Welcome back to our series of blogs on Blind Spots! We all have Blind Spots, things that are potentially hazardous that we don’t even see, things that we should know, or have awareness of, but don’t. This series of blogs focuses on common financial Blind Spots that we see when working with our clients.
Many of you work for an employer that has a 401k plan. Hopefully, you are taking advantage of the plan as part of your retirement savings strategy. In working with our clients over the years, we have discovered that there are several Blind Spots that relate to 401k plans. Here are a few of the most common that we see. I wonder how many of these apply to you?
How much you can contribute, including catch up: Do you know how much you are allowed to contribute to your 401k? In 2019, the annual limit is $19,000. This amount increases periodically to keep pace with inflation. Also, if you are over 50, you can also make catch up contributions of $6,000/year.
The match formula: If you are fortunate, your employer may match some of contributions. A typical match is 100% of contributions up to 3% of salary. Make sure you get all of your employer’s match – it is “free money.”
Vesting schedule: If your plan includes employer contributions that aren’t tied to your contributions or are paid as part of profit sharing, there might be a vesting schedule – meaning that you can’t access all of the employer’s contributions until a certain number of years have passed. Make sure you understand the rules so you don’t forfeit money if you change jobs.
ROTH provisions: Does your 401k have ROTH provisions? This allows you to make after tax contributions that grow tax free and can be withdrawn tax free in retirement (as long as certain provisions are met). Make sure you consider making ROTH contributions, particularly if you are young.
Default Investment Alternative (QDIA): All 401k plans must have a default investment choice; so that, if you forget to choose investments for your 401k contributions, the plan will automatically invest them in the default choice. Check to see if your funds are invested in the QDIA and if that is really the proper investment choice for you.
Target Date Funds: These are funds that contain a predefined mix of stock and bond mutual funds that are designed for an employee retiring in a certain year; for example, a “2025 Target Date Fund.” These funds have no flexibility. Their investment mix is defined by the prospectus, so they can’t move in or out of a particular investment even if the investment environment dictated so. Don’t just choose this fund. Understand what is in it, and decide if this mix is okay with you. While the target date is the approximate date when investors plan to start withdrawing their money, the principal value of a target fund is not guaranteed at any time, including at the target date.
Loan provisions: Some (not all) 401k plans allow you to take loans out against your balance. Different plans have different loan provisions. In most cases, if you leave the employer before the loan is paid off, the loan balance is due immediately! If you can’t pay off the loan, it will be considered a distribution and will be taxed and possibly incur an additional 10% penalty.
So, these are just a few of the most misunderstood provisions in 401k plans. And, there are many more. As such, we have coined the entire 401k as a Blind Spot for most people! If you are like most people, your 401k may very well be your largest investment account. It is an important part of your long term planning. Please make sure you understand how to best leverage your plan.
As they say, “You don’t know what you don’t know.” Without being aware of your financial Blind Spots it is almost impossible to make sound financial decisions. At Second Half Strategies, we try to identify and help you uncover your various financial Blind Spots. Our Wealth Management process includes Planning, Guidance and Advice. By following our process, you should have the confidence to know that you are taking proactive steps to uncover and eliminate your 401k Blind Spots!
What process are you using to find and address your Blind Spots?
Content in this material is for general information only and not intended to provide specific advice or recommendation for any individual. No strategy assures success or protects against loss. Investing involves risk including loss of principal.