Making the Most of Your 401(k) Plan

Choosing the Best Options as Part of Your Overall Retirement Plan

Your 401(k) plan may be one of your largest assets, so how you manage it is critical to the success of your overall retirement plan. Rather than considering your 401(k) in isolation, think about it as part of your whole retirement plan.

The first step is to build a comprehensive financial plan that estimates how much you are going to want or need to retire, when you plan to retire, how long you are likely to live and what your risk tolerance is along with a number of other factors. From this plan you can determine an appropriate asset allocation for your entire portfolio, including your 401(k). The key to your plan’s success resides not only in the investment selections you make, but also the careful consideration of these additional variables.

Salary Deferral – How much money will you defer in your 401(k)? While variations in income or significant expenses can impact year‐to‐year deferral amounts, we generally encourage maxing out your 401(k) contribution. For 2022, that is $20,500; if you are age 50 or over by the end of the calendar year, you can contribute an additional $6,500.

Roth option – Should you select the Roth 401(k) option? We prepare a careful analysis of your current financial position as well as your likely tax bracket in retirement to help with this decision. Selecting a Roth 401(k) option will require distributions starting at age 72, but if you don't want to take them, you can roll over your Roth 401(k) into a Roth IRA and continue to defer distributions.

Asset Allocation – If your investment allocation calls for bonds, dividend paying stocks or less tax friendly investments, you can locate those within your 401(k), where taxes are deferred, creating a tax friendly strategy.

Comparable choices – Consider the investment choices in the 401(k) compared to your other investment choices. Your advisor can help you select the best choices within and outside your 401(k).

After‐tax contributions – Should you make after‐tax contributions? The answer: maybe. Under IRS guidance, after‐tax contributions to a traditional 401(k) can be more easily rolled into a Roth IRA if an individual retires or separates from his or her employer. Under the guidance, if the entire 401(k) is rolled over, the plan administrator will distribute the pre‐tax contributions that can be rolled over into a traditional IRA and the after‐tax contributions that can be rolled over into a Roth IRA. For investors who have maximized their contributions to 401(k)s and IRAs, this is a nice way to put additional money into a tax deferred account. One complication: investors who later do partial distributions will need to keep track of the after‐tax portion. More information about after‐tax contributions can be found in a recent post: After Tax Rollover Rules. Roth and/or after‐tax account balances can provide significant income tax advantages in retirement.

Retirement and your 401(k) – What should you do when you retire? While you can continue to leave your money in your 401(k), you might also consider a rollover into an IRA. When done properly, a rollover will not incur income tax or penalty. A rollover IRA can have advantages over a traditional 401(k), including a wider array of investment options, professional management, exceptions allowing penalty‐free early withdrawals, and the ability to stretch the tax deferral beyond your lifetime. Properly done, a rollover IRA can maintain the same creditor protection enjoyed by a 401(k). The decision to roll over into an IRA should be made simply on the merits of what is best for your personal situation.

In summary, we encourage all of our clients to follow these planning steps to maximize the benefits of your 401(k) as part of your overall retirement plan:

1. Have a comprehensive financial plan. Revisit the plan at least annually. 
2. Estimate how much you are going to want or need to retire.
3. Assume you will live longer than you think.
4. Have a well‐diversified portfolio with investments spread across a number of asset classes. This will not only help maximize results, it will help reduce risk.
5. Work with a financial advisor, and if you don’t understand an investment or strategy ask the advisor to teach you about it.