Employees across America have a love-hate relationship with 401(k) plans, as many workers take full advantage of their retirement accounts while others bemoan the shortcomings of some employer plans. Yet whether your 401(k) plan is the best of the best or leaves something to be desired, there's one principal 401(k) strategy you can follow in order to make the most of what your employer offers you to help you with your retirement savings. In particular, there are a few key rules that you'll want to follow in figuring out how to make your 401(k) work as hard as it can for you.
1. Focus on controlling costs.
The rules that govern employer-sponsored plans are the same for most employers across the nation. But that doesn't mean that every 401(k) plan is a good one. In many situations, it can be hard to find solid investment options that put your needs first, and instead, high-cost investing options can make it hard to maximize your long-term returns, especially if their performance isn't good enough to overcome the headwinds that high expenses create.
If there's a single principal 401(k) rule to serve as the centerpiece of your retirement savings strategy, it's to make sure not to waste money on high-cost investments. Often, you'll be able to find at least one low-cost option in a 401(k) plan, with the typical choice being an index mutual fund that concentrates on a major stock market index like the S&P 500. If you have such an option, check to make sure that the cost of that fund is actually lower than other investments on the 401(k) plan menu, and if it is, you'll want to gravitate toward using it as much as possible. That way, you can minimize the amount you lose to fees and save more of your own money for yourself.
2. Look at the Roth 401(k) option if it's available.
Many people look at a 401(k) as a way to reduce their current taxable income, using pre-tax money to fund their retirement account. Yet increasingly, employers have offered Roth 401(k) options within their retirement plans, and for many workers, the Roth 401(k) can be a better way to save for retirement than a traditional option.
In particular, a Roth 401(k) makes the most sense for those who are in low tax brackets currently. For them, the tax benefit of a deductible contribution is minimal at best, and the prospect for a higher tax rate in retirement is more likely. By contrast, if you're in a high tax bracket now, the Roth 401(k) isn't as valuable, as you give up a big tax deduction now in the hope of avoiding what is more likely to be a lower tax rate in retirement. Regardless, though, it makes sense to go through the math and figure out whether a Roth 401(k) contribution could make sense for you.
3. Avoid the temptation to take out a 401(k) loan.
Unlike most retirement accounts, many 401(k) plans allow workers to borrow against their retirement account balance during their careers. That may seem like a smart option, especially given the easy process for getting access to your money and the fact that you're essentially paying interest to yourself.
The problem, though, is that borrowing 401(k) money in a loan takes it out of the market and therefore reduces the eventual size of your retirement nest egg. That, in turn, jeopardizes your entire retirement savings strategy, because the average returns you'll need to achieve your goals will be much greater than they would be if you left your 401(k) money untouched.
401(k) loans also open up a host of other dangers. In particular, if you lose your job, you'll often have to repay your loan within a short time or else risk having the loan amount treated as an early distribution, subject to taxation and penalties. Failing to repay in a timely fashion creates similar risks.
Some 401(k) plans are definitely better than others, but you can still find ways to utilize any plan regardless of its quality. By following these three principal 401(k) rules, you can make the most of your retirement account and ensure a prosperous and secure financial situation in your golden years.
Dan Caplinger has no position in any stocks mentioned, and neither does The Motley Fool. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.