How to Change Your 401(k) Contribution? Expert Tips on Maximizing Your Retirement SavingsPersonal Taxes
Statistics show that over sixty million Americans invest in 401(k) plans. On average, workers in the United States save close to $200,000 before reaching their legal retirement age.
You can save much more by making wise investment decisions and deferring a significant percentage of your salary to your retirement plan.
Changing your 401(k) contributions enables you to generate more profit from investments or free up a portion of your salary if your living expenses increase.
Whether you should make these changes depends on various factors ranging from when you’d like to retire, to your actual investment strategy.
In this article, we’ll give you expert tips on maximizing your retirement savings and changing your 401(k) contributions to create a cozy cushion for old age.
Table of Contents
401(k) Fund Types
Roughly 70% of all employers in the United States offer 401(k) plans to their employees, but the terms of these plans vary from one company to another.
Still, most employers match employees’ contributions up to 5%, which means you should invest at least the amount your employer is willing to match.
It’s entirely up to you how much of your salary you want to direct toward the retirement plan. Ideally, 10% of your annual income should go to your 401(k) plan. Most plans enable you to invest in bonds, stocks, money market instruments, and other assets through mutual funds.
This umbrella term refers to a multitude of fund types that involve different amounts of risk. Investing in so-called conservative funds carries minimal risk, but your profits will increase slowly.
Aggressive funds are high-risk, high-reward as you can profit immensely in a short time or lose your money if the asset’s value goes down.
Value, balanced or specialized fund investment options all carry different amounts of risk. So, if you want to play it safe, you should invest in a low-risk option, while investment in a specialized or aggressive fund might help maximize your savings.
Some 401(k) plans enable you to invest in Target-date funds that reach their peak value around the time when you want to retire.
Besides profit, several other factors, such as age and your estimated retirement date, might prompt you to consider other investment options that will enable you to accumulate profits faster.
The important thing to note is that you can invest in multiple options at once and combine conservative and aggressive funds.
Aggressive investment options are generally better suited for professionals at the beginning of their career paths. You should slowly transition to low-risk funds as your retirement approaches to minimize the chances of losing a substantial portion of your savings.
Calculating how much money you’ll need to retire can help determine the percentage of your salary you want to direct into a 401(k) plan and find the investment opportunities that will allow you to reach your goal.
Adjusting a 401(k) Plan
The frequency at which you can adjust your 401(k) plan depends on the plan’s terms. Some employers offer plans that can only be modified once per year, while others let workers change their contributions whenever they want.
Hence, you must first check how often you can adjust your 401(k) contributions. You’ll have to either speak to your company’s HR officer if your employer administers 401(k) plans internally or contact an external plan administrator.
The fastest way to find out who your plan administrator is to check your retirement account statements, as the name of the company or individual in charge of your plan should be included in this document.
- Choose how much you want to contribute: Most 401(k) investors contribute 10% of their salary to their retirement plans. You can increase your investment to 15% of your annual income if you recently got a raise or decrease it to 5% if you want to boost your spending power.
- Submit the paperwork: Your 401(k) plan administrator should provide you with the documents you must fill out and submit. Some providers allow you to complete this process online.
- Validation process: The administrator will approve the adjustments you’ve made to your plan. The changes will reflect on your next paycheck.
8 Tips on Maximizing Your Savings
The IRS limits the maximum amount you can contribute to a 401(k) plan per year. These limits are adjusted annually, which is why you must check if you’re currently contributing as much as you can to your 401(k) plan.
In 2023, 401(k) plan holders with Single tax filing status cannot contribute more than $22,500 to their retirement plans or $30,000 if they’re older than fifty. On the other hand, there’s no minimum amount you must contribute to a 401(k) plan.
The easiest way to maximize your retirement savings is to adjust your contributions to reflect the annual threshold corrections automatically. Let’s look at other methods you can use to increase your 401(k) savings.
1. Don’t Withdraw 401(k) Savings Before Your Retire
The money that goes into a 401(k) plan isn’t taxed until you withdraw it. As a result, you can postpone paying income taxes for the funds you keep in this account until you retire.
You’ll pay a 10% early distribution penalty and income tax for the sum you withdraw if you’re younger than 59-1/2.
Borrowing against your 401(k) plan is also not advisable because it will eliminate the plan’s tax benefits and prevent you from making contributions until you pay the loan.
2. Diversify Investments and Avoid Unnecessary Risks
Don’t put all your eggs in the same basket. Invest in different types of assets to ensure your retirement savings won’t be affected by a single risky investment decision.
Assess your risk tolerance carefully before each investment because you might lose all your savings if you impulsively decide to put all your money into a single asset.
Moreover, you shouldn’t change your investment strategy abruptly whenever an exciting new asset appears on the market.
Investing in volatile funds early in your career can help you boost your savings. Still, you should transition towards more conservative funds to protect your capital as you get closer to retirement.
3. Check the Asset’s Fees Before Investing
The capital you’ll have after thirty or more years of making regular 401(k) contributions depends on the fees you’ll pay over that time.
Investors are required to cover custodial, individual service, investment, and administrative fees that range from 0.3% to 2% of their savings. Your employer should inform you about the 401(k) plan fees before you decide to start investing.
In addition, you’ll have to cover the front-end load fees whenever you invest in an asset. Usually, these fees don’t exceed 3% of the asset’s value. Even so, putting money into mutual funds with fees over 2% will reduce the profitability of the investment.
4. Use a 401(k) Plan to Reduce Your Tax Liability
The sum withheld from your salary will affect your taxable income. Consequently, increasing the percentage of your monthly pay that goes into your 401(k) plan will lower your tax liability.
Tax deferral enables you to pay income taxes for the funds you save and the profit you make through investments within a 401(k) plan when you retire. However, FICA taxes aren’t excluded from your tax liability calculation.
Contributing to a 401(k) plan can also make you eligible for a saver’s tax credit if your adjusted gross income is below the threshold for your filing status.
The IRS adjusts the saver’s credit threshold annually, so to qualify for this credit in 2023, your AGI must be under $36,500 if your filing status is single. Married couples filing a joint return can claim this tax credit if their AGI is less than $73,000.
5. Learn More about 401(k) Matching
Employer matching isn’t compulsory, so your company’s 401(k) plan may not require your employer to match contributions you make to the plan.
Still, over 60% of companies match a certain percentage of the employee’s 401(k) contributions. Depending on the plan, an average employer matches between 3% and 6% percent of the employee’s annual salary.
To maximize your savings, you should ensure that the amount you contribute to your retirement plan meets or exceeds the company’s matching percentage.
6. Don’t Forget to Check the Plan’s Default Deferral Rate
The SECURE Act 2.0, passed in 2019, prevents employers from setting the default deferral rate under 3% in plans with automatic enrollment. Hence, all 401(k) plans established after December 29, 2022, must have a 3% and not higher than 15% deferral rate.
Still, most companies opt to contribute 6% of their employees’ salaries to 401(k) plans and allow them to decide if they want to increase this rate.
So, to maximize your retirement savings, you must check the default deferral rate for the plan your employer is offering and adjust it through the plan amendment process if necessary.
7. Consider Rolling Over Your 401(k) to Your New Employer
Cashing out your 401(k) plan when changing jobs will reduce your retirement savings because you’ll have to pay taxes for the entire amount.
So, instead of taking a lump-sum distribution, you can roll the plan over to your new employer once you become eligible to participate in a new 401(k) plan.
Remember that some plans don’t allow rollovers, and the administrator of your old plan may not be able to transfer your savings to a new account.
In this case, the most profitable solution is to leave the savings where they are, but you can only do this if you already contributed over $5,000 to the plan.
8. Combine Traditional and Roth 401(k) Plans
Keeping all your savings in a traditional 401(k) plan can push you into a higher tax bracket after you retire. In addition, you’ll have to pay income taxes for each withdrawal which will limit the profitability of your investments.
Most importantly, all traditional 401(k) plans come with required minimum distributions that dictate how much money you must withdraw from your account every year. Roth 401(k) plans won’t have RMDs starting from 2024.
Moreover, using traditional and Roth 401(k) plans will enable you to choose when to make pre-tax and after-tax withdrawals so that you can maximize your income.
Some employers don’t offer both of these retirement plans. Consequently, combining them is only possible if the company you’re working for provides this option.
Frequently Asked Questions
Increasing or decreasing your 401(k) contributions usually lasts several weeks, and changes become effective in the next payment period. Filling out the necessary documents and submitting them takes only a few minutes.
You don’t have to report 401(k) contributions when filing taxes unless you make an early withdrawal from your retirement account.
You don’t have to pay a fee to move your savings from one 401(k) plan to another, but your new plan may have higher fees than the old one.
Your plan provider should stop deferring funds to your 401(k) once you reach the contribution limit. If your plan’s administrator doesn’t stop payments in time, you’ll be taxed twice on the overcontributed amount.
Maximizing Retirement Savings by Making Timely 401(k) Plan Adjustments
Opting into a 401(k) or automatically enrolling in a plan you don’t fully understand will limit your ability to maximize savings.
Deferral rates, investment options a plan offers, or the maximum contribution you can make in a year are among the factors you must consider when exploring ways to increase your capital.
You’ll also have to choose the investment strategy that best fits your goals and enables you to save the amount you need to live comfortably when you retire.
Hence the best way to make the most of the options available in your 401(k) plan is to keep up with the latest contribution thresholds, choose funds carefully and adjust your plan whenever necessary.
Logan is a practicing CPA and founder of Choice Tax Relief and Money Done Right. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.