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Step by Step: How to Make Your 401(k) Selections Like a Pro

7 Minute Read

If you’re like most workers who value a 401(k) second only to health benefits, the day you receive your enrollment package is an exciting one. Soon you’ll be building your retirement nest egg with the help of your employer’s (hopefully) generous 401(k) match—you can’t wait to get started.

So you rip open your envelope and glance over the contents: forms, a nice-looking brochure, and maybe a letter from your employer welcoming you to the company’s 401(k). Once you’ve read the letter, however, the rest of the materials simply don’t make a lot of sense. There’s information about vesting, beneficiaries, equities, risk assessments and mutual fund options, but nothing’s clicking.

The only thing that seems clear is that investing in a 401(k) is important business. Your ability to retire depends on you getting it right. But how can you make such major, long-term decisions when you don’t even understand what the choices are?

That’s why we asked an investing professional to walk us through the pieces of a typical 401(k) enrollment packet and answer some of the most common questions about their roles. To get the ball rolling, we’ll start with the easy stuff and then work our way up to the more complicated components.

Step One: Start With Your Plan Document

The best place to start is your company’s Plan Document, according to Drew McMillin, an investing professional in Nashville, TN. This document provides all the important details specific to your company’s retirement plan like the employer match and vesting schedule.

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What’s a vesting schedule? The money you put into the 401(k) and its growth is always yours. But many companies require you to remain employed a certain number of years before the money they contribute to your 401(k) is 100% yours. With each year of employment, an increased percentage of the employer match is yours to take with you if you leave your job.

The Plan Document also includes information about the fees related to your 401(k), the services available to you, and how to make changes to your account.

Your Action Step: The more you understand about the specifics of your 401(k) plan, the more confident you’ll be. If you don’t have a copy of your Plan Document, contact your human resources department for one. They should be able to give you a copy or tell you where to find one.

Step Two: Don’t Overlook Your Beneficiary Designation Form

Anyone who’s filled out a life insurance application is familiar with a beneficiary form. This is where you state who will receive your 401(k) money in the event of your death. If you’re married and have kids, this probably won’t be a tough decision.

However, this is one form people truly fill out and forget. “I talk with so many clients whose beneficiary forms are out of date,” Drew said. “In many of those cases, the people have divorced and are remarried, but their 401(k) would go to their ex if they died.” Other times, the investor has had children, but neglected to add them to the form.

Your Action Step: If it’s been a while since you filled out your 401(k) beneficiary form, contact your 401(k) plan manager to make sure those funds end up where you want them.

Step Three: Your Plan Enrollment Form Is Where the Action Is

This is the form you’ve been waiting for, since it’s the one you’ll use to officially commit a percentage of your paycheck for retirement. But there are a couple of other things about this form you don’t want to miss:

  • Before-tax or Roth: Some retirement plans allow you to deduct your 401(k) contribution from your pay before-taxes or after-taxes with a Roth 401(k). Dave recommends the Roth since you won’t have to pay taxes on the money you withdraw from your Roth 401(k) in retirement. Pre-tax contributions will lower your taxable income now, but you’ll pay taxes on withdrawals in retirement.

Your Action Step: Contact your 401(k) plan manager to find out if you have the option to choose before-tax or Roth contributions. If you can, take advantage of the Roth with your next paycheck!

  • Automatic rebalancing: If it’s available, Drew says it’s a good idea to select the automatic rebalancing option. Once a year, your fund manager will rebalance your funds—sell off some of the high performers and buy more of the lower performers—to protect your nest egg from stock market ups and downs. A strong market may favor your aggressive growth funds, for example, while your growth-and-income funds move at a snail’s pace. When the market turns, however, your aggressive growth funds will take a hit, while your growth-and-income funds keep their slow and steady pace.

Your Action Step: Again, your 401(k) plan manager can tell you if your plan offers an automatic rebalancing feature. Drew recommends calling the plan manager (contact information is included with your enrollment documents) and speaking with an actual person rather than navigating a website to make sure your changes are put into place.

It’s a Brochure—Not a Bible

You’ll also use your plan enrollment form to select your 401(k) investments, and this is where a lot of people get lost. More than a third of 401(k) participants don’t even know how their money is invested!

Remember that brochure or booklet that came with your enrollment packet? It’s from your 401(k) plan manager. It should provide fairly detailed descriptions of all your investing options. Some companies do a better job at this than others, but no brochure is going to give you the complete lowdown on all your investing choices.

Another problem with these materials is that they make a big push for target date funds, Drew said. Target date funds have predetermined investment mixes depending on the date you plan to retire. If you’re young and have 30 or more years to retire, you’ll start out with a decent mix of growth stock mutual funds, but, as your retirement date gets closer, the mix will become more and more conservative.

As your investments move to less and less risk, there is less and less return. When you reach retirement age, your 401(k) will be heavily invested in bonds and money markets that won’t provide the growth you need to support you through 30 years of retirement.

Your Action Step: Dave recommends ignoring the target date funds and build your own portfolio from individual funds.

So I Just Pick a Few Funds With the Highest Performance, Right?

Without a thorough understanding of your mutual fund options, it’s incredibly easy to make poor investing choices. For instance, one company’s 401(k) materials have 17 investment choices that aren’t target date funds: six growth funds, four growth and income funds, two equity income funds, two balanced funds, four bond funds, and one cash-equivalent money market fund.

If you’re trying to invest according to Dave’s advice by splitting your 401(k) investments evenly between growth, growth and income, aggressive growth and international funds, you’re already in trouble—according to the brochure, you don’t have any aggressive growth or international options!

After a quick review of the options in this sample brochure, Drew said, “I’m really familiar with this company’s funds, what they’re invested in, and their stated goals. Of the six options they have listed as growth funds, two are actually international funds and one is an aggressive growth fund.”

That’s exactly the kind of insight you need to help you make smart choices in your 401(k). “But a lot of people don’t know you can work with an outside professional to select your 401(k) investments,” Drew said.

Other investors worry that working with their own investing pro will be expensive. Your investing professional may charge a one-time fee for a 401(k) consultation, and that’s a reasonable expectation for the time they spend with you. Just make sure you know what to expect before your appointment so there are no surprises.

Your Action Step: Whether you’re just starting to invest in your 401(k) or you’ve had one (or several) for years, an experienced professional can help you navigate your options and outline a strategy to meet your retirement goals. Talk with an investing professional in your area.

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