Making the most out of your 401k can make all the difference in the world when you're ready to retire. With the ability to sock away $19,500 per year – or even $26,000 if you're over age 50 – in a tax-advantaged way, it's fairly straightforward to wind up a millionaire by retirement just by using your 401k.
Of course, just because it's straightforward doesn't mean it's easy. If it were easy, everyone would already be on track to reach that goal. To get there, you need a plan to take you from wherever you currently are financially to where you want to be. These five strategies are ones you need to consider for your 401k as you work to build your winning retirement plan.
No. 1: Set your contributions based on a percentage of your salary
You have a choice in how much you contribute to your 401k plan. Most companies either let you set your contribution amount as a specific dollar amount or as a percentage of your salary. Unless you're at the point where you're actively contributing the maximum you're allowed, you'll want to set your contribution based on a percentage of your salary.
The reason for this is that as you get raises, a portion of those raises will flow directly into your 401k plan. That's a pretty painless way to assure your 401k contribution increases over time even if you're not actively contributing to it along the way.
No. 2: Set that contribution rate to be at least as high as your employer will match
If your employer offers you a match, investing enough to maximize that match should be the very first investment you make with an eye toward your long-term future. A 401k match represents the most straightforward path toward building your nest egg available to many people. Indeed, depending on the terms of your match, it may even form a central part of the easiest way to double your money available to you.
Whether you want to invest beyond that amount in your 401k is up to you. On one hand, it's an incredibly easy way to sock away a lot of money automatically, directly from your paycheck, which can be a great way to put yourself on track to winding up rich. On the other hand, 401k plans often have limited choices and may have high fees attached to them. If you're not happy with the terms of your 401k, you may want to consider putting the next batch of long-term money in an IRA instead.
No. 3: Sign up for automatically escalating contributions
If you're just getting started investing, you might find it difficult to come up with a significant amount of money to invest right off the bat. One strategy that many companies offer to help with is an escalating contribution. In essence, with these plans, you can sign up for a current contribution, the target you'd like to get to, and the step amount between the two that gets you there. Then, every year, your contribution will increase by the step amount until you reach your target.
For instance, assume you start with a current contribution of 5%, set a target at 10%, and include a 1% step. In your first year, you'll contribute 5% of your salary toward the plan. In the second year, you'll contribute 6%. In the third year you'll contribute 7%, and so on until you reach 10%. From that point on until you change your contribution amount (or hit your plan's maximum), you'll be socking away 10% of your salary for your retirement every paycheck.
Leveraging automatically escalating contributions is a great way to make a commitment to funding your long-term future without having to make a huge immediate sacrifice. As you better establish yourself, get past the expensive start-up costs in a new job, earn raises, and figure out ways to get your everyday costs of living down, it should get easier to save more. With this type of plan, you make the promise to yourself and your future today, and then give yourself the time it takes to make it a reality.
No. 4: Invest in low-cost index funds for your long-term money
Over the long term, the simple strategy of regularly buying into a broad-based index fund tends to beat investments trusted to the vast majority of professional money managers. That makes index investing in your 401k a great way to build your nest egg over time. It's easy, it's low maintenance, it's typically very low cost, and it gets you market-type returns without much effort beyond the initial paperwork to set things up.
For money you're saving for your long-term future inside your 401k, indexing is one of the very best things you can do. Just recognize that a stock-heavy approach can be a great way to build wealth over time but is an extremely risky way to generate cash for your near-term spending needs. As you get closer to needing to spend your money, you should start moving some of it out of stocks and into assets like CDs or cash that will more likely be worth what you need when you need it.
No. 5: Review at least annually and adjust when needed
While automatic investing in your 401k can be a great way to build wealth, the reality is that life changes. You may advance in your career, giving you more money to invest. You may choose to cut back hours or take time off to raise a family or care for a loved one. The market may wildly outperform your expectations, getting you closer to your goal that much faster. And don't forget, every year that goes by, you'll be getting that much closer to your anticipated retirement date.
For whatever the reason, a plan you set in motion in the past may have been perfect at the time you set it up but not necessarily your best path forward from today. As a result, you should review your plan at least annually and make adjustments based on your updated reality. Set a reminder in your phone. Put a repeating invitation to yourself in your calendar.
Whatever it takes to get you to do it, make sure you take a little bit of time now and then to check up on your own future. It's a lot easier to make small course corrections along the way to help you get closer to your goal than to wake up and find that your goal is out of reach because you didn't make a small tweak sooner.
Make your 401k the cornerstone of your retirement plan
With these five strategies, you can go a long way toward making your 401k the cornerstone of your retirement plan. Just remember that investing works best as a long-term tool for building your wealth over time, so the sooner you get started, the better your chances of winding up on top.