This month is a great time to take stock of the situation with your 401(k). These days, many new hires are automatically enrolled in their plan, but are unaware of how much they are contributing, and how that money is being invested. If you have not checked your 401(k) in a while, October is a good time to take stock of the situation. You still have a little bit of time left in the current year to make changes.
For starters, make sure you are enrolled and participating! These days, most employers offer some sort of matching contribution. You don’t want to miss out on free money, so make sure you are enrolled, and at least participating to the match level. We could do an entire post on matching alone, so this is a key area to know and review. Know how much you are contributing, and how much your employer is contributing.
Where is that money going? By this, I mean be sure you are not just sitting in cash and not actually invested. Some plans that auto-enroll employees take the safest, default route and put that money in cash. It may be up to you to then select your investments. You need to know how your money is invested and make sure that it’s working for you. At minimum, a target-date fund could be used. Perhaps better, would be to select a static portfolio option that matches your risk tolerance.
One choice you should make, is to be certain your 401(k) plan is on automatic increase (sometimes referred to as automatic escalation). Many of us set our 401(k) contribution when we enroll and then forget to check that annual contribution. Each year, it’s good idea to automatically increase your contribution by a percent or more. We are learning that realistically we need to save 15% to 20% of our lifetime earnings for a secure and comfortable retirement. I lean toward the higher number for security.
To check if you have this auto-escalation feature, log into your 401(k) account. Each provider has this feature in a different location but it’s generally in your contribution or deferral percentage area. What you want to look for is your deferral percentage and review your current percentage. There should be an option for “auto increase” or “automatic escalation”. Be sure this is set to 1% at minimum. You can schedule the annual increase for more if can afford the deferral. Regardless, you can’t exceed the annual maximum personal contribution allowable each year.
It’s best for this auto increase to occur at the beginning of each year to really take advantage of the increased contribution, time, compounding, and dollar-cost averaging over the year. However, getting started in October is still worth it. Increasing your annual contribution by at least 1% per year can really help you hit that higher savings threshold and build your account balance over time. It’s automatic going forward and can make a big difference.
How big of difference? Consider this classic example from U.S. News & World Report from 2017: Assume that two 401(k) savers, both age 25 and earning $40,000, each contribute 6 percent of their pay to the plan. Both also receive a 2 percent raise each year and get the same 6 percent rate of return on their investments. But only one of them chooses auto-escalation, with the contribution rate rising 1 percent each year and maxing out at 15 percent of the person's annual salary. By age 65, the employee not using auto-escalation would have saved approximately $513,000, while the employee using auto-escalation would have more than $1.1 million.1
That’s a big difference in how well-funded and secure your retirement could be. Moreover, most will not even miss the 1% increase per year from their salary. Take the above example in year two. Your new base salary would be $40,800. At 6% on your original salary, you would be contributing $2,400 per year. After your 2% raise and 1% automatic increase to 7%, you would be contributing $2,856 per year. That averages out to roughly $8.77 per week more than you are contributing, but you are potentially growing that annual increase exponentially over time.
Want to talk about your 401(k)? As an independent Certified Financial Planner™, I can help you analyze your 401(k) help you get on track. Contact me and let’s get started. #talktometuesday #education #Hireaplanner #stressfree #savings #goals #debtfree #budget #401k #autoincrease #autoescalate #CFPPro #LetsMakeAPlan
1. Rebecca Lake, Build a Better 401(k) Balance With Auto-Escalation, U.S. News & World Report, June 23, 2017, https://money.usnews.com/investing/articles/2017-06-23/build-a-better-401k-balance-with-auto-escalation