4 Things You Didn’t Know About a 401(k)
A 401(k) is a unique retirement plan that offers tax-deferred benefits, matching opportunities and long-term savings. The way you use these benefits will determine how much of a savings you’ll have.
For more than 30 years, the financial advisors at Scarborough Capital Management have helped busy people make smarter financial decisions. When clients first come to us, many have the same questions about how to manage your 401(k), so here are 4 things you may not know about your 401(k) plan.
1. You May Be Eligible For ‘Free’ Money
If you have a 401(k), you are likely eligible for an “employer match.” This means that when you contribute a certain percentage of your paycheck to your retirement plan, your employer will match that contribution up to a certain amount (typically up to 5 percent). That extra percentage has some conditions, but for the most part, it’s free money to you – and not just once, but every year!
Not taking advantage of an employer match is essentially leaving money on the table.
This may sound like a no-brainer, but believe it or not, millions of people each year don’t take advantage of this, resulting in an estimated $24 billion that’s left behind every year, according to this CNBC article.
Take-away #1: Adjust your contributions to your retirement plan to ensure you get the full match every year.
2. A Loan from Your 401(k) Can Be Harmful
While many retirement plans allow you to take a loan from your plan for certain circumstances, borrowing from your 401(k) has its disadvantages.
First of all, you may lose out on an important resource: Time. Through the power of compounding, time can help you build wealth. If you take money out of your retirement plan too soon, you interrupt that process.
Second, when you take a loan from your 401(k), you may be subjecting yourself to double the taxes. When you take money out of a 401(k), you have to pay the loan back using after-tax dollars. However, you will have to eventually pay taxes again when you take money out after retirement.
Take-away #2: Discuss your short-term financial needs with a financial advisor before making a decision that could effect your long-term goals.
3. Your Tax Refund Can Help Grow Your Plan
Do you look forward to receiving a tax refund at the end of the year? Per IRS data, nearly three out of four Americans do, and the average refund last year was about $2,900. While getting a check in the mail is always nice, this isn’t a bonus or a gift. It’s actually a return of your own money after you provided an interest-free loan to the government.
Stop giving free loans to Uncle Sam, and instead, use that money to benefit yourself! Let’s do the math:
If you receive a refund of $2,900, this could equate to about $240 extra on your net paycheck every month. This money can be used to pay off debt or put into your retirement accounts to grow.
Take-away #3: If you typically receive a tax refund at the end of the year, talk with a financial advisor about adjusting your tax withholding so less is deducted out of your paycheck each month. Then, put that money to work, either paying off high-interest debt or investing it for your future.
4. Changing Your Money Mindset Can Help Grow Your 401(k)
We have many clients who are 401(k) millionaires. One commonality we have noticed over the years is that they tend to focus on the future and prioritize savings by putting it on auto-pilot.
It can be easier said than done, but when you prioritize the future over immediate gratification, people often start wanting every dollar they have to work as hard as possible for them. Whether buying a car or grocery shopping, when the priority is the future, people tend to look for the best deal. This can help you achieve your goals faster.
Sadly, this isn’t the norm. A lot of people spend on auto-pilot – and therefore, often continually struggle with debt and end up not having the freedom to do things they want, such as traveling, changing careers or retiring when they had hoped.
In fact, with the conveniences available to us today, many people are on auto-pay and may not even remember what is being taken out of their account every month.
- Do you pay for a gym membership but never go?
- Did you sign up for an app or subscription a long time ago that you no longer use?
- Did you change Internet or TV providers but forget to cancel the previous plan?
- Did you sign up for a trial but forget to cancel?
There are many ways people spend money without even being aware of it. While auto-pay can be extremely convenient, make sure you review your account on a regular basis to ensure you’re not wasting money. This extra money could be used toward your future, instead of paying for something you had in the past.
If you’re able to, take the opposite approach and put your spending on auto-pilot. If it’s not already set up, you should be able to automatically contribute the maximum amount you can to your retirement plan. Just set it and forget it.
This is where financial planning can play a critical role. Having a financial advocate on your side can help you make better, smarter decisions.
Take-away #4: When making a purchase, think about how it will affect your future. Stay accountable to your goals. If possible, start saving early, so you have more time to generate wealth.
If you already have a financial advisor, talk to him or her about your 401(k) and how you can maximize your saving capabilities. If you aren’t currently working with a financial advisor and wonder how to manage your 401(k), contact us. We specialize in 401(k) plan management and can assess your current situation.
Securities through independent Financial Group, LLC (IFG), a registered broker-dealer. Member FINRA/SIPC. Advisory services offered through Scarborough Capital Management, a registered investment advisor. IFG and Scarborough Capital Management are unaffiliated entities.