By W. Devin Wolf
Courtesy to The Bellingham Business Journal
1. Take the free money
Make sure you are taking advantage of your employer match. They have been increasing, with most offering a dollar-for-dollar match for the first 6 percent of employee deferrals (up from $0.50 per $1), according to a 2013 survey from the AON Hewitt consultancy.
If you aren’t participating in your employer’s retirement plan or maximizing the matching opportunities, you are drastically reducing your chances of success.
Think of it this way: If an employee is making $50,000 per year, contributing 6 percent for 35 years, receiving a full match on the first 6 percent and earning a 6 percent annual return, then that employee is not only missing out on the $357,958 from their contributions, but they are also missing out on an additional $357,958 from the matching contributions for a total of $715,916. Not bad considering this employee only contributed $105,000 of their own money.
2. Increase your savings
The 401(k) contribution limits are set to stay the same in 2014, allowing employees to contribute $17,500 annually with an additional $5,500 “catch up” contribution for those turning 50 or above in 2014.
Not only will the increased savings increase your chances of retirement success, but qualified retirement plans receive tax deferral. This means that when you have dividends, interest and realized gains in your retirement account, you don’t owe taxes in the current tax year. By deferring the taxes until later, the money you would have spent on taxes is put to work increasing your nest egg.
It is always best to make your savings automatic, and some plans allow you to set up automatic annual increases to your contributions as well. If you don’t have this luxury, make it a point to increase your contribution percentage every time you get a raise.
3. Save to the proper account
According to AON Hewitt, half of all plans now include a Roth 401(k) option. With the Roth option, you forego the immediate tax savings of the traditional 401(k), but in return receive tax-free growth.
The key to determining which account is right for you is understanding your taxes relative to the tiered-income tax brackets. If you think you will receive a greater tax deduction now relative to your tax bracket in retirement, the traditional 401(k) may be best.
Are you uncomfortable predicting future tax brackets? Me too. One strategy to combat this is to diversify between Roth and traditional 401(k) accounts.
Let’s say you are in the 25 percent tax bracket by $10,000 of taxable income. In this case, you might want to save your first $10,000 to the traditional 401(k), locking in the immediate 25 percent tax savings, and the remaining $7,500 contribution to the Roth 401(k). By doing this, your tax rate on the Roth 401(k) contribution will be reduced to the 15 percent bracket.
For those really excited about the Roth 401(k) option, the Taxpayer Relief Act of 2012 allows in-plan Roth conversions. Essentially, you are able to pay the tax and move assets from the traditional 401(k) to the Roth 401(k) if your plan supports this feature.
4. Reduce expenses
Retirement-plan expenses have been a hot topic lately. 408(b)(2) regulations implemented in 2012 require that fee information be provided to each employee. While you may not be able to control plan expenses, you can review investment expenses and select more cost effective investments.
Use a free service like Morningstar to view the fund expenses and avoid investments with loads, 12b-1 fees or high administrative fees. These expenses have nothing to do with the actual management of the investment, and you may actually be paying for more of the plan level expenses by using these funds.
Too often, investors feel like they are diversified because they invest in multiple mutual funds. Diversification is about what you own inside of the mutual funds and how diversified these holdings are.
You can use a free service like Morningstar’s portfolio x-ray to see how your portfolio looks as a whole. For stocks, review diversification between regions, market capitalization (Large Cap, Mid, and Small), valuations (growth versus value) and sectors.
Review your portfolio to make sure you are taking an appropriate level of risk and you are fully diversified. Company stock can increase risk and reduce diversification. If you hold company stock and the company folds, you lose both your job and your retirement.
Finally, once you have built the right portfolio, be sure to routinely rebalance the account. Many plans allow you to automatically rebalance, or buy and sell the funds in your portfolio to get back to your desired asset allocation, once per year.
W. Devin Wolf is a certified financial planner and a wealth manager at the fee-only firm Financial Plan Inc., in Bellingham. He leads the company’s 401(k) branch and serves as chief investment officer, helping families, corporations and foundations make smart financial decisions. Financial Plan Inc. is online at www.financialplaninc.com.
This is the first of four installments featured this week on BBJToday.com that offer year’s end financial advice for business and personal life. Contributing writers’ columns are also featured in the December edition of The Bellingham Business Journal.