Neglecting retirement accounts can cost you money
Your 401k plan is not going to configure itself and make you wealthy on its own
Most of us are saving money for retirement in some form or another. This is so that we don’t need to work until the end of our lives. Saving and investing for your retirement is not something that your employer or the government is responsible for, it is something that you need to manage on your own. Many assume that since they have a pension, 401k, and/or social security, they will be financially fine when iit comes time to retire. This is far from the truth, especially in today’s world. You don’t want to be left behind from being careless with your retirement funds.
You start working a full time job. Now what?
Employers everywhere are including retirement benefits as a part of their employee benefits packages. There are various plans available depending on the type of industry, labor union, location, size of company, and other factors. Usually, human resources or a manager will guide new employees towards options that are offered but sometimes these resources are not laid out and communicated properly to the employees. It is important to understand what is offered and how long it takes to start receiving benefits.
Here are some popular retirement account types that are offered by employers: 401k, 403b, Roth 401k, Simple IRA, Simple 401k, and Payroll Deduction IRA. 401k is one of the more common retirement accounts for private company employees that operate for profit. 403b is usually offered to non-profit and government employees. “Simple” plans are offered to employees of companies of less than 100 employees.
We won’t get into the specifics of each of these now but if you are an employee and you are not sure which plan is offered to you, ask to see which plans you can contribute to. Some organizations allow contributions to start as soon as a grace period or probation period is completed for new employees. Others allow the benefits from day one. You want to set up your account with the chosen plan provider as quickly as possible so that no free money is left on the table.
How to set up contributions
Once you have your account created, there are a few items that should be addressed right away. It’s common for the plan to follow default settings and selections which may not be correct for your goals and strategy. Typically, a chosen percentage of your paycheck will go to this account. If your employer offers a company match, you will want to contribute a high enough percentage to obtain the full match. Contributions should align with how you envision your retirement in the future. If you can afford to contribute more, your investments will grow larger in less time.
Once you start funding the account, you are on your way to a happy and prosperous retirement, however, there is more to do as the money is not yet invested.
Investment options
The IRA plan provider will have a list of funds to choose from. The money that is contributed to the account can be spread across as many funds as desired for automatic investment each paycheck. You cannot invest in any mutual fund, ETF, index fund, or stock that exists which limits the options but there should be some that are equivalent or good enough when compared to familiar ticker symbols.
It can be helpful to look up some ticker symbols that are available to you. Check for funds that are index tracking such as S&P500, Russell, Nasdaq, total stock market etc. There may be some bond funds mixed in with the stock funds.
There may also be target date funds with the retirement year in the name such as “2050 fund”. These funds are auto rebalancing which means as you get closer to retirement, the funds will slowly transition to put more into bonds than stocks to reduce your risk profile. Let’s say you start your first job at 23 years old and want to retire at 60. If you invest in a target date 2030 retirement fund, this does not mean it will invest your money in aggressive funds to retire at an earlier age. Rather, the opposite is true. These funds assume you are close to the point where you will be using the investments to live off of and will result in a conservative investment allocation. If you plan to invest in a target date fund, make sure the time horizon is appropriate for your age and desired outcomes.
What to do if you change your job
Changing careers and jobs is common nowadays and even more so for employees that are early in their professional life. Many will ask what happens to their company match and retirement money if they no longer work for their employer. It varies in every situation but most people will not lose their individual and company contributions that are invested for retirement.
In my case, I’ve changed jobs a few times and never had an issue moving my investments and continuing to grow them.
After you change organizations, there are a few options with what can be done with retirement accounts. One option is to keep the money where it is and let it continue to grow there. Minimal work is required to do this but plan changes, announcements, and employer changes via your former employer can make holding the funds there more cumbersome than it needs to be.
Another option is to roll over your investments into another investment account. You will want to roll over your investments to one of two places. The first option is to roll your investments into your new employee sponsored plan. The benefit to this is that you can keep all your retirement investments in one place. The downside is that this plan may have fund options that are more limited. Additionally, if you change jobs again, you will need to roll this plan into yet another plan. A second option is to roll the funds into an independent, self managed IRA. This rollover is the method I have used and there are many reasons why I prefer this method:
- There is more control over your portfolio and many investment choices
- Updates and changes are sent to you in an email or text without your former employer having to contact you.
- Reduced fees
- Option to link with a standard and Roth accounts and get incentives from that brokerage company.
- Less rules and stipulations
- Easier for beneficiaries to deal with if they need to
Whenever I change jobs, I roll my 401k into my Rollover IRA account by following the instructions on the 401k provider website. This process is as easy as filling out the form with the account number and mailing address of the rollover IRA company. I emailed the forms and the 401k provider mailed the check to my other brokerage. The entire process can be done in under 2 weeks.
Different types of retirement plans offered by employers
The most common retirement account offered by employers in the United States is the 401k. The main principle of the 401k is that money is contributed to the account from each paycheck before taxes and other deductions hit the paycheck. An employer match is commonly offered so the match is exactly the same as the individual contribution up to a certain amount. The 401k contribution is more significant than many realize since it is a percentage of the gross pay, not the net pay.
Individuals who work for government entities or not profits will have a 403b rather than a 401k. There is no significant difference between the two and both work the same way. The 403b may offer catch up contributions that exceed the normal yearly limits if the employee has been working for 15 or more years.
Key mistakes to avoid
Ignoring a retirement account can be costly if you neglect it for many years and lose valuable time during periods of market growth. Here are some key mistakes that people make without realizing the consequences:
- Not contributing the minimum amount to get the full company match. This leaves free money on the table and a missed opportunity to invest another 2-5% of your gross income per month for retirement.
- Not investing in the right funds. If you are earlier in your career and fully invested in bonds or emerging markets, you may be missing out on significant stock growth.
- Not investing the funds that are transferred into a rollover IRA. Although the funds have been rolled into another account, the investment funds still need to be purchased or else the money will just sit in the account as cash and not earn any interest.
- Taking a distribution to the retirement plan rather than rolling it over into an IRA. Making a distribution can be costly since the account will be penalized for early withdrawal as well as taxed additionally if under the age of 59.5.
- Leaving multiple retirement accounts in former employer plans that have high fund expense ratios and account management fees.