Have you thought about your 401(k) lately? A 2017 survey from Scarborough Capital Management found that 43.6 percent of retirement savers spend just one to two hours per year managing their workplace plan. A little more than 25 percent said they lacked basic know-how about their 401(k).
If you’ve been more hands-off than hands-on with your plan, the beginning of a new year is a prime opportunity to check in and see how your portfolio is progressing.
“The largest problem people face with preparing for retirement is apathy,” says Barry Kozak, a consultant with October Three Consulting in Chicago. “If you get in the habit of looking at all the benefits, rights and features of your plan each year, you’ll actually start to appreciate it more.”
Turning a blind eye to your 401(k) also runs the risk that you’ll become complacent about your investments, which can have significant consequences. For instance, your portfolio may underperform, or you may unknowingly expose yourself to more risk than is comfortable or necessary.
Complacency is something you simply can’t afford, especially if a 401(k) is the cornerstone of your retirement strategy. Today’s investors must be more proactive with retirement planning and investing because “the days of the traditional pension fund are gone,” says Marc Doss, regional chief investment officer for Wells Fargo Private Bank in San Diego.
[See: 12 Steps to a Stronger 401(k).]
Updating your annual contribution rate, asset allocation and overall investment strategy in early January can set the tone for how you manage your plan the rest of the year. “Just like everyone should have an annual physical, so should everyone annually review their 401(k)s,” Doss says. As the new year begins, taking these four steps should keep your 401(k) healthy.
Find your target contribution rate. Automatic 401(k) enrollment makes it easier than ever to join an employer’s plan, but there’s an unintended downside if you enrolled at a low default contribution rate.
In 2016, default contribution rates for 401(k)s with automatic enrollment ranged from 1 to 8 percent, with an average rate of 4.2 percent, according to investment consulting firm Callan. Doss says most people need to save 10 to 20 percent of their income to accumulate sufficient retirement wealth in their employer’s plan. “Most financial plans allow for withdrawal rates of 3 to 4 percent of the asset value over retirement,” he says. “This means someone with $1 million in a 401(k) at retirement can withdraw $30,000 to $40,000 annually, which is a much lower amount than most investors realize.”
Default contribution amounts are a good start, but that’s all it is — a start, says John Lescure, first vice president for Maine and New Hampshire at People’s United Wealth Management. “No one’s worried about having too much money in retirement,” he says, and the ultimate goal should be maxing out your plan contributions each year if possible.
Auto-escalation can help you do that. This feature, if your plan includes it, lets you increase contributions incrementally each year. At a minimum, Doss says, your contribution rate should be enough to get the full match from your employer.
Review your asset allocation. How much you save in your 401(k) is only one ingredient of retirement planning success. What you invest in is just as critical.
Target-date funds, for example, are becoming an increasingly common default investment of 401(k) plans. According to Callan’s research, 88 percent of defined contribution plans made target-date funds their default investment option in 2016.
Although target-date funds can ease some of the pressure of choosing an ideal asset allocation, they may not be right for every investor. If you have a higher — or lower — risk tolerance, you may need to look at what else your 401(k) plan offers.
[See: 7 Tips for Finding the Best Target-Date Retirement Funds to Buy.]
Lou Cannataro, partner at Cannataro Park Avenue Financial in New York, says risk capacity, or the amount of risk you need to take to satisfy your investment objectives, is often overlooked. He says investors may have the stomach to handle a drop in the market if they know that over time it will rebound, but often don’t consider whether their investments are equipped to deliver needed income during an extended market downturn. “It’s not enough to understand this is a marathon, not a sprint; your investments [also] have to be prepared for periods of what may feel like uphill terrain.”
As you review your asset allocation, rebalance your portfolio as needed. “Investors should rebalance at least annually, and the beginning of the year is an appropriate time to act on that discipline,” Doss says.
Check the plan’s fees. Fees can detract significantly from 401(k) investment earnings. According to consulting firm NEPC, the average expense ratio of 401(k) investments dropped to 0.41 percent of assets, while the cost of the plans, including management fees, record-keeping and trust and custody services, notched up 0.43 percent in 2017.
Kozak acknowledges that excessive fees have become less of a problem, but he advises investors to still look closely at the net returns after fees and commissions on their investment options. In other words, as you review your plan at the beginning of the year, consider whether the expense is justified by the returns your 401(k) investments generate.
Performance can often blind investors, Lescure says, particularly during a sustained bull market. To find cost-efficient, consistently performing investments, read the plan’s disclosure documents, analyze each fund’s fees and consider how recently your administrator benchmarked the plan to determine whether the fees are reasonable.
Assess your tax situation. A traditional 401(k) uses pre-tax dollars, but making the switch to a Roth 401(k), which is funded with after-tax dollars, has its advantages. “Many people don’t realize that socking away so much money into your traditional 401(k) can create what we call a tax torpedo in retirement,” says Megan Clark, CEO and executive wealth manager of Clark Financial Solutions in Reston, Virginia.
[See: 7 Things That Can Derail Your Retirement Investing.]
If 401(k) withdrawals push your income higher in retirement, that can affect how much you pay for Medicare premiums and your taxes in general. Converting to a Roth 401(k) can temporarily inflate your tax bill in the year of the conversion because you’ll have to pay income tax on pre-tax contributions, but you’ll get the benefit of tax-free withdrawals in retirement.
“The analogy we use all the time for this question is would you rather pay taxes on the seed or the harvest?” Clark says. The former is what you put in and the latter, what you take out. “If there’s a Roth option in your plan, you should be using it.”
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Give Your 401(k) a New Year’s Checkup originally appeared on usnews.com