Back when you were in grade school, passing a quiz involved memorizing random facts. Heck, you can probably still recite the 50 U.S. state capitals or the periodic table of elements. Unfortunately, adulthood ushers in a new set of tests, and knowing capitals or elements won't earn you an A grade on your retirement.
According to the American Benefits Council, 80 million people in the U.S. are actively participating in a 401(k). The highest-performing savers among this 80 million are making all the right moves. They're contributing 15% or more of their salary, they're investing in low-cost mutual funds, and they're increasing contributions regularly. The lowest-performing savers, as you might guess, are far less engaged. They may have been auto-enrolled in the plan and don't know much about how their money's invested.
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Wondering where you fall on that spectrum? Test yourself on these five 401(k) characteristics to find out.
1. Contribution rate
A survey from global advisory Willis Towers Watson found that 73% of employer respondents were automatically enrolling their employees in the workplace retirement plan. That's an increase from 68% in 2014 and 52% in 2009.
Employers like to implement auto-enrollment because it's been proven to increase 401(k) participation. But there is a downside. To enroll an employee automatically, an employer must define the savings contribution rate. And that rate is often lower than the rate selected by savers who enroll voluntarily.
If you can't remember or never knew your contribution rate, check in on that today. If it's less than 15% of your salary, plan on increasing that percentage every time you get a raise. Keep up with those increases until you reach 15% or hit the 401(k) annual contribution limits. In 2020, you can contribute up to $19,500 in your 401(k), or $26,000 if you're 50 or older. These caps only apply to your contributions, and not those made by your employer.
2. Employer-matching rules
Employer-matching contributions are free deposits into your retirement account, funded by your employer. They're called "matching" because the amount you get depends on how much you contribute out of your own pay. Every plan has its own formula. Often, an employer will match your contributions dollar for dollar, up to a cap that's expressed as a percentage of your salary.
Say your employer matches your contributions up to 5% of your salary. That means when you contribute 5% of your salary, your employer will deposit the same amount into your retirement account at no charge to you. That's free money, and you'd be crazy not to take advantage of it.
Find out how much you should contribute to max out employer-match, and then raise your contribution accordingly.
3. Vesting rules
Employer-match is technically free money, but there is a catch. Most employers prefer to invest in employees who are loyal. That's where vesting rules come in. Vesting rules define your ownership of employer-match contributions over time. Generally, you'll own a small percentage in the first year, and that percentage gradually rises to 100% over five years or so.
If you leave your job when you're 50% vested, for example, you can only take half of those employer-match contributions with you.
Vesting should be a consideration when you're evaluating a new job offer. And sure, a big signing bonus or a much higher salary might compensate for the matching contributions you give up. Just make sure you increase your own contributions in the new job to make up for the money you left behind in unvested employer-match.
4. Fees you pay
You may not know it, but you are paying fees within your 401(k). Most plans charge administrative fees, which cover the cost of running the retirement plan. Some employers pay these fees for you, while others pass the fees on to you. Check your statements for an annual fee amount, or ask your plan administrator if you're paying an admin fee. Note that you can't do much about 401(k) admin fees, other than invest your money elsewhere if the fee is exorbitant.
You also pay investment fees. The most common type of investment fee is what's called an expense ratio -- essentially a mutual fund's administrative fee. Some funds also charge sales fees, either when you buy fund shares or when you sell them.
High investment fees can degrade your returns over time. You can keep these low by choosing passively managed funds with expense ratios of less than 0.10%.
5. Ways to automate
Your plan may have several features to automate your retirement savings. Unless you have the time to manage your account hands-on, you should take advantage of these automations. Options to look for include:
- Automatic escalation: Auto-escalation increases your contribution rate annually. According to Benefits News, a person who starts with a contribution rate of 6% and increases it by 2% annually will save almost as much after 35 years as someone who started with a 15% contribution rate.
- Automatic rebalancing: Automatic rebalancing adjusts your positions within your 401(k) each year according to your desired asset allocation. Rebalancing is important as it helps you manage risk. It involves selling off riskier assets and purchasing more stable assets with the proceeds. When the market is strong, your riskier assets grow faster -- which can leave you with too much money invested in those positions. Rebalancing corrects that by reducing your riskier positions and increasing your more stable ones. If that sounds too complicated, rely on your 401(k) to do it for you automatically.
Take control of your 401(k) today
Retirement may not be at the top of your priorities list, but the decisions you make today define your lifestyle tomorrow. Spend a couple hours getting to know your 401(k) and how it works, and you take a huge step toward a comfortable, A-grade retirement.
