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The #1 tip to help maximize your 401(k) investing


By Clark Howard Staff 

We as a country can’t continue to pay for the Social Security, Medicare and Medicaid obligations that we’ve promised our citizens. The math simply isn’t going to work, especially as we enjoy longer life-spans. When you get right down to it, you are the only who can provide for your retirement — particularly if you’re under 40.

That’s why saving for retirement is so key. But you can’t just save a bit and think, “OK, I’m getting the job done.”

Make sure you’re doing this in your 401(k) at work

To have a secure retirement, you want to save a dime out of every dollar you make during your working lifetime. That works out to be an effective savings rate of 10%.

Maybe you’re saving zero right now and 10% seems like a bridge too far. Clark has talked about his “baby steps” approach to saving that starts with saving just one penny (1%) out of every dollar you make and gradually stepping it up from there. That’s a great way to ease yourself into a savings habit.

If you have an employer match on your 401(k), try to put in at least enough to pick up the match. If you’re not, you’re leaving money on the table that could be yours. Employer matches can vary by a lot, but for many companies, the way it works is the employer will match up to 50% of the worker’s contribution up to 6% — so if you contribute 6% of your annual salary to your 401(k), your employer will contribute 3%.

The contribution cap is $18,000 for 2016. Those who are 50 and over can make additional catch-up contributions of another $6,000. But once you pick up all the employer match money you can, there may be other better investment vehicles for your money. Read this article for more insight.

What if your employer doesn’t offer any retirement plan at all?

That’s the predicament nearly 80 million people face, according to a study from the Employee Benefit Research Institute.

For those people, there are two basic alternatives. The first is to open up a simplified employee pension (SEP). The paperwork to set up a SEP is simple and you can typically open it wherever you want, like at a low-cost investment house, at no cost. SEPs work like a traditional IRA with a current deduction, but everything is taxed at retirement. They also offer flexibility, in that investors can put in nothing in a year or as much as $53,000 or 25% of your compensation for the year.

The other option when you don’t have access to a retirement plan through work is to open a Roth IRA. Here’s a primer on Roth IRAs to get you started.

Don’t tap into your 401(k) — ever!

According to a new study from Fidelity Investments, nearly one in four people have a loan against their 401(k) right now. There are a lot of reasons why people may choose to borrow against their 401(k). But here are five reasons why you shouldn’t!

1. You’re likely to reduce or stop your contributions during payback. The Fidelity study says almost half of people who do a 401(k) loan reduce how much cash they stash for retirement while they’re repaying the loan. That’s because they’re struggling to make those payments back. And worse still, a third of people end up stopping contributions completely during their repayment time.

2. The “Hey, I’m paying myself back” rationale isn’t so straightforward. When people do a 401(k) loan, they tend to justify it by saying, “Well, it’s my money. I’m paying myself back.” But the thing is, you pay yourself back with after-tax money that then will be taxed again when you retire!

3. If you do it once, you may do it again. Once you take out your first 401(k) loan, what are the odds you’ll do another? Half. You have a 50/50 chance of this being a case of wash, rinse, and repeat, according to Fidelity.

4. The real cost is opportunity. Taking the long view, the stock market has a lot more up years than down years. So if you’re not as invested in the market because you’ve reduced or stopped your contributions during payback, you’re missing a lot of the gain that takes place over time.

5. The net effect is less for you in retirement. A 401(k) loan today means an enormous reduction in what you have to live on in retirement. So you’ll either have to work more years to make up for it or live a life that could put you in near-poverty during retirement.

So look at all the angles: You reduce your contributions, you pay yourself back with after-tax money that then will be taxed again when you retire, and a lot of people contribute nothing during that time period they pay back that loan.

The choice is ultimately yours

You can either start saving money now, or face the fact that you may not get to retire.

Not retiring is not the worst thing in the world; after all, retirement itself is a relatively new concept in human history, less than 150 years old. The idea of a government-provided old age fund or pension goes back to Germany in the 1870s. The idea that you’d put in your time and then have your latter years to just have fun soon spread across Western Europe, before eventually coming over to Canada and the U.S.

Prior to that, the basic notion was that you worked until you dropped dead or were too ill to go to work. That’s how human beings did it since the beginning.

Remember, the choice is yours…

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