The financial landscape has changed dramatically since the introduction of the 401(k) in 1978. Most workers can no longer rely on or even access employer pensions to fuel the retirement lifestyles they want. But in the world of the YOYO (You’re On Your Own) economy, the 401(k) remains a great saving vehicle and a key component of a plan for a financially secure future.
An easy, first step
The drawback of the YOYO economy is also its strength: we have more control than ever over our financial lives. And while the variety of investment possibilities may be paralyzing, contributing to a 401(k) is an approachable way to start investing immediately and building healthier money habits today that will serve you throughout your life.
Unlike other benefits you may receive from your employer, in most cases you can enroll in a 401(k) plan whenever you like. You can start, stop or change your level of contribution at any time. Many employers sweeten the deal by matching your contributions up to a set percentage – in other words, free money. If you are able, you should contribute at least as much as your employer’s limit.
The right plan for your life
On that subject, how much should you contribute? Should you try to build your own 401(k) portfolio with a self-directed option, or rely on retirement date funds? The right answer will depend on your unique circumstances, but there are some guidelines that may help you navigate the details:
- If you’re starting early in your career, I typically recommend after-tax (Roth) contributions if they are available to you. The Roth is a great solution before your income pushes you into higher tax brackets.
- Pre-tax (traditional) 401(k)s make more sense for workers in their peak earning years, if they anticipate being in a lower tax bracket when they retire.
- The most important thing you can do is get started! Pledge to contribute what you can, and increase your 401(k) contribution by 1% every year.
- When choosing a portfolio, look for diversity in assets and low fees. Controlling your costs will pay dividends in the long run.
Making it work
While a 401(k) is a great tool for retirement saving, that doesn’t mean you should ignore your present needs. For many workers, it is not realistic to max out your annual 401(k) contributions. And that’s okay! You must balance all of your priorities and financial goals. It might be more important for you to pay off debt, save for college, or prepare for a major purchase like a car or a new home. The important thing is to get started and make your 401(k) a component of your financial landscape.
One last thing: this kind of planning should be an ongoing exercise. If you’ve come up with a plan for your 401(k) and your other financial goals, great! But your goals and life circumstances will inevitably change over time, and your plan will have to change, too. If you’re not sure where to begin, a CFP® Professional can help you create a flexible financial plan. And remember, it’s never too late to start!