Making 401(k) contributions is often autopilot investing,
which can be a good thing. You're practicing dollar-cost averaging, which means
you automatically invest regularly whether stocks are up or down. Because you
fund a 401(k) through payroll deductions, you probably don't even miss the
money you invest.
But you don't want to go into complete hands-off mode with
your 401(k) plan. Checking in every so often will ensure you choose the best
investment options and that you're on track to hit your retirement goals.
Here's how to give your 401(k) a quick checkup in 2021.
1. Check the beneficiary
Even if you have a will, it's essential to check that the
beneficiary you've designated for your retirement accounts is still the person
who should receive the money when you die. Beneficiary designations supersede
wills. That means if the beneficiary listed on your 401(k) is someone you
divorced a decade ago and your will says that your new spouse gets all your
assets, your ex-spouse will still get your 401(k) money.
While the new year is a good time to review your
beneficiaries, it's essential that you update this information any time you
experience a major life event, such as marriage, divorce, or the birth of a
child.
2. Estimate your retirement goals
It's tough to predict your retirement needs, particularly if
you're in your 20s or 30s. But financial planners generally recommend replacing
about 80% of pre-retirement income. Even if your golden years are decades away,
use a retirement calculator at least once a year to estimate whether you're on
track to reach your goals. As you get closer to retirement, it will be easier
to plug in more-precise numbers because you'll have a better sense of how long
you want to work and when you plan to claim Social Security.
3. Make a plan for catching up
If you're falling short, the sooner you can start saving
more, the easier it will be to catch up. Make sure you're getting your full
company 401(k) match. Beyond that, look at ways to save more, even if you can
only afford to invest an extra 1% or 2% of your salary. If your 401(k) plan's
investment options are limited, you may want to contribute only the amount you
need to get your full match and then invest the rest using an individual
retirement account (IRA).
In 2021, you're allowed to contribute:
- Up to $19,500 to your 401(k), plus an extra
$6,500 if you're 50 or older.
- Up to $6,000 to your IRA, plus an extra $1,000
if you're 50 or older.
4. Review your risk tolerance and asset allocation
You never want to drastically change your risk tolerance in
response to short-term stock market fluctuations. But revisiting how much risk
you're taking with your 401(k) once a year is a good strategy. If you're
terrified of a stock market crash or you're getting closer to retirement,
you'll want to shift some of your holdings from stocks to bonds, even if that
means lower returns. Or if you're worried that your money won't grow fast
enough, you'd shift more into stocks, even if that means taking more risk.
The 110 rule can give you a good estimate of what your
allocation should be: Subtract your age from 110 to get your proper stock
allocation. So a 30-year-old would aim for 80% stocks and 20% bonds, while a
50-year-old would want 60% stocks and 40% bonds.
5. Make sure your fees are low
Review your 401(k) fees each year to be sure investment
costs aren't eating away at your returns. Many plans offer target date funds
that automatically rebalance based on your age and planned retirement date.
Convenient, yes, but the average expense ratio is 0.51%, meaning that $51 of a
$10,000 investment goes toward fees.
Many plans also offer passively managed index funds with an
expense ratio of 0.1% or less. That may not sound like a huge difference, but
if you invest $5,000 per year and get 6% annual returns, lowering your expense
ratio from 0.51% to 0.1% would leave you with nearly $30,000 extra at the end
of 30 years.
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