Arguably the most important investment vehicle to help you get on track for your long-term financial goals is maximizing your workplace retirement plan. Whether you have access to a 401(k) or 403(b), here are ten things you may not know about your retirement plan.
1. Access to Roth Contributions
Your 401k may allow you to defer your salary into a Roth portion of your plan. With Roth contributions, your deferrals are on an after-tax basis, rather than a pre-tax basis with Traditional contributions. Both contributions grow tax-free, but Roth contributions distribute completely tax-free (whereas Traditional contributions are taxable). Regardless of your tax bracket, we are huge proponents of getting money into Roth accounts to create long term certainty in your plan, and most importantly have autonomy over your money. If rolled to a Roth IRA, there are no required minimum distributions regardless of age while you are living. This means you can take when you want, if you want, whether the market is up or down. This control helps avoid the biggest danger during retirement: sequence of returns risk
2. Are You Maximizing Your 401k Too Quickly and losing free money from your employer match?
If you over contribute to your 401(k) in the early months of a calendar year, you run the risk of missing out on a potential employer matching contribution if you max out the 402(g) limit (20,500 if under age 50) too quickly.
Some 401(k) plans will honor the match regardless of how fast you contribute, but it is worth the time checking to see if the employer match stops if you contribute too quickly!
3. Percentage Contributions Based on Top Compensation or Full Income?
If you plan on setting a fixed percentage contribution to your 401k and are a high-income earner, it is worth confirming to see if your contribution is based on your full income. The IRS’s annual compensation limit for 2022 is $305,000. Therefore, if you are over that limit and set yourself up for percentage contributions, you could be limiting yourself to under the maximum salary deferral limit. To prevent this, it is worth considering contributing flat dollar amounts instead of percentage amounts to ensure the maximum limit is hit. Again, something specific to your 401(k) to find out how income calculations are made.
4. Do You Have Access to After-Tax Contributions Inside of Your Plan?
Many who contribute to their 401k think they are fully maximizing their plan by contributing the maximum salary deferral ($20,500 in 2022) and receiving a full employer match. However, the annual limit that can go inside of your 401k is $61,000, or the 415(c) limit. If your plan allows after-tax contributions, you could contribute $61,000 a year into your plan by way of the MegaBackdoor Roth strategy. Learn more about the MegaBackdoor Roth here:
5. Are You Subject to A Vesting Schedule?
Be aware of any vesting requirements inside of your 401k, particularly if you are entertaining a potential job switch. Your salary deferrals (your personal contributions) are always 100% vested and yours, but any employer matching contributions may be subject to a particular vesting requirement.
Cliff vesting, for example, dictates that an employee owns 0% of employer’s contributions until a certain time requirement is met. Ex: 100% vested after a three-year cliff means after three years, all employer matching contributions are yours.
Graded vesting, for example, means over the course of a time period, an employee receives percentage ownership of employer contributions (ex: 20% each year for first 5 years until fully vested).
6. You Can Have Multiple 401k Plans If You Have Multiple Jobs
For example, let’s assume a W2 physician also does consulting on the side. The physician could, in theory, fully max out her 401k at her physician practice, and max out a separate 401k with her consulting income. It is important to note that an individual gets one salary deferral limit ($20,500) each year, so if that is used in the physician 401k, it cannot also be used in the consulting 401k. This is referred to as the 402(g) limit.
However, the 415c limit applies to each plan individually. So, the physician could contribute $61,000 to her physician 401k and $61,000 to her consulting 401k in the same year through other mechanisms such as the after-tax non-Roth contributions, matches, or profit sharing.
To learn more about having multiple 401k plans, watch this video here:
7. Avoid Target Date Funds
While better than letting your retirement savings sit in cash, oftentimes target date funds are too much of a blanket fund selection with no insight on your personal financial circumstances (income need, health concerns, social security/pension, etc.) and may unnecessarily position your long-term wealth into more fixed income and less equities than appropriate for your financial plan. For a deeper dive into why we recommend staying away from target funds, click here
8. Avoid Actively Managed Funds
We believe in holding low-cost, passive index funds inside of your retirement plan. In order to keep fees and expenses as low as possible, we would generally recommend avoiding mutual funds with upfront sales charges or funds that are actively managed.
See here for the biggest value adds a financial advisor can provide (beyond portfolio management)
Also, see how EWA seeks to keep portfolio costs as low as possible
9. Your 401k Is Safe from Employer Bankruptcy, Your 457 May Not Be
If your employer is subject to bankruptcy, your 401k plan is off the table and 100% yours. This may not be the case with a deferred compensation 457 plan, depending on the plan type.
10. Do you have access to a Spillover Deferred Compensation Plan?
If you are a highly compensated employee who is set to max out an annual 401k plan, are there parameters for any excess contributions? Do they “spillover” into an after-tax bucket– in which case could you pursue a MegaBackdoor Roth strategy? Is there any deferred compensation that could be funded with spillover contributions? Understanding the terms of this is crucial to get a handle on your long-term savings plan. Some companies offer a deferred compensation plan where they will continue the “match” above IRS income limits into this spillover deferred comp plan, but in most cases, you must manually sign up for this in advance.
It would be prudent to consult with a financial professional before making any changes or updates to your long-term retirement plan.
Equilibrium Wealth Advisors is a registered investment advisor. The contents of this article are for educational purposes only and do not represent investment advice.
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Past performance is no guarantee of future results. The change in investment value reflects the appreciation or depreciation due to price changes, plus any distributions and income earned during the report period, less any transaction costs, sales charges, or fees. Gain/loss and holding period information may not reflect adjustments required for tax reporting purposes. You should verify such information when calculating reportable gain or loss.
This content has been prepared for general information purposes only and is intended to provide a summary of the subject matter covered. It does not purport to be comprehensive or to give advice. The views expressed are the views of the writer at the time of issue and may change over time. This is not an offer document, and does not constitute an offer, invitation, investment advice or inducement to distribute or purchase securities, shares, units or other interests or to enter into an investment agreement. No person should rely on the content and/or act on the basis of any matter contained in this document. The tax and estate planning information provided is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
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