For many Americans, one of the best ways to build wealth is to save in an employer-sponsored retirement plan like a 401k. It makes good sense: there are many advantages to this type of account.
The money comes out of your paycheck before you even see it and it’s easy to sign up for the plan. But the best part is that with a traditional 401k, you don’t pay taxes on the money now. Instead, your contributions are tax-deferred which may help you save more now. This is an important factor in growing wealth, as saving more today allows compound interest to work in your favor.
But not all 401k plans are alike. Employers are able to choose a wide variety of options for their employees, and some are better than others. It’s helps to know exactly how good or bad your plan is. If you have a retirement plan you’re not happy with, you can adjust accordingly to make the most of your money.
Here’s what to look for when analyzing a 401k:
Watch the Fees
Employers have to pay fees to maintain a 401k retirement plan, so the quality of your plan often has a lot to do with how big your company is. The smaller your retirement plan, the higher the fees. Companies have the option to pay the fees or to spread the cost to all employees. If the expense ratios on the investments within your 401k are more expensive than what you’d get on the open market, you have an expensive 401k plan.
Some plans also carry funds that have front end commissions (like A, B, C class shares). Since the commission is taken out at the beginning, you’ll have less of your money going to work for you. Some plans also have ongoing 12b-1 fees that are mostly used to pay a commission to the salesperson. Many people can find comparable investments at a lower price.
This is critical because investment cost is one of the largest factors in long term returns, as every dollar you pay takes away from your return.
If you find that your plan only has expensive investment options, speak up! If you work with your plan administrator, you might be able to convince them to add low cost index funds.
Find Your Perfect Match
Some companies will match employee contributions to the 401k plan. If your company offers a 3% salary match, when you contribute 3%, they’ll contribute the same amount to your account. This is a great benefit as you’ll be able to put even more in the retirement plan. Some companies don’t offer a match, or they’ll provide a discretionary match at the end of the year. Unfortunately, there’s not much you can do if your company isn’t willing to pitch in.
The strategy for how you want to contribute to your plan depends on how your company distributes the match. In some cases, if you max out your retirement plan at the beginning of the year, you’ll miss out on some of the company match as it’s distributed at each paycheck. If that’s the case, make sure to spread out your contributions to get the full match. Your company might also choose to do a true up — and give you the maximum match — at the end of the year.
Choose the Right Fund
Employers are also able to choose the funds available in a 401k plan. Hopefully, your employer has chosen low cost index funds or target date funds.
If you don’t have a great fund selection, it’s possible to talk to your plan administrator to add good funds to your plan. You can also choose the less expensive options within the 401k if you have retirement accounts elsewhere. You’ll use the rest of your accounts to create your ideal asset allocation.
To Roth or Not?
Some employer plans also offer the ability to contribute to both a Roth 401k or a traditional 401k. With a Roth 401k, you pay tax on the money now, but you’re able to withdraw all your money — including your earnings — tax-free in retirement. This can be a great option for younger savers.
If you expect your earnings to rise significantly in the future, you can pay the tax now while you’re earning less. It’s nice to do a little bit of both when possible. This will give you a bit of flexibility in your retirement about how you withdraw your funds.
Saving in a tax-advantaged plan like a this retirement account can be a great way to grow your wealth. By understanding the good and bad of your retirement plan when analyzing your 401k, you can make smart investment choices that will help you build your nest egg.