The 401K, a widely used retirement vehicle offered by employers, is well known. But there are a few facts that you might not already be aware of.

History and a brief overview of 401(k) plans

Now the prime retirement account vehicle for full-time employed workers whose companies offer the benefit, the 401(k) was not originally designed to be the retirement account for the masses.

It was created as a way for executives and others to avoid taxes on their deferred compensation. Later, a benefits consultant wanted to find a way for employees to save while receiving an employer match, and in 1981 the IRS allowed employers to fund these accounts through payroll deductions. That kicked off the account’s popularity.

A 401K eligible employee can set aside up to $19,500 in 2020 into the plan. If over 50, they can also add a “catch-up” up to $6,500. Some firms provide a matching contribution up to a certain percentage or dollar amount, free money to the employee, and tax-deductible to the employer.

The match is always pre-tax, but if the option exists in the plan, the employee can choose whether their contribution is pre-tax, known as Traditional, or after-tax as a Roth. Typically, the plan sponsor (usually an investment services company) provides a menu of conservative to aggressive options so each employee can invest according to their particular strategy.

Because they are employer plans, 401(k)s are strictly regulated. A third-party administrator or TPA usually oversees the plans, so the employer has no influence over an employee’s account and can’t monitor it. Requests for withdrawals and rollovers are generally sent to the TPA to take care of. 

That’s $25,600 or $33,000 to be set aside tax-deferred, depending on your age. But is that the maximum allowable? Not necessarily.

As they used to say on the informercials: But wait, there’s more!

The IRS caps the total amount of defined contribution plan limits at $57,000. The missing component, after the employee’s 401(k) contribution and the employer’s match, if any, is an after-tax contribution to the plan. Not all plans allow for this, but some do. This is the limit for solo 401(k)s and SEP IRAs as well.

Imagine that you’ve contributed $19,500 to your plan. Your employer match has kicked in $6,000, bringing the total to $25,500. For the $57,000 plan limit, the catch-up contributions don’t count.

Therefore, you can add to that $31,500 after-tax to reach the upper limit of $57,000. Why would you add in additional funds that are not tax-deductible? You may not get the current year tax deduction, but it will grow tax-deferred until it’s time to take the money out.

401(k) fees and retirement withdrawals

It’s essential to consider the fees in your plan and the options. If your plan sponsor is an insurance company, you may be paying an additional “separate account” charge that may go by the name Variable Account Charge or Mortality & Expense (M&E).

Plan sponsors, whether insurance companies or not, may charge the employer additional fees as well, which may or may not be passed down to you. They may offer other services such as “advice” for an additional cost, but you can most likely find similar advice more cheaply by asking your financial advisor.

When choosing your funds, look at the expense ratios and the share class (if you’re investing in mutual funds.) Those with high expense ratios and share classes that are not labeled “institutional” or “load-waived” aren’t good for your bottom line.

Also, read your plan documents to see what kinds of withdrawals are allowed once you’ve reached age 59 ½ and can withdraw without penalty. Some plans don’t allow you to withdraw monthly, and may restrict you to annual or quarterly withdrawals.

401(k) Rollovers

In some of our previous articles, we’ve mentioned that you should consolidate your like-kind retirement accounts, i.e. Traditional with Traditional and Roth with Roth, rather than having a number of accounts from previous employers sitting in old 401(k)s.

Some 401(k) plans allow for rollovers into the plan itself. This might not be a bad idea if you’ve investigated the plan in detail and know that the fees are low. And that you can withdraw funds whenever you want after you’ve reached 59 1/2.

Another option is to roll all your 401(k) plans into an IRA once you leave the companies that sponsor them. Typically IRAs have lower fees, fewer restrictions, and a bigger menu of investment options than employer 401(k)s.

Either way, you’ll probably have some paperwork to fill out. The best way to roll funds into or out of a plan is to perform a direct rollover, where the funds go directly from one service provider to another. Many can do this transfer electronically, which is safer than having checks mailed out. Sometimes, the check will be mailed to your address but made out to the new financial company, FBO (for the benefit of) your name.

In an indirect rollover, the funds come to you instead. You have 60 days to deposit all the money back into a retirement account. If you don’t, it will be considered a withdrawal, and you’ll owe taxes and perhaps a penalty if you’re under 59 ½. If you only invest a portion of the money back in, the remainder is also considered a withdrawal and taxed and potentially penalized.

The key to staying invested is to have a diversified portfolio with enough aggressive funds (stocks) to reap the gains when the market is rising. And enough conservative or noncorrelated money (bonds) so that you can sleep at night when the market is dropping.
Since no one has a crystal ball, it’s important to diversify at an investment level: international and US, small, large and medium-sized companies, government and corporate bonds.

Do you need some assistance with your 401(k)? Or are you thinking about opening one up for your own business, whether you’re self-employed or have some staff? Give us a call at 619.255.9554 or email us to set up an appointment.

Platt Wealth Management offers financial plans to answer your important financial questions. Where are you? Where do you want to be? How can you get there? Our four-step financial planning process is designed to be a road map to get you where you want to go while providing flexibility to adapt to changes along the route. We offer stand alone plans or full wealth management plans that include our investment management services. Give us a call today to set up a complimentary review. 619-255-9554.

It seems like so many of us tend to over complicate things, whether in finances or life or business. As we move through life, we accumulate more, and we get entrenched in routines that no longer serve us. However, keeping things simple is essential at any stage of life.

Having less to keep track of is freeing! In honor of National Simplify Your Life Week, which is celebrated the first week in August, let’s take some steps to simplify our business and finances.

Simplify your business: Do the big rocks first

At this point, you probably automatically prioritize your workday routine. Taking care of the top three priorities that move the needle every day is an effective way to make sure you get the essential things done. 

One way to think of it is the “Big Rocks” theory from Stephen Covey. Suppose you have a certain amount of sand and a certain amount of big rocks to put in a bucket. When you fill the bucket first with sand, none of the big rocks will fit in the bucket. 

But if you start with the big rocks first, the sand fills in around them. With limited time in the day, it’s important to fill the hours first with the big rocks, which are your top priorities, and allow the smaller tasks to fill in around it.

Another way that those in business determine their most important tasks is to consider a 2×2 matrix with one axis being urgent and the other important. You might also know it as the Eisenhower decision matrix after President Dwight D. Eisenhower. 

You can sort all your daily tasks into one of the four boxes. Urgent tasks are what you need to do right now, and people typically react to them. Important tasks are the ones that lead to success, and people are responsive to them. 

The main problem is that people often tend to confuse urgent for important.

• Not important and not urgent

These tasks should be removed immediately from an executive’s list. Delegate these is you want them done or deleted them completely.

• Not important and urgent

They may demand attention, but ultimately these tasks don’t help achieve any goals and should be delegated or eliminated. 

Phone calls and texts often fall into this category. They may be relevant to others, but not to you, and so you should limit your time in this quadrant.

• Urgent and important

Crises and problems fall in here. Perhaps counter intuitively, you should also try not to spend too much time here! Develop solutions that prevent the crisis from happening. Planning and organizing are good ways to reduce the tasks that fall into this quadrant.

• Not urgent and important

Here’s where you want to spend your time. Not reacting to crises, so these tasks are not urgent. However, they help you achieve your goals and mission. 

Simplify Your Finances

Needlessly complicating your financial life usually involves paying more in fees as well. You have even more motivation to streamline here. When index funds solve your need for diversification, there’s no reason to add in other types of investments, for example

Simplify Your Finances: Consolidate

It’s also helpful to consolidate your accounts with one financial advisor where possible. The exception possibly is your 401(k), which typically needs to stay with the management company until you leave the firm.

Your financial planner should be able to view all your accounts so they can properly diversify it. When you split your funds among different advisors, none of them have an overall picture, so you’re not getting the diversification you need.

It also helps to consolidate your traditional (as in, non-Roth) retirement accounts into one. Many investors who have worked at several firms maintain one traditional IRA account. They roll all their 401(k)s into it with no tax consequences when they leave each firm. All their pretax retirement money is in the same pool, making life much easier when it comes time to take required minimum distributions (RMDs) at the age of 72.

The IRS considers all your pretax accounts when calculating RMDs. If you have several traditional retirement accounts and you lose track, you could accidentally underpay your RMD.
Underpayment will result in a 50% penalty on the amount that you should have taken out but didn’t. It is much easier to have everything in one place and receive one notice from the custodian of the amount you need to take out.

Similarly, you can consolidate your checking and savings accounts. Pick the highest interest rate savings account net-of-fees to put all your money in, and the cheapest or no-fee checking account.

You don’t need more than one credit card for your personal life, and probably only one for your business. When there’s no reason to maintain multiple cards and accounts, consolidate down to one.

If you want to talk to us about simplifying your financial life, please give us a call at 619.255.9554 or send us an email. We’d love to hear from you.