July 23, 2024
Rules, Allocation Tips, Company Match and more.
Hello, everyone. Welcome to another episode of Money Fundies. My name is Matt Stearns, and we're here today at Wilhelm Winery in Mercer County, Pennsylvania. If you haven't been here, please check it out. Last episode, we talked about my secret tips for beginner investors, and hopefully, you checked that out. I think it's a good tool, not just for beginners, but for people that have been investing for a while, and it's always a good idea to revisit the fundamentals.
Today, I wanted to talk about a popular subject and something that's on the minds of a lot of Americans, and that's the 401(k) plan, and just how you should go about setting it up, important considerations to make, and how they really function from both my perspective and for your perspective as the worker. Okay, so a 401(k) is just a fancy name that the IRS gave a section of their tax law to allow these plans to be set up with benefits for the employer. So, whatever money an employer contributes, they get a tax break on. And, of course, as the employee, you get significant and beneficial pre-tax benefits, meaning that as you contribute money to your 401(k), it reduces your salary or your taxable salary when you have to go and pay income taxes at the end of the year. In doing so, you save for retirement, and you defer those taxes. You get a tax break in the present; you defer those taxes for when you retire or want to withdraw those funds.
Now, for most 401(k) plans, you can't access those funds until, one, if you retire, and you're over the age of 59 and a half. So, for most plans, if you're over fifty-nine and a half and you retire from your company, you can withdraw those funds penalty-free, and you have to pay tax on them. Okay, if you retire before the age of 59 and a half, with most plans, you have the right to roll those funds over, and you have two options. Basically, you can roll the funds over into a traditional IRA, an individual retirement account, because they have the same tax advantages or same tax circumstances, if you will, or you can roll your 401(k) into another company's 401(k) plan.
So, if you switch employers, you can then roll that into another company's 401(k) plan. For quite a long time, the consensus has been to be, and it still is for the most part, if you leave a company and you leave a 401(k) plan, to roll that money into an IRA, whether you retire or you're switching jobs. Because to move your money from a 401(k) to an advisor like myself, you get more management; you get better fund options. So, if you come to an advisor like myself, we can utilize the entire marketplace of investment options as compared with the one or two dozen options that you have within your company's 401(k) plan. Okay, so you have more options and more flexibility, and traditionally, the fees are lower by utilizing an advisor like myself.
So, we're seeing some transition in fees for 401(k) plans, setting up cheaper and cheaper plans for small businesses, and I think that trend's gonna continue, so it's gonna make the decision-making a little bit more obscure. But for the most part, switching your plan, if you retire from a 401(k) to an IRA, is a wise idea because you get access to a professional advisor who's gonna manage your funds and offer you investment advice outside of just your company plan. Okay, so a lot of benefits from rolling over your 401(k) into a traditional IRA.
And, like I said, there's zero tax consequence with that. When it comes to being employed and deciding how to go about investing in your 401(k) and how much to contribute and what funds to select, there's a little bit of contention in this area, but for the most part, and for the reasons of this video, when it comes to making an election about how much you want to contribute to your 401(k), I recommend that you always start out with maximizing what the company that you're working for is going to give you. So, if they're gonna match your first three percent, you should at least match three percent. In doing so, you're basically getting three percent free money. If they're gonna match three percent and then a half a percent on the next four percent you contribute, you should contribute seven percent, and then in return, you'll get five percent. Okay, so always maximize the company match. This is essentially free money and something that you should always try to take advantage of.
If your company does not offer any employee match, I think it's wise to start by talking to an investment advisor like myself, especially a fee-only investment advisor, and have them give you their opinion about whether it's wise to invest in the 401(k) plan. We're starting to come up with them. Okay? I also have clients who I've taken from 401(k) plans like this, who don't have a company match, and I'm able to invest them at a lower cost, give them more options, and more flexibility with their money. In a lot of cases, I can also offer them a Roth option, which isn't a popular option, at least in this area, as far as the way that you can contribute your money within your 401(k).
And that leads me to that topic, which is if your company offers you a Roth or a traditional 401(k) option, please refer to one of my previous episodes that I did talking about the Roth IRA and comparing it to the traditional IRA, as you can make the same distinctions or decisions based on the IRA or the 401(k). Because, um, the 401(k) and the IRA function relatively similarly, except they have different contribution limits and a couple of other lesser-known trade-offs and options, as far as taking loans and things of that nature, that is beyond the scope of this video.
Okay, now the last thing I want to talk about is how to go about choosing to make your own investments in allocating your funds. Okay? So, when it comes to a 401(k) plan, one of the inconveniences is you, as the employee, have to actually build your own portfolio. Okay? And some employers make this easier; some employers have a helpful investment advisor; some do not. Okay? But at the end of the day, you're responsible for making the investment decisions within your 401(k). I can't cover this entire topic of portfolio allocation within this video. Okay? But when it comes to portfolio allocation in the 401(k), there are tons of helpful resources available to you.
But in general, I like to use the 1:20 rule. Okay? So, if you're 20 years old, subtract your age from 120, and that would leave you with a hundred, and that's the percentage that you should have invested in stocks. Okay? So, if you're 20 years old, you should have a hundred percent of your money invested in stocks. If you're thirty years old and subtract that from 120, you should have 90 percent of your money invested in stocks, so on and so forth. Now, realize this is just a rule of thumb; this isn't what I recommend in every circumstance, and it's not how I go about building portfolios for my clients. But for those of you that are out there struggling to get a grasp on how you should go about investing your portfolio, this is a great little rule of thumb to go about it.
And the other percentage, say you're 30 years old, you should have 90% in stocks and 10% in bonds. Okay? If you don't have the option to invest in target-date funds, I strongly advise those because those funds adjust themselves over time, so it requires less research by yourself as the investor, and in making fewer decisions, and instead allowing these people in higher places that do this for a living to make those decisions about how to invest your money. And so, as you get older, the fund will adjust itself to become more conservative and aligned with your investing goals.
Okay? So, if you have the option, invest in target-date funds. Over 50% of employees who are invested in 401(k) plans invest in target-date funds, and there's nothing wrong with that. And if you don't have target-date funds as an option, utilize the little rule that I just told you, and you should set yourself up for success when it comes to building your own portfolio within your 401(k) plan.
So, those are my tips, and that's what I want everybody to know when it comes to 401(k) plans. As always, if you have any questions, reach out to me. I've also facilitated the management of my clients' 401(k) plans if I manage their IRAs as well, or perhaps even some taxable or standard investment accounts. So, that's something I can facilitate. But that's all I have for you today. Thank you for joining me, and of course, we'll see you next time. Thank you very much.
