When to Cash Out your 401(k)
Your age at withdrawal and work status are contributing factors to the potential effects of cashing out your 401(k). You can, indeed, incur a 10% withdrawal penalty if you remove your money before you are 59 ½. However, some funds allow an early withdrawal penalty-free at 55 so long as you are also retired. There are also allowances for certain hardships. The bottom line is to learn what your options are before withdrawing so you won’t get surprised by any fees or penalties.
5. Outstanding 401(k) loans
Avoiding a 401(k) loan is a good idea if you can manage it. Even if you’re paying yourself back with interest, it is still a missed opportunity for potential growth, had the money remained invested. If your 401(k) loan is outstanding at the time of retirement or when you leave your company, it can spell bad news for you. If not paid off, the entire loan may be treated as a distribution, and you’ll be taxed on it accordingly. Make sure you’ve paid any outstanding 401(k) loans before changing companies. Your retirement will thank you for it.
6. How and When to Remove your Money
As you near retirement, you’ll want to determine how and when to remove your funds. Of equal importance is knowing what to do with them once you have them in your possession.
If you have an issue with debt and feel like you need to withdraw from your 401(k), the act of accessing the account can potentially void the protections in place and open it up to creditors.
One popular option is to roll over your 401(k) into an IRA because it broadens your investment choices and gives you more options to make withdrawals. In this scenario, however, you would lose the benefit of a penalty-free withdrawal and incur taxes on the money you withdraw from the IRA. While there is no hard line against touching the funds once they are in your 401(k), you’ll want to be mindful of knowing the pros and cons before you do it.
Final Thoughts on What to Know About Your 401(k) Before Age 50
As you approach retirement age, you’ll need to consider your 401(k) more strategically than ever before. While each person’s circumstances are unique, the considerations above will help you to begin planning for the next phase of life – your retirement.
At Paces Ferry, we use our experience and vision to help you plan for retirement and feel secure about your finances. If you’re interested in starting a conversation about your retirement plan, please reach out today.