It’s time for the annual open enrollment period at many companies, which means employees around the country are facing important but confusing choices around their 401(k) plan. How do you decide which options to select, and what will the choices you make now mean for your financial future?
Every situation is different, so there’s no one-size-fits-all strategy that will create the best outcome. Still, there are some broadly applicable ways to approach the maze of choices and make sound decisions for this year’s 401(k) plan. Here are four key points to consider during open enrollment.
- To Roth or not to Roth?
When contributing to your retirement plan at work, the Roth K allows you to put money in after-tax and have tax-free growth. The withdrawals you make later will be similarly tax-free. That’s fantastic, of course, but if you choose to go this route you’re also passing up the opportunity for lower tax liability now. Basically, your choice comes down to “tax me now or tax me later?” There’s no universally correct answer here, so your best bet is to estimate your financial picture in retirement.
If you project that your income tax rate during retirement will be similar to your current rate, then it may not make much financial sense to pay the taxes now instead of later. Taking the tax break now by deferring into your traditional 401(k) plan may be the better option. Work with your financial planner and tax advisor to look at all factors including current tax deductions versus projected deductions, current income versus projected income, and current versus projected tax rate during your retirement years. These and other factors will affect the amount of tax you pay on your contribution dollars.
2. Investment selection methodology
A well-diversified portfolio should contain at least five different asset classes, typically not in equal percentages. Most advisors recommend a lower weighting on more volatile asset classes. Your time horizon for accessing the funds should help you decide how much to allocate for equities versus fixed income alternatives like bonds. Ideally, your advisor works closely with you during open enrollment to tailor portfolio allocation for your particular situation.
When in doubt, it’s usually a good bet to use one of the target fund options that allocate investments based on your projected retirement date. Keep in mind, though, that there’s still much debate within the financial industry around glide paths or the method in which the allocation changes through the years prior and after hitting the target year. However, you decide to balance your investments, make sure you have a sound rationale for where your money is going. Performance should not be the only reason you choose an investment option.
3. How much should I contribute?
This is another question with no universal answer, but there is a universal path to finding the best answer for you: Look carefully at your cash flow. Retirement monies in qualified accounts generally aren’t accessible until 59½ without paying a penalty, so you want to avoid early withdrawals if at all possible. Therefore, it’s critical to take a hard look at your cash flow and determine how much you can realistically save. The key is balancing your cash flow needs with the tax advantages of the retirement plan — but remember, you can still access these funds in a true emergency. Also note that if you are considered a highly compensated employee at your company, while you can still contribute up to the annual limit ($18,500 in 2018), the percentage of your total salary to get there may be capped, e.g. HCE making 200K of income may be capped at 7% of total salary, only allowing a 14K contribution.
4. Pay attention to beneficiaries
The most inexpensive way to update your estate plan is to carefully examine the beneficiaries listed on your retirement accounts. There are strong tax advantages to leaving your spouse as a primary beneficiary. Unbeknownst to many, your beneficiary designation supersedes what your estate documents say. It is not uncommon for someone to never change an ex-spouse on an old retirement plan. The courts have addressed this on several occasions and the listed beneficiary designation always wins, no matter what a divorce decree says. If you list a revocable living trust as your beneficiary, it’s for the trust to have conduit provisions in order to preserve the spousal tax benefits.
Retirement accounts are often the largest invested asset that an individual or family owns. They’re too important to risk through carelessness or ignorance, despite the intimidation factor. Take the time to learn about your options during open enrollment, then create a set process for making choices and follow it closely.
Meredith Moore is a 20-year veteran of the financial advisory industry who specializes in bringing a customized approach to support the highly personal dynamics that govern her clients’ relationship with money and success. She is the recipient of numerous industry awards and a noted speaker and writer focusing on the intersection of power, money, and gender within relationships. Ms. Moore can be reached at www.artisanfsonline.com.
Meredith C. Moore of Moore and Artisan Financial Strategies, 1125 Cambridge Square, Suite C, Alpharetta, GA 30009 (770) 587–0281.Learn how to take control of your financial life and discover what makes women’s financial planning needs such a unique challenge with our free, white paper: https://www.artisanfsonline.com/.19.htm