As the spouse of a Foreign Service officer, Cathy Lincoln moved frequently and changed jobs with each new post while raising two children. She had neither the time nor the inclination to pay attention to her retirement accounts. "I had a set-it-and-forget-it attitude," says Lincoln, 56, of Washington, D.C. After a divorce, however, she wanted to see if her investments were on course. Rather than run the numbers herself, she consulted an adviser at the Royal Bank of Canada, which administers her IRA. On the adviser's recommendation, she tweaked her investments and rolled a 401(k) held by a former employer into the IRA. The fine-tuning put her accounts in good running order, she says. "A financial adviser pulls it all together."
Planning for retirement is like taking a long road trip. At first, you put your plan on cruise control, letting your employer make some or all of the calls about how much to save and in which investments. Later, as your finances and priorities become more complicated, you take the wheel yourself, tweaking those investments and dialing up (or paring back) your contributions. By the time you're approaching retirement, you may want to turn over the driving to an expert (at least temporarily) who will look under the hood and calibrate your investments to your exact needs.
No matter what stage you're in, your employer-sponsored 401(k) plan is key to getting you where you need to be. These pretax accounts, also called defined-contribution plans, now far surpass pensions as the retirement savings vehicle of choice among private companies. In 2014, more than 90 million Americans were covered by a defined-contribution plan, with assets totaling more than $6.5 trillion, according to Vanguard. The average account balance with Vanguard was $102,682. Employers played a key role in fattening those balances, bringing the average contribution rate to 10.4% of annual pay, including a 6.9% average contribution rate by employees.
These six steps will help you get the most out of your 401(k) and take advantage of the momentum your employer offers.
1. Get a head start
Given the daunting prospect of financing your own retirement, you'd think that throwing money into your 401(k) from the start of your career would be a top priority. In fact, many young (and not-so-young) workers go with Plan B: procrastinating. In recent years, companies have countered that tendency to stall by automatically enrolling employees in the company plan. Workers are given the opportunity to opt out, but relatively few do. In 2014, employees whose plans included automatic 401(k) enrollment had an 89% participation rate, compared with 61% for employees in plans with only voluntary enrollment, according to a 2015 study of Vanguard plans.
The gentle push to begin steadily saving makes for a powerful head start. A recent Wells Fargo study showed that people ages 55 to 59 had accumulated three times the retirement stash of those 60 or older. How so? The younger group had started saving consistently at 31, six years earlier than the older group. "It's only a six-year difference, but when you think about the power of six years of savings compounded over 25 years, that's significant," says Joseph Ready, director of institutional retirement and trust for Wells Fargo. "The message is, don't lose the power of time. Start saving as early as possible."
2. Step up the pace
The downside of relying on your employer to make your savings decisions is getting lulled into thinking you're saving enough. About half of participants who are automatically enrolled in a Vanguard 401(k) start at a 3% deferral rate, and many are content to stay there. "They think that this must be the right savings rate, and they leave it alone," says Ready.
Lately, more employers have taken advantage of that very tendency by initially setting contributions at 4% or more and automatically hiking the contribution rate by one percentage point a year, most often up to 10%. Employers also increasingly offer a dollar-for-dollar match rather than the once-common 50 cents on the dollar. A recent survey of large employers by Aon Hewitt, a benefits consulting firm, showed that 19% of companies match contributions dollar for dollar up to the first 6% of salary, and 23% offer the match up to the first 3% to 5%. "Plan sponsors are trying to make the plan as appealing as possible. They're telling you to invest your retirement funds with them because they can help you the most," says Rob Austin, director of retirement research at Aon Hewitt.
If your employer doesn't pave the way for you with automatic nudging, you'll have to get there on your own. Aim to contribute at least 10%, including the company match, within the first few years of your savings career; you should contribute more if you get a late start. Many retirement experts recommend saving as much as 12% to 15%, including the employer contribution, from the get-go. (Some 24% of Kiplinger readers who responded to a recent poll save 11% to 15% of their income for retirement, and 34% save more than 15%.) In 2016, you can kick in $18,000 and, if you're 50 or older, another $6,000 in catch-up contributions, for a total of $24,000.
The get-go is also a good time to start contributing to a Roth 401(k), if your employer offers one. This option, offered by six out of 10 large employers, lets you contribute after-tax dollars to your account. Withdrawals are tax- and penalty-free if you have had the account for five calendar years and are 59 1/2 or older. Given that your salary and tax rate will likely go up as your career progresses, your early career is a good time to start funding a Roth. You can contribute the annual max to the Roth 401(k) or split your contributions between the pretax and after-tax accounts.