The history of 401(k)s is a surprisingly short one — brief enough that there are undoubtedly people in today’s workforce who began contributing to a 401(k) when the option was first introduced.
401(k) plans grew out of the Revenue Act of 1978, which went into effect in 1980 and was designed as a way to provide a tax-free way for employees to defer compensation from bonuses and stock options. Employers soon saw the potential to create tax-advantaged retirement savings plans for employees as well. In 1981, the Internal Revenue Service began allowing employees to make such contributions toward their retirement, and 401(k)s became an increasingly common retirement option offered by employers.
In 1996, the amount held in 401(k) plans in the United States reached $1 trillion. In this same year, 401(k) Day was established on the first Friday after Labor Day.
401(k) Day is an excellent time to educate yourself about your retirement options and your current plan. Here are some helpful steps you can take:
Reviewing your 401(k)
Life is busy, so it’s easy to lose sight of your 401(k)’s performance. 401(k) Day can help remind you that checking in on your 401(k) at least once a year is advisable, with more frequent reviews as you get closer to retirement. This process allows you to assess the account’s performance, identify any potential problems, and make changes as needed.
Your review should include:
- The contribution amount: Aim to maximize your 401(k) contributions, saving as much money as possible while still retaining a comfortable debt-to-income ratio (below 36 percent) for your ongoing expenses. Make sure you’re saving at least as much as your employer is willing to match; not doing so is essentially leaving free money on the table.
- Performance indicators: Check the growth of your investments and compare them to overall market performance as reflected by major indexes like the Dow and S&P 500. Adjust your investment mix if your portfolio is underperforming or does not align with your retirement goals.
- Your risk tolerance: Assess how comfortable you are with the current markets, and whether you want to pursue safer, low-risk investments or higher risk investments that will potentially yield higher returns.
- Expense ratios: Higher expense ratios will hamper the growth of your 401(k) and lead to lower returns over time. Review these ratios and explore options for lowering them.
- 401(k)s from previous jobs: Accounts left with a former employer have more limited growth potential, and can be lost entirely if you forget about them. Check for former accounts using the Labor Department’s Employee Benefits Security Administration search tool, and roll any former 401(k)s to your current plan or to an IRA.
- Beneficiary information: Your 401(k) should designate beneficiaries who will receive the account’s assets in the event of your death. Update these beneficiaries if necessary.
Is your 401k on track with your retirement goals?
One of the favorite phrases at Grey Ledge Advisors is, “You have enough.” It’s always rewarding to tell a client that they’ve saved up enough money to retire.
You’ll need to carefully weigh a number of factors before you get to this point. Does your 401(k) have enough money to support your basic needs such as housing, health care, food, utilities, and transportation? Are you planning to make any lifestyle changes, like traveling more? Do you want to leave money to your heirs or charitable causes? Will your 401(k) savings be able to keep up with anticipated inflation?
Some common retirement savings goals include having 10 times your annual salary on hand at the time of your retirement, or having enough that you can meet your expenses by withdrawing only 4 percent of your retirement savings each year (which will make the account last 30 years). You can also use a retirement calculator to determine the savings you’ll need to comfortably retire.
Everyone’s circumstances are different, and 401(k) Day is a good reminder to set up a meeting with a financial advisor. These professionals can review your 401(k), offer personalized guidance, and determine what changes are necessary.
Is it time for a change?
By reviewing your 401(k) at least once a year, you can update it to better reflect your current circumstances and your retirement goals. Rebalancing is a process where you reallocate your asset mix to adjust your risk tolerance and pursue higher-performing investments.
Some common reasons for rebalancing a portfolio include:
- Life events: Personal circumstances such as change in income, the birth of a child, unexpected health care expenses, or higher education costs will affect how much money you can comfortably contribute to your 401(k). This, in turn, will affect other factors such as your risk tolerance and financial goals.
- Market performance: Periodic rebalancing allows you to adjust your investments based on current market performance and forecasts. It also allows you to adjust your asset allocation if certain investments are underperforming.
- Updated goals: If you’re seeking to move up your retirement date, or push it back, rebalancing lets you adjust your 401(k) accordingly.
What if I don’t have a 401(k)?
You may not have a 401(k) if your employer doesn’t offer retirement benefits, if they offer a different type of retirement plan, or if you’re not eligible for your company’s 401(k) plan. Alternatively, you may have simply neglected to sign up for an employer’s plan, or opted out due to financial constraints. You may also lack a 401(k) if you’re self-employed.
401(k) Day is a good time to research the options available at your workplace and explore other retirement options, such as solo 401(k)s that can support a self-employed person and their spouse. Consult with a financial advisor to review your budget and set up a savings plan; even a small amount put toward retirement each paycheck can add up substantially over time.
The professionals at Grey Ledge Advisors will offer the support necessary to get your 401(k) and retirement goals on track. Contact us today using our online form or by calling 203-453-9075.