You're interviewing for a new job, and you ask whether the company offers a 401(k). The employer says yes, and you move on to other topics. When you accept the job, you enroll in the 401(k) plan and begin making contributions, but later on, you're disappointed by your savings.
What went wrong? You forgot to dig into the details of the plan. Many people mistakenly believe that one 401(k) is as good as the next, but that's not the case. Here are a few questions you always should ask about your company's 401(k).
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Is there an employer match, and if so, how much?
Many employers offer a 401(k) match -- which means they'll contribute some money to your 401(k) every time you do. But they rarely match you dollar for dollar. For example, a company might pitch in $0.50 for every dollar you invest until your contributions reach 6% of your salary. So if you make $50,000 a year and contribute 10% of your salary ($5,000) to your 401(k) per year, then your employer will add another $0.50 for every dollar on the first $3,000. That amounts to an additional $1,500 in retirement savings for you.
If your employer does offer a match, it's wise to contribute at least that enough to get every penny of that free money. When you factor in compound interest, even a small employer match can grow into tens of thousands of dollars by the time you're ready to retire. That $1,500 above could grow to nearly $188,000 after 30 years, assuming your investments earned 8% per year.
Is there a waiting period before you can enroll in the 401(k)?
Most companies allow you to enroll in their 401(k)s as soon as you start your job, but this isn't always the case. Some may make you wait up to a year before you become eligible. If this is the case, you need to save for retirement on your own in the interim.
If you don't have an IRA already, now may be a good time to open one. These accounts are easy to open and fund, and they offer the same basic tax advantages as 401(k)s. IRA contribution limits are lower than those of 401(k)s, however. In 2018, you can contribute up to $5,500 to an IRA and $18,500 to a 401(k) if you're under age 50. People aged 50 and older can contribute $6,500 and $24,500, respectively. However, even contributing a lesser amount to an IRA is better than putting no money toward retirement savings while you wait to become eligible for your employer's 401(k).
What's the vesting schedule?
Most people don't realize this, but not all of your employer-matched funds are yours right away. All of the money you contribute yourself is always yours to keep, even if you only stay at the job for three months and then quit. But employer contributions usually follow a vesting schedule.
There are two ways this might work. Some employers have a graded schedule whereby you gain ownership of the employer match over time. For example, after one year, 25% of the employer contribution is yours to keep, and after two years, 50% is yours, and so on. Others require you to work for the company for a certain number of years, after which you become fully vested all at once.
If you leave your job before you're fully vested, you'll lose some or all of those employer-contributed funds, depending on the vesting schedule. This is especially important to pay attention to if you don't plan on to remain in the job very long.
What kind of 401(k) do they offer?
Traditional 401(k)s are pre-tax, which means your money is free from tax when you put it into your account. However, you're taxed on it when you begin taking withdrawals from the account in retirement. This type of 401(k) has been around for a long time, and it's still the most popular among employers.
But there's another option that's getting more and more attention: the Roth 401(k). As with Roth IRAs, contributions you make to a Roth 401(k) are taxed up front, but you don't have to pay any taxes when you take the money out of the account in retirement. This type of 401(k) may be a better fit for you if you're in the early stages of your career and in a lower tax bracket than you expect to be in retirement. But if you believe that you're in a higher tax bracket now than you'll be when you retire, it makes sense to put your money in a traditional 401(k) so you lose less of your savings to the government.
What kind of investment options are there, and what are the fees?
Most 401(k)s enable you to choose from several investment products, including stocks and mutual funds. Your employer can provide you with information on your options, but it's up to you to figure out which ones are the best choice for your situation. That comes down to three basic factors: the fees, the risk level, and the expected rate of return.
You want to choose investment products that will return more than the rate of inflation, which most experts estimate will be around 3% per year over the long term. Look at how well the investment products have historically performed and consider your risk tolerance, which tends to decrease with age as you get closer to retirement and have less time to recover from market dips.
It's also important to pay attention to the expense ratio on mutual funds. Most investment products also charge you administrative and record-keeping fees, among others, and these can cut into your profits. Typical 401(k) fees add up to about 1% of your assets every year. However, larger 401(k) plans tend to be cheaper than this while smaller plans may be more expensive. You may not have a choice about paying these fees if you want to contribute to the 401(k), but you can look for the lowest-cost investment products.
A low-fee index fund is a good choice for most investors. These funds provide broad market exposure and a low expense ratio. For the risk-averse, a target-date fund might be a good choice. These funds automatically become more conservative as the target date approaches -- which generally means they move money out of stocks and into bonds -- so they're simple and relatively low-risk, though they may not provide spectacular returns.
A 401(k) can be a great vehicle for growing your nest egg, but it may not give you the returns you hope for unless you take the time to learn the ins and outs of the plan. By asking your employer these five questions, you can get a good idea of whether or not the company's 401(k) is the best place for your retirement savings.
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