Your 401(k) is a smart place to store your retirement money, but putting a percentage of your paycheck into it every month is not enough. You need to understand how your investments, the plan's fees, and any employer match play into putting you on track for your retirement goals.
Here are four key things to do to get the most out of your 401(k).
1. Understand the costs.
Many savers don't realize their 401(k) even charges a fee, because they never receive a bill. Instead, the money is automatically taken out of your account each year. These fees cover the expense ratios for mutual funds (essentially an annual fee) and administrative expenses, like record keeping.
Fees are usually a percentage of your assets, but the amount depends on what your investments are, how much you have invested, and your employer. Larger companies can usually offer more affordable 401(k) plans because the administrative fees are spread out across more employees.
As a rule, you shouldn't pay more than 1% of your assets in 401(k) fees. That means you're effectively losing $1,000 every year for every $100,000 you have in the account. The only time you should consider paying more is if your employer-matched contributions make up for what you lose in fees.
You can find out how much your 401(k) costs by checking the plan summary or looking at the prospectus for your investments. If you have questions, ask your plan administrator or your company's Human Resources department. If your plan's fees are high, talk with your employer about offering lower-cost investment products, like index funds -- mutual funds that passively track a market index. If that doesn't work, consider stashing your savings in a more affordable IRA instead.
2. Contribute at least enough to get your full employer match.
At the very least, you should contribute enough of your income to your 401(k) to get any employer match available. This is free money, and it drastically reduces the amount you need to save for retirement on your own.
Say you make $50,000 and your employer matches $0.50 on the dollar for the first 6% of your salary. This means an extra $1,500 per year as long as you contribute $3,000 of your own money each year. That $1,500 per year in employer-matched funds could add up to more than $153,000 over 30 years, assuming a 7% rate of return. And that doesn't include your own contributions.
3. Know your vesting schedule.
Your vesting schedule determines when your employer-matched funds become yours to keep. Some companies offer immediate vesting -- any employer-matched funds you earn are yours to keep right away, even if you leave the company after a month.
But it's more common for employers to offer a graded vesting schedule; for example, you get to keep 25% of your employer-matched funds after one year, 50% after two years, and so on. Or you may have to work for the company for a certain number of years before you can keep any of your employer contributions. If you quit before you're fully vested, you forfeit some or all of your employer-matched funds, depending on the vesting schedule.
This isn't an issue if you plan to stay with the company for several years, but if you're thinking about changing careers, be mindful of it. Talk to HR to learn more about the plan's vesting schedule, and try to stay until you're fully vested so you don't miss the money.
4. Periodically reassess your investment strategy.
Your retirement goals and risk tolerance will probably change over time. Typically, as you age, your risk tolerance decreases because if your investments lose value, they might not rebound before you need to the money to live on. That's why it's smart to invest more in lower-risk investments, like bonds, as you near retirement.
Reevaluate your investment strategy every year to make sure it's still in line with your goals and risk tolerance. These yearly checkups are also a good time to sell off assets that have consistently performed poorly, so you can reinvest in a more promising asset. This may help boost the performance of your portfolio.
A 401(k) is not something you can put money into and never think about again. You should understand exactly what you're getting out of the plan and how much it costs, and periodically reevaluate your portfolio to ensure you're on track for the retirement you want.