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If you value your company’s 401(k) benefit, 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 401(k) match and the right investment selections—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 401(k) selections—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 I wanted to share insights from an investing professional, Drew McMillin. He’s based in Nashville, Tennessee, and his advice will help you learn more about the pieces of a typical 401(k) enrollment packet. Understanding your workplace 401(k) is the first step toward the retirement of your dreams.
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How to Make Your 401(k) Selections in 5 Simple Steps
Ready to dig in? These five steps will help you make smart 401(k) selections you can feel good about. To get the ball rolling, let’s start with the easy stuff and then work our way to the more complicated components.
Step 1: Start With Your Plan Document
The best place to start making your 401(k) selections is your company’s Plan Document, according to Drew. This document gives you all the important details specific to your company’s retirement plan, like the employer match and vesting schedule.
What’s a vesting schedule? It’s an outline for when the money your company contributes to your 401(k) is completely yours. The money you put into the 401(k) and its growth are 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 401(k) portfolio.
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 HR department. They should be able to give you a copy or tell you where to find one.
Step 2: 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 3: Complete Your Plan Enrollment FormThis is the form you’ve been waiting for! 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:
- Pre-tax or Roth: What’s the difference between a traditional pre-tax 401(k) and a Roth 401(k)? A pre-tax 401(k) allows you to make contributions from your pay before taxes are taken out. But when you contribute to a Roth 401(k), your contributions are made after taxes are taken out. I always recommend the Roth option 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 pre-tax or after-tax contributions. If you can, take advantage of the Roth option with your next paycheck!
- Automatic rebalancing: If it’s available, Drew said it’s a good idea to select the automatic rebalancing option for your 401(k) selections. 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 for your investment selections. Drew recommends calling the plan manager (contact information is with your documents) and speaking with an actual person.
Step 4: Learn About Your Investment Options
You’ll also use your plan enrollment form to select your investments for your 401(k) portfolio. This is where a lot of people get lost. Over 40% of 401(k) participants in a Prudential survey said they do not know how their assets are allocated or even what products their money is invested in!(1) That’s not okay!
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 401(k) selection 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-plus years of retirement.
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Your Action Step: I recommend ignoring the target date funds so you can build your own 401(k) portfolio from individual funds.
Step 5: Pick the Right Funds for Your 401(k)
Without a thorough understanding of your mutual fund options, it’s easy to make bad investing choices. For instance, let’s say a sample company’s 401(k) materials have 19 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 my advice by splitting your 401(k) portfolio 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 investment selections. “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 cost for the time they spend to help you make smart 401(k) selections. Just make sure you know what to expect before your appointment so there are no surprises.
Make Your 401(k) Selections With a Pro
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.
Looking for the right investing pro? Try our SmartVestor program! It’s a free, easy way to find qualified pros in your area. A SmartVestor Pro will help you understand your investment selections so you can make smart decisions about your future. Find an investing pro!
About Chris Hogan
Chris Hogan is the #1 national best-selling author of Retire Inspired: It’s Not an Age. It’s a Financial Number and host of the Retire Inspired Podcast. A popular and dynamic speaker on the topics of personal finance, retirement and leadership, Hogan helps people across the country develop successful strategies to manage their money in both their personal lives and businesses. You can follow Hogan on Twitter and Instagram at @ChrisHogan360 and online at chrishogan360.com or facebook.com/chrishogan360.