If you want to secure your retirement, your 401k, or equivalent plan, is very important. I have spoken about retirement accounts before, and I have also stressed the importance of doing so over a long period of time.
Perhaps even more important is understanding the ways each type of plan works, and which ones should be prioritized.
In reality, I’m not sure I can cover all of this in just one post, but I’m going to doing that now. Because who doesn’t like savings, right?
Getting serious about retirement savings
I have now been a “real adult” for a little over 8 years. Haha…real adult. Actually, I’m not sure I’ve reached that point yet. Maybe one day!
But seriously, it’s crazy that it’s been that long. And yet, only in the past year have I started to take retirement savings very seriously. Of course, I had some savings that came in the form of mandatory contributions, but I didn’t really look beyond those savings.
And while I can’t say with absolute certainty that everything I’ve done in the past 8+ years has been ideal from a financial standpoint, I do believe I did at least okay.
Yes, I have personally made the point a few times that saving over the long run is essential. And it is. So the fact that I did not maximize all my retirement accounts for the first part of my career – or even try to – may make me seem like a hypocrite. But my loans were pretty rough. Before I refinanced, most of them had interest rates of nearly 8%. Even with an optimistic estimate, that figure roughly matches the stock market. So, I felt it made more sense to wipe out my student debt as quickly as I possibly could.
keys to maximizing your 401k
Before diving into the types of accounts you should actually investigate, there are four main strategies you should always leverage when it comes to your retirement:
- Maximize employer matching
- Maximize pre-tax contributions
- Minimize total taxes paid
- Invest for the long haul
These are our main goals. The last one will not necessarily be impacted by how you structure your savings, but the others almost certainly will.
It should also be noted that you might not be able to achieve all of these at the same time. I know I’m not. For example, I am not even coming close to maxing out my pre-tax contributions. But more on that later.
Nevertheless, the closer you can get to achieving all of these goals, the safer and more secure your future will be.
Your 401k is Not always (totally) in your favor
Depending on a number of factors, you may have a few options or a slew of options when it comes to retirement plans. State and federal regulations play a part, as do the choices your employer makes. And although we like to think our employers are always looking out for us, there may be cases where that isn’t necessarily true.
For instance, if your employer offers a 403b plan, they may choose not offer matching on that plan intentionally. And no, not just because they’re cheap. If they don’t offer matching on their 403b plans, your employer will be exempt from ERISA guidelines.
What does that mean, exactly? It’s worse than you might think. On top of not offering matching, being exempt from ERISA guidelines also loosens regulations on the employer. Per the link above, the result is that they are not required to undergo screenings. These screenings are intended to prevent those in high-ranking positions from receiving disproportionate levels of compensation.
It’s a bit crazy that these things actually happen, but such is life.
Types of retirement accounts
Yes, there at least a few retirement accounts you may be able to use for your savings. That said, there could be subtle or even significant differences in terms of what is available to you. I hinted at this above – some employers may offer more options than others. That said, let’s consider the typical accounts offered:
401k and 403b
Most of you are probably familiar with the 401k and the 403b. Even if you aren’t saving aggressively, your employer may require you to contribute to one of them.
The primary difference between the two is that the 401k is typically offered as an employer-sponsored plan in the private sector, while the 403b is relegated to public entities. Both accounts allow employees to stow away up to $18,500 on a pre-tax basis.
There are other differences of course; for example, 403b plans are exempt from certain administrative processes that do apply to 401k plans. I’ll be honest here: even though I work in the public sector, this seems a bit backward to me. Shouldn’t governmental organizations be subject to more scrutiny, not less? But, I digress – I obviously have no chance of winning that battle.
As far as the plans themselves, it’s hard to speak a lot about that because each plan is probably different for each organization. As mentioned above, your employer may or may not offer a match if you have a 403b plan; the same applies to 401k plans, though probably for different reasons.
There are also other considerations, such as the amount of the match (if you get one), the funds offered by your employer, whether the funds are “mobile,” and so on.
This mobility idea is actually a very important consideration. You know that phrase “You don’t know what you don’t know?” That could not have been more true for me. With my previous employer, the money they matched on my retirement plan had a time requirement before I was fully vested. Because I wasn’t fully vested, I lost the entirety of the money. Obviously I didn’t do this on purpose, but because of that mistake, I lost over $4,000. While it may be difficult or impossible to avoid this scenario, it’s good to at least be aware of the possibility. I wasn’t.
Bottom line: because there are so many variables, you’ll want to meet with someone in HR to discuss all of the options offered by your employer.
457b: the fire starter!
I recently opened my first 457b, and I am very excited about it. Much like the 401k and 403b, you fund your 457b with pre-tax dollars.
But there is one key difference between the 457b and similar accounts: it has no age requirement for withdrawals.
Most retirement accounts, including 401k and 403b, require you to be age 59 & 1/2 before you can withdraw from them without being penalized. Otherwise, you will incur a 10% penalty. The 457b, on the other hand, only requires that you leave the employer where you worked while contributing to the plan. Even though I have no immediate plans to retire or even leave my current job, having that flexibility for the future is a huge plus. Score one for financial independence, retire early.
Roth and traditional IRA
Both of these accounts are tax-advantaged, but the unlike the accounts previously mentioned, the tax savings take the form of a write-off on your tax returns. 401k and the others work by having a set amount withheld from your check that isn’t taxed, and is then put into your retirement account.
The difference between the two lies in when you are taxed. With a traditional IRA, the tax savings happen on the front end, meaning they are funded with pre-tax dollars. Earnings and additional contributions are also tax-free.
With Roth IRA accounts, you fund the account with after-tax dollars (although earnings are tax-free). You won’t be taxed when you withdraw money.
There is much debate as to which of the two is better, and there is no straightforward answer. The biggest two considerations are:
- Your taxable income. Most of us will earn less after we’re retired, which means paying taxes later would be better than paying taxes now. After all, less income means a lower tax rate.
- What percentage each bracket will be taxed. This is even more speculative than the previous point, since each president and each administration seems to have its own agenda. If you think tax rates will be much higher in the future, you may want to contribute a Roth. But no one really knows what will happen.
Health savings account (hsa)
While not technically a retirement account, it can actually be used as one. I like to refer people to the Mad FIentist article on this, because he explains it better than I can.
Basically though, this is a more advanced technique that may not be for everyone. The main reason is that it requires you to get a high-deductible health plan (HDHP). That probably won’t work if you have significant medical expenses.
If your ongoing medical expenses are not significant, the HSA might be worth a closer look. That’s because these accounts are funded tax-free, and you could potentially roll them into a Roth when you are nearing retirement and pay effectively no taxes on them. Pretty cool stuff.
How to prioritize
Using my keys to maximizing savings from above, the first two priorities (maximizing employer match and pre-tax contributions) should indeed be priority #1. Once you have max out your employer’s match, though, you can weigh other options. However, it does make sense to completely max out your retirement accounts, since reducing your taxable income is the simplest way to save on taxes.
What are your goals?
For me, saving as much as I can is definitely priority #1, since I would like to reach financial independence at a minimum. However, I am also saving some travel money on the side. And I’m certain that many of you have other priorities I had not even thought about. At the end of the day, though, there’s no denying the importance of retirement saving.
If you can set things up the right way, you could be well on your way to a comfortable (and perhaps even early) retirement!