There's so much to love about a 401(k).
First, there's all that free money. Ninety-five percent of employers currently make 401(k) contributions on behalf of their workers, chipping in an average of 3 percent of workers' salaries, according to Profit Sharing/401(k) Council of America, or PSCA.
Then there's the fact that 401(k) contributions are made with pretax earnings. That means you're putting away hard-earned dollars before paying the Internal Revenue Service. Earnings in a 401(k) grow tax-deferred until you withdraw decades later, so your money compounds even more.
With so much going for them, it's no surprise that most workers have come to embrace 401(k) plans. Nearly 78 percent of individuals who are eligible to participate in one have done so, and 401(k) assets now total $500 billion, according to the PSCA.
But enrolling in a 401(k) is not enough to ensure a profitable retirement, you need to properly fund and manage it.
With that in mind, here are some pointers to help you maximize the power of your plan.
Workers who steadily save in a plan throughout their careers until age 65 generally will be able to replace 83 percent to 103 percent of their preretirement income, according to The Employee Benefits Research Institute and the Investment Company Institute.
10 rules for savvy 401(k) investing
- Get in early.
- Fund up to the limit.
- Be careful of going on savings autopilot.
- Don't let a new job torpedo your old 401(k).
- Diversify. Diversify. Diversify.
- Think before you borrow.
- Consider a Roth 401(k).
- Take advantage of catch-up contributions.
- Scrutinize the 401(k) before you're hired.
- Cash out wisely as a retiree.
1. Get in early.Enroll in a 401(k) as soon as you can and then be consistent about saving. There will always times when you think you can't afford to put money away for the future. Whatever the reason -- you've got to pay for a new baby, a mortgage, college tuition or even bills -- there's no stopping the clock. Resist the temptation to "opt out" of a 401(k) or cut back savings levels, even for a short while.
When you're young that starting salary may feel thin enough as it is, so diverting money into a 401(k) plan may not be at the top of your list. It might help to remember that because money is put in pretax, a dollar stashed in your 401(k) is worth more than what will wind up in your paycheck anyway. For example, a $2,000 contribution to your 401(k) means you invest every penny of that $2,000. For an employee in the 25 percent tax bracket, that $2,000 left in your paycheck would quickly be cut down to $1,500 by taxes alone.
But the biggest windfall is the employer match, not tax breaks, says David Foster, a fee-only Certified Financial Planner in Cincinnati.
"To heck with the taxes. If your employer matches 50 cents on the dollar for your first $2,000, and you get $1,000, that's a 50 percent return in year one. Nothing matches that."
What to do if you've procrastinated? Don't give up. Enroll pronto and help make up for lost time by contributing more than the minimum amount required to trigger your employer's match.