How to Make the Most of Your 401(k) (or 403(b)/457)

Transcription

2 Why a 401(k) (or a 403(b)/457)? Payroll deduction is an easy and convenient way to save for retirement Your employer may provide matching funds that help your retirement savings grow faster Earnings in the account grow tax-free or tax-deferred You get a tax break when you contribute to the plan (with a Traditional account) or when you take money out (with a Roth account) once you reach age 59½ 2

3 4 Key Questions to Ask How Good Is My Plan? Are My Savings on Track? How Should I Allocate My 401(k), 403(b), or 457 assets? What Do I Do With the Assets When I Leave My Job? 3

4 Question 1: How Good Is My Plan? Things to consider: Fund lineup Fund expenses Plan expenses Company match Roth 401(k) option Availability of additional help 4

5 Fund lineup At a minimum it should include: U.S. large-cap stock fund U.S. small-cap stock fund Foreign-stock fund Bond fund Index funds: often your cheapest option Target-date funds: good for set-it-and-forget-it investors 5

6 Fund expenses Charged by the company that runs the fund Appear on your plan disclosure statement and expressed as a % of assets and as a dollar amount per $1,000 invested Actively managed (non-index) funds should charge no more than 1%; index funds no more than 0.25% 6

7 Plan expenses Charged by the plan provider to cover record-keeping, customer service, administrative costs, etc. These may be spelled out on your plan documentation, or you may need to ask the plan administrator Find out about fees charged for services such as using the plan's brokerage window or taking out a loan Smaller-company plans tend to cost more for participants than largercompany plans Median 401(k) fees per participant (including fund and plan expenses; Source: ICI, 2011): Plans with <100 participants: 1.29% Plans with >10,000 participants: 0.43% 7

8 Company match Money the company contributes to the plan on your behalf Typical setup: Employer contributes 50 cents for each dollar you put in, up to 6% of pay Find out the vesting schedule when the matching money becomes yours Even in a poor plan, it often pays to contribute at least enough to get the match 8

9 Roth 401(k) option Allows participants to invest post-tax money today in order to enjoy tax-free withdrawals in retirement Best used by those who expect their income tax rates to be higher in retirement than they are today May be combined with a Traditional 401(k) for tax diversification 9

10 Additional plan features Find out if the plan offers free investment advice Ask about plan rules for hardship withdrawals to cover medical or college costs, or to purchase a home, for example 10

11 If your plan is bad Talk to the company benefits department about where it falls short they may not be aware of the problems Consider saving enough for the company match, then maxing out an IRA, then adding to the plan 11

12 Question 2: Are My Savings on Track? Things to consider: The role your 401(k) plays in your retirement plan How much you will need in retirement Road-testing your savings plan 12

13 The role your 401(k) plays in your retirement plan Other retirement-savings vehicles may include: IRA Social Security Your home (downsizing, reverse mortgage, etc.) Other savings 13

14 How much you'll need in retirement Lots of moving parts: number of years until you retire, how much you've saved so far, your savings rate now and in the future, whether you will work in retirement, whether you have a spouse who also is saving, and when you will take Social Security Common (but imperfect) rule of thumb: save 15% of pay, including the company match and any IRA contributions Better still: Use online retirement calculators to see where you stand; the more detailed, the better; try at least three different ones Consider talking to a fee-only financial advisor if needed 14

15 Road-testing your savings plan As you get closer to retirement, use the 4% rule to see where you stand Example: You've saved $500,000. Could you live on 4% of that amount ($20,000) plus Social Security your first year? If you don't have enough saved, ramp up saving and/or consider working longer 15

16 Question 3: How Should I Allocate My 401(k), 403(b), or 457 Assets? Three key ways to allocate your 401(k) or other company retirement plan Method 1: Buy a target-date fund and call it a day Method 2: Take advantage of advice engine provided by your plan Method 3: Allocate your own assets 16

17 Method 1: Buy a target-date fund and call it a day How it works: Target-date funds are designed to be set it and forget it Pick the fund that matches your anticipated retirement date, and the target-date fund takes it from the there: sets and updates stock/bond mix and selects underlying investments Morningstar s favorite target-date series: T. Rowe Price, Vanguard 17

18 Method 1: Buy a target-date fund and call it a day Pros You don t need deep investing knowledge Enables you to take advantage of professional asset-allocation advice Limited upkeep requirements; may help you combat bad behavior Cons Eggs in one basket: Most target-date funds feature funds from a single firm, and few firms do everything well Target-date funds aren t universally good; some are costly or draw from subpar lineups Preset stock/bond mix may or may not suit your situation 18

19 Method 2: Take advantage of advice engine offered by your plan How it works: You answer a series of questions about your financial situation and other assets Advice engine suggests a recommended allocation using funds available in your plan Some plans even take the next step and implement those recommendations for you 19

20 Method 2: Take advantage of advice engine offered by your plan Pros You don t need deep investing knowledge Usually free of charge Enables you to take advantage of professional asset-allocation advice Limited upkeep requirements; may help you combat bad behavior Cons Not available at many employers Recommended stock/bond mix may or may not suit your situation Recommendations may not be 100% objective Portfolio may suffer from de-worsification too many options 20

21 Method 3: Allocate your own assets How it works: You determine the stock/bond/cash mix that best suits your situation and preferences You research and choose individual investments You handle ongoing maintenance 21

22 Method 3: Allocate your own assets Pros Allows you to customize your choices and make updates when you see fit Allows you to produce a portfolio that conforms to your philosophy (e.g., all index funds) Cons You may not have the time or knowledge to build and maintain the portfolio Free rein/limited guardrails can lead to behavioral traps like performance-chasing, excessive loss aversion 22

23 How to allocate your own assets Step 1: Arrive at a suitable stock/bond mix Factor in your age Under 40, or even 50? Most of your portfolio belongs in stocks Over 50? Start taking risk off the table Good sources of asset-allocation guidance include: Target-date funds (Vanguard, T. Rowe Price s series are M* favorites) Morningstar Lifetime Allocation Indexes: nssummary.pdf 23

24 Sample asset allocation for someone just starting out Investment mix of retirement assets for accumulators should skew heavily (or entirely) toward stocks, be diversified globally U.S. Stocks: 54% Non-U.S. Stocks: 35% U.S. Bonds: 6% Non-U.S. Bonds: 1% Treasury Inflation- Protected Securities: 0% Commodities: 4% Source: Morningstar s Lifetime Allocation Indexes, Moderate Index for Retirement in

25 Sample asset allocation for 40-somethings For people in their 30s and 40s, equity allocations remain high, but bonds grow a bit; portfolio begins to be slightly less global U.S. Stocks: 57% Non-U.S. Stocks: 30% U.S. Bonds: 7% Non-U.S. Bonds: 1% Treasury Inflation- Protected Securities: 0% Source: Morningstar s Lifetime Allocation Indexes, Moderate Index for Retirement in

26 Sample asset allocation for 50-somethings Bond stake increases at the expense of stocks; foreign weightings continue to decline Inflation protection plays a greater role U.S. Stocks: 47% Non-U.S. Stocks: 19% U.S. Bonds: 21% Non-U.S. Bonds: 3% Source: Morningstar s Lifetime Allocation Indexes, Moderate Index for Retirement in 2025 Treasury Inflation- Protected Securities: 3% 26

27 Risk continues to diminish at age 60 and beyond, but stocks take up a big share of the portfolio Positions in safe securities cash and bonds drift up Inflation protection also increases to help protect purchasing power U.S. Stocks: 31% Non-U.S. Stocks: 10% U.S. Bonds: 34% Non-U.S. Bonds: 5% Treasury Inflation- Protected Securities: 12% Source: Morningstar s Lifetime Allocation Indexes, Moderate Index for Retirement in

28 How to allocate your own assets Off-the-shelf asset-allocation guidance is a start, but take into account: Human capital: volatility of work earnings Other assets, such as a pension Spouse s asset-allocation choices How much you have saved (less = somewhat higher equity weighting) Your risk capacity How long you expect to be retired (longer = higher equity weighting) 28

29 Step 2: Populate your portfolio with high-quality core funds in line with your asset-allocation preferences Core Large-company stocks and funds Broad-market index funds Intermediate-term bond funds Broad foreign-stock funds Balanced funds Target-date funds Noncore Company stock Sector funds Small-company stocks/funds Emerging-markets funds Region-specific funds TIP: 80%-100% of most portfolios should consist of core investments. 29

30 How to identify great core funds Cheap out. Look for: U.S.-stock fund expense ratios less than 1.00% International-stock fund expense ratios less than 1.25% Bond-fund expense ratios less than 0.75% Simplify: Index funds can be a solid choice Evaluate quality of firm: Morningstar Stewardship Grades Look for long manager tenure: At least 5 years, preferably 25 Consider past returns over a number of market environments (though remember the limitations!) Read analyst reports for a qualitative overview 30

31 Question 4: What Should I Do With the Assets When I Leave My Job? Four key options Option 1: Take the money and run Option 2: Let it be Option 3: Roll it into an IRA Option 4: Roll it into a new employer s plan (only an option if you re not retiring) 31

32 Option 1: Take the money and run Pros Access to a lump sum all at once can use to pay off debt, etc. Cons Ugly tax treatment: Money taxed as ordinary income plus incurs a 10% penalty if you re under age 59½ Your money will no longer benefit from tax-deferred compounding (or tax-free compounding, if you re in a Roth option) 32

33 Option 2: Let it be Pros Plan may be low-cost and top-flight Plan may feature options unavailable outside of 401(k)s, such as stable-value funds If you re over age 55 and have left your employer, can tap money without a penalty (must be 59½ to tap an IRA) 401(k) plans may have extra legal protections unavailable in an IRA Cons Company may not allow it You may be paying an extra layer of expenses that you could avoid by rolling over into an IRA Difficult to monitor many different accounts 33

34 Option 3: Roll it into a new employer s plan Pros Can make sense if new plan is gold-plated: ultralow fees plus strong investment lineup If using advice from provider, can get more holistic view of various accounts Cons Won t be an option if you re retiring May pay extra administrative costs that aren t present in an IRA 34

35 Option 4: Roll it into an IRA Pros Can avoid extra layer of fees that may accompany 401(k) plans More choices: Can take advantage of open architecture and buy almost anything Less oversight: Can roll multiple 401(k)s from multiple former employers into a single IRA Cons You may miss out on 401(k)-only choices, such as stable-value and institutional funds May miss out on some legal protections available with 401(k) wrapper Lack of guardrails makes it easier to get into trouble 35

36 5 Key Takeaways Pay attention to costs Always get the match Keep it simple Be holistic about your retirement plan Get help if you need it 36

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