401(k) Decision Checklist

LAST REVIEWED Sep 18 2019 12 MIN READ

By Damian Davila

401(k) plans are one of the primary ways that Americans use to save for retirement. According to the latest data from the Employment Benefits Research Institute (EBRI), 78% of employed U.S. workers report being offered such a plan by their employers and 85% of eligible employees report contributing to their employer’s retirement saving plan. While setting up and contributing to an employer-sponsored 401(k) plan is a great first step towards reaching your nest egg target, there are still many other critical, yet often forgotten, action items involving your retirement account. Here's an easy checklist of key investment decisions and action items for your 401(k) plan.

Set up a beneficiary for your 401(k)

Whether you were were either automatically enrolled in your employer’s 401(k) plan or or you set it up a long time ago, you may have left out specifying an actual beneficiary for your account or opted to leave everything to your estate. However, life happens: you may no longer be single, have no dependents, or be with the same spouse.

Not naming a beneficiary to your 401(k) plan, leaving it to your estate, or forgetting to update your beneficiary are big mistakes because they can create plenty of potential legal problems down the road. The Employee Retirement Security Act (ERISA) clearly states a defined benefit plan or defined contribution plan, such as a 401(k), needs to provide a death benefit to the participant’ spouse. The only exception is when the spouse previously consents to naming someone else beneficiary.

Action Item: The beneficiary form of your 401(k) is so important that it actually trumps your will. As you reach different milestones in your life, make sure to update your beneficiary form. If your spouse agrees to design other beneficiaries than her or him, make sure to get written consent from your spouse. Also, avoid designating children under legal age as beneficiaries because they won’t be able to make decisions on the inheritance until they reach legal age and discuss with your plan administrator about the tax implications for nonspouse beneficiaries.

Contribute the necessary amount to maximize your employer’s matching contributions

Surveys have estimated that from 91% to 98% of employer-sponsored 401(k)s match contributions of employees. While the specific formulas that employers use to match employee contributions vary per plan, one fact never varies: there are many plan holders not taking full advantage of the tax-deductible match.

Even worse, plan holders needing the match the most are the ones that miss it more often. 42% of workers earning less than $40,000 and 30% of workers younger than 30 don’t contribute enough to get their full employer match. The average U.S. workers foregoes $1,336 a year or an extra 2.4% of annual income (source).

Given that most financial planners recommend saving 10% to 15% of your income for retirement, maximizing your employer’s matching contributions is key to reach those saving targets.

Action Items: Check the applicable rules for matching contributions for your plan and take steps to bump up your contributions to make the most out of employer contributions. Read How Much Should You Put in Your 401(k). Make sure that you don’t go over the limit set by the IRS, which is $18,500 ($24,500 for those age 50 and up) in 2016.

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Check the vesting period of employer contributions

As with everything else in life, there’s no such thing as a free lunch when it comes to employer matching contributions. In order to prevent a high turnover of talent, some companies may opt for vesting of employer contributions. For example, an employer could require an employee to work for three years before gaining full rights to employer contributions on his retirement account. Part ways with your employer before three years have passed since you received employer contributions and say goodbye to those monies!

Action Item: Find out whether you gain increasing rights to employer contributions per year (graded vesting) or have to wait a predetermined period to gain full rights (cliff vesting). This way you’ll be sure of the fully vested balance on your 401(k), a key number to have when planning a rollover or parting ways with your employer. To learn more about rollovers, review: How to Roll Over Your 401(k).

Decide between a Roth and Traditional 401(k)

If your 401(k) provider offers you the option to choose between these two options, that's great! (Human Interest offers this to our clients!) This will give you more flexibility for you to choose the type of 401(k) that best suits your financial needs. Roth is post-tax and traditional is pre-tax and one may be better for you depending on your age and future retirement plans: on one hand, if you don’t expect a salary raise for several years, you’re better off contributing to a Roth 401(k). On the other hand, if you’re just a few years away from retirement, then you’re better postponing taxes by contributing to a traditional 401(k).

Regardless of where you choose to put your funds, remember that all employer contributions are made with pre-tax dollars. So, even if you choose a Roth 401(k) for yourself, your employer would make any contributions or matches to a separate traditional 401(k).

Finding out that you have two retirement accounts, one that takes pre-tax dollars and another that takes after-tax dollars, is good news: it allows you to hedge your bets against your tax bracket during retirement. (If you want this benefit even with just a traditional 401(k), look into setting up an IRA for yourself.)

Action Item: Read this article to help you decide: Roth 401(k) vs. Traditional 401(k).

Take a second look at your default investment options

Another investment decision that you may have not reviewed in a while is the list of default investment options in your 401(k). If you were automatically enrolled in your employer’s 401(k) plan and you didn’t change the default investment options, then chances are that all of your monies are in a target-date fund. Depending on your retirement strategy, a target-date fund may no longer be an adequate investment for you.

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Another reason for taking a second look at your default investment options is that legislation affecting your retirement accounts changes over time. One example is the Securities and Exchange Commission (SEC)’s reform on rules governing money market funds, scheduled to affect all types of investors, including individual ones, as early as October 14, 2016. Given this reform, plan administrators may change their default money market fund, stop subsidies of fund expenses to help avoid negative yields in a persistent low-interest-rate environment, among other changes.

To learn more about the SEC’s upcoming money market fund reforms, read:October 2016 SEC Changes to Money Market Investments

Action Item: Check whether or not you have selected default investment options in your 401(k). If so, review the prospectus of those funds to determine their fit with your retirement saving strategy.

Review the fund allocation of your paycheck contributions

Not putting all of your eggs in one basket is a timeless investment maxim. By diversifying your paycheck contributions into several funds within your 401(k), you’re committing to keep track of those allocations over time.

Here’s a sample scenario. In the first year of your 401(k), you decide to break up your paycheck contributions as follows: 30% into company stock, 50% into an index fund, and 20% into bonds. This goes on for many years, but one year you decide to change to allocate 100% of your paycheck into company stock to take advantage of price break provided to employees of your company. The years go by and you forgot about this change in allocation and at the end of every four-month period you keep on having to rebalance your portfolio and you don't understand why.

Forgetting about reviewing how your contributions are split into holdings within your 401(k) is the easiest way to increase investments fees, including front-end and back-end load fees, due to increased trading and suboptimal rebalancing.

To learn about other causes that your 401(k) is not performing as it should and how to fix it, read: Your 401(k) is Underperforming the Market: What Should You Do?

Action Item: Once a year and after a major change in your life (e.g. marriage, birth of a child, salary increase), make it a habit to review how your paycheck contributions to your 401(k) are split and make adjustments, if necessary.

The bottom line

In sum, don’t just set your 401(k) and forget about it. While having a retirement account improves your chances of actually saving for retirement, you’re still responsible for several investment decisions to optimize the outcome of your nest egg. Updating your beneficiary as necessary, taking full advantage of an employer match, and evaluating your default investment options are just some of the action items to set up your 401(k) for success.

Damian Davila is a Honolulu-based writer with an MBA from the University of Hawaii. He enjoys helping people save money and writes about retirement, taxes, debt, and more.

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