Many people are of the opinion that it’s perfectly fine to fall back on Social Security for retirement income. But that strategy could make your senior years a lot less enjoyable.
Social Security will only replace about 40% of your pre-retirement paycheck if you earn an average wage. And many seniors need a good 70% to 80% of their former income to live comfortably — hence the need for personal savings on top of those monthly benefits.
When it comes to saving for retirement, you have choices. Anyone with earned income is eligible to open and save in an IRA. But if your employer offers a 401(k) plan, you may be inclined to sign up and take advantage. If you’re going to do that, though, here are some steps you can take to help ensure that you’re making the most of that retirement plan.
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1. Snag your full employer match
Vanguard reports that 95% of its employer plans offer some type of matching incentive. If your 401(k) comes with a match, do your very best to snag it in full. Not only is that free money for your retirement, but it’s money you can invest at present to grow your balance further.
Let’s say you get $3,000 in employer matching dollars in your 401(k) this year. If your plan generates an average 8% yearly return over time, which is a bit below the stock market’s average return, that $3,000 will be worth over $44,000 in 35 years.
2. Aim to keep your fees low
One downside of saving for retirement in a 401(k) plan is that you’re generally limited to a bunch of different funds. IRAs, on the other hand, typically allow you to invest your savings in stocks. And that could be a far more cost-effective option.
Many of the funds you’ll commonly find in 401(k)s are notorious for charging costly fees — notably, mutual funds and target date funds. So if you’re going to invest your 401(k), consider going heavy on index funds. Because these funds are passively managed, they don’t tend to charge nearly the same fees (known as expense ratios) as their actively managed counterparts.
3. Consider a Roth
It’s not a given that your employer’s 401(k) will include a Roth savings feature. But if you do have access to a Roth 401(k), it could pay to forgo an up-front tax break on your contributions in exchange for the benefits involved.
Investment gains in a Roth 401(k) are yours to enjoy tax-free, whereas with a traditional 401(k), you’re paying taxes on gains eventually. So if you contribute $100,000 to a Roth 401(k) over time and your balance ends up being worth $500,000, you get to walk away with a $400,000 gain without the IRS getting a piece of it.
Plus, with a Roth 401(k), you set yourself up with tax-free withdrawals during retirement. That could ease a lot of the financial stress you might encounter once you shift into a lifestyle that has you living off savings, as opposed to earning money.
Also, don’t forget that as of this year, Roth 401(k)s no longer impose required minimum distributions. That gives you more say over how you manage your savings.
You don’t have to save for retirement in a 401(k), and that option may not even be on the table. But if it is, and you decide to sign up to your employer’s plan, make sure to claim your complete match every year. Choose your investments savvily to minimize your fees, and think seriously about putting your money in a Roth 401(k).
