The 401(k) is a popular retirement savings vehicle for a number of reasons, including its prevalence, potential for an employer match, and the income tax advantages — all of which are appealing to workers socking away wages for retirement. There was $5.6 trillion in 401(k)s at the end of last year.
But with so many people using 401(k) plans, it’s worth asking if they are really making the most out of all a 401(k) retirement plan has to offer. After all, you only want to retire once and you don’t want to leave any money on the table. Here are five ways to maximize your 401(k) this year.
1. Employ tax-efficient asset location
Traditional 401(k) plans, which means they are non-Roth accounts, come with two major tax advantages: Contributions and investment gains are not taxable until you withdraw the money. The contribution is tax-deductible, so it lowers your taxable income in the year you make it which saves you taxes today. Then, investment gains are tax-deferred, so more money gets reinvested back into your portfolio, growing your nest egg.
One way to make the most of the tax deferral is by being aware of asset location, which is different from asset allocation. Asset location refers to putting tax-inefficient investments like those with high trading volume (such as actively managed mutual funds) or those that pay out a lot of interest or yield (such as high-yielding bonds and real estate investment trusts, or REITs) in places that don’t tax the gains, like a 401(k).
By housing tax-inefficient investments in a 401(k) and rather than a regular brokerage account, you avoid the income tax levied on the interest and earnings of your investments. Accounts outside of the 401(k) are good places for index funds that are usually tax-efficient, or individual stocks that are also tax-efficient — meaning you don’t trade them a lot and don’t incur taxable gains. Maximizing a 401(k) means making the most out of a 401(k)’s tax deferral by using that as a place for your tax-inefficient investments.
2. Avoid fees
You may not see a bill for investment services, but fees are debited from your 401(k) mutual funds every day. Fees are a drag on your return, which means less profit for you and a smaller nest egg in the long-run.
When choosing investments inside your 401(k), it’s a good idea to know what the fees are. You can check with the fund administrator or read the required summary plan document that every 401(k) has. Some active mutual funds are more expensive than others. Fund families like Vanguard or T. Rowe Price usually are inexpensive, while other active mutual fund fees can be egregious. Try to keep 401(k) mutual fund fees below 1%.
5. Check your beneficiaries
As with any other account, make sure the beneficiaries are up to date. This may sound like mundane common sense, but our lives have a way of changing, and you want to make sure your primary and contingent beneficiaries are current. This is especially true for 401(k)s left behind at a previous employer which are sometimes forgotten.
The 401(k) is a great place to save for retirement, and if you maximize all of what the plan offers, your money can work smarter and harder.