If you’re among the thousands — ahem, millions — of Americans who couldn’t bear to look at their retirement accounts in 2020, that’s okay. But we’re in a New Year, with a new administration, maybe you’ve got a new budget, and if the last year taught us anything, it’s that there’s plenty more ‘new’ to come. So, consider this your gentle nudge to give your 401(k) allocations a look in the next few weeks.
You already know how important your 401(k) account is — it allows you to save and invest for your retirement goals, all while offering tax advantages, too. All of the funds within your 401(k) plan grow tax-deferred until withdrawn, explains Brittney Castro, certified financial planner and founder of Financially Wise. Plus, your employer may also match your contributions (a common employer match rate is 3%) which Castro calls ‘free money’ toward your retirement goal.
READ MORE: How To Save $1 Million In Your 401(k)
When it comes to “maximizing” your 401(k) potential, there is the maximum contribution to consider first. In 2021, you can defer up to $19,500 of compensation into your 401(k). Plus, Individuals aged 50 or older can contribute an additional $6,500 in ‘catch-up’ contributions.
Of course not everyone can afford to put away that much, but even if you can and do (congrats!) we still need to be thoughtful about our allocations and take a hard look at whether our accounts need to be rebalanced every now and then. Here’s a look at how you can maximize your retirement potential, every day, with just a few tweaks to your account now. Trust us, you’ll be so thankful you did.
Assess if you need a retirement account rebalance.
With strong market performance in 2020, now is an excellent time to assess your retirement plan allocation, according to Kelly Crane, CFP, CLU, CFA, MBA, and president and chief investment officer of Napa Valley Wealth Management. He says if your portfolio was heavily invested in U.S. growth stocks, like big tech, there’s a high chance your account is out of balance and thus riskier than your target 401(k) allocation. He suggests shifting your focus toward value stocks, like banking and insurance, which are traditionally more mature and conservative businesses in stable industries that offer stable balance sheets.
READ MORE: 401(k) vs IRA: What’s The Difference?
“If your U.S. equity positions greatly appreciated, consider reallocating to internationals, which are currently relatively inexpensive,” he continues. “We’re in a ten to a 12-year run of U.S. stocks outperforming internationals, and historically after this type of run, the tide reverts.”
Since most 401(k)s don’t rebalance on their own, Crane reminds you that you need to make sure your current 401(k) allocation matches your return goals and risk tolerance as well as your time horizon for retirement.
If you’re inching closer to retirement, it’s time to pivot your allocations.
Hey, you’re almost there! Amazing! But let’s make doubly (triply) sure you’re prepared for the big day. Crane says if you intend to retire in the next three to five years, it’s crucial to generate the income you’ll need to enjoy your golden years. “In your portfolio, downshift from aggressive investing to a risk-adjusted allocation,” he explains. “Making this change early, before retirement, could prevent you from needing to liquidate in the face of a future downturn.”
READ MORE: What To Ask Before You Open A 401(k)
And on that note, figure out your retirement age.
If you’re at the beginning of your career — or only a decade in — retirement probably feels like an idea rather than a reality. That’s normal, but still, it’s important to start as young as you can to prep for your retirement. Castro says a big part of that is figuring out what age you’d like to retire: is it 65? 70? Earlier than either of those? By understanding how long you have to go to meet your goals, you can set micro-sized annual aspirations to help you get there at a manageable pace. And by meeting recurring 6-month or annual goals, you’ll know you’re on track without having to worry.
Ensure your portfolio is diversified.
Which, in short, means not putting all of your hard-earned eggs in the same basket. As Castro defines, a diversified 401(k) has a wide range of assets such as equities, bonds and cash to match your overall risk tolerance and goals. “Diversification works because different types of assets react differently to the same economic event, and therefore have a different rate of return each year,” she continues. “By owning a variety of each that responds differently every year, you are able to maximize your potential rate of return with the least risk.”
Avoid retirement-plan withdrawal penalties if you can.
Suppose you took advantage of the CARES Act’s temporary elimination of the standard 10 percent early withdrawal fee and withdrew some much-needed cash from your retirement plan last year. In that case, Crane says it’s vital to keep up with the repayment plan. After all, you want to avoid paying the taxes that could come with this choice. “These withdrawals must be repaid within three years. If not, they will be considered to be a distribution from your retirement plan, triggering taxes and any early withdrawal penalties,” he explains.
Take advantage of target-date funds.
If you don’t have someone actively managing your account like a fiduciary, you may not understand the best practices of Target Day Funds, according to Katelyn Magnuson, a millennial money expert and the founder of The Freelance CTO.
Target-date funds make retirement planning easy to set and forget. “All you do is pick the year closest to when you plan to retire, and the funds are then built to be more risk-tolerant when you’re younger, and less risk-tolerant — more stable — as you get closer to your retirement date,” she explains.
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- IRA vs. 401(k): What’s the Difference?
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