Finance In a Flash: 401ks and FAQs
On this episode of Finance In A Flash, Nick and Chip discuss the importance of contributing to 401k's and their benefits. They go through 401k frequently asked questions, tax benefits of 401k's, and have a quick discussion on how you should view investment options within your 401k plan. Chip and Nick then discuss what you should do if you have an old or inactive 401k plan and whether or not you should consider rolling it over to your new 401k plan or roll it over into an IRA. Lastly, always remember to check your beneficiary designations on your 401k plans!
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Transcript
Nick Faulkner (00:00): Hey, everybody. Welcome back to finance in a flash. On this episode, we talk about one of the most popular topics in all of the financial planning world. 401k's we go over 401K's FAQs. How much money should you save to a 401k, 3%, 10%, 15%. We break that down for you later in the podcast, we also go over the tax benefits of contributing to a 401k. We then transition into what kind of investment options do you have to pick from within a 401k. Granted, it can differ, but what should you be looking for within your plan? We also go through what happens if you have a new job, start a new job, and you have an old inactive 401k. What can you do with that? Can you roll it over to new 401k? Can you roll it over to an IRA? We break that down for you later, as well as always make sure you know, your beneficiary designations on all your accounts, especially your 401ks is forgotten the most. We hammer that at least three or four times within the podcast, because it's so important. Anyways, thank you so much for listening to Finance in a Flash. Let's go
Nick Faulkner (01:07): Welcome back to Finance in a Flash, we have Chip here, and we are going to go over a, I feel very much of a buzzword topic when it comes to financial planning or, you know. If you're still in the workforce, which is 401K's, but first, the world is obviously chaotic gearing up to election time. I think everyone, starts to get a little on edge, but, Chip how is it holding up?
Chip Hymiller (01:33): It's holding up great for me. it's nice. The weather has finally gotten a little bit better and no humidity here and football season is in full force. It's great to see the games. I know that you and I talk about that a lot and it gives us something to escape to, I think.
Nick Faulkner (01:55):Yeah, definitely my,not that anyone cares, but I have three, fantasy teams that are in first year taught first, but no one cares. I just, you know, I thought I would just share that information. Not only, podcast host, but a fantasy football manager.
Chip Hymiller (02:09): But Nick, I realized a long time ago that fantasy football is just pure luck. It doesn't, it takes no skill to do. That's kind of like the NCAA pools
Nick Faulkner (02:20): We had Stephanie win in our office, was it two years ago? And I don't know if she's watched a NCAA basketball game in years probably. I watched every single one and I came in like dead last. So take it that what you will, but it's better to be lucky than good. I think.
Chip Hymiller (02:40): Absolutely no doubt
Nick Faulkner (02:42): Anyways, getting back to 401K's. I feel this is very familiar with a lot of people. They might not know the ins and outs, but I feel that almost everyone at least has heard of a 401K before, but just to give a refresher to everyone listening chip, if you could explain to us what actually is a 401k?
Chip Hymiller (03:01): Yeah. So a 401k actually is an account generally that is created by your employer who establishes this account for all of their employees and they've set up this plan and it allows employees to defer money into it on a systematic and recurring basis.
Nick Faulkner (03:24): Perfect. So a lot of people say, I don't know if my company matches, my company does a 3% match. They do a 50% match up to 6%. They throw on all these terms. But generally speaking, for example, a company matches your 401k contributions. Can you explain just kind of what that, what that means? I mean, it's simple in it of itself, but there are a few stipulations to that depending on the company.
Chip Hymiller (03:53): Yeah. So every company is a little bit different and, you know, first of all, a 401k plan, it's basically, your employer, whenever, you are paid your paycheck. The employer, if you've decided to contribute to a 401k plan, kind of holds the amount of money that you want to contribute to the plan back and then forwards that money along with a company match, usually, to the 401k vendor. 401k vendors, I mean it could be any one from fidelity. I know fidelity is probably the largest, but Vanguard, Schwab, T Rowe price. They all have, options for 401ks, but basically the employer is responsible for withholding the money from your paycheck and forwarding that money to the 401K vendor.
Nick Faulkner (04:47): Perfect. So let's say, you know, what would be a ballpark, how much should I know this is kind of a general question may be hard to answer, but I guess, is there a baseline to how much you would suggest for people to save to their 401k? Let's say, you know, their company, you know, they match 8% of themselves. Their company matches, you know, 4%, you know, that's 12% total. Is that too much? Is that too little? Is there a specific baseline that you normally have?
Chip Hymiller (05:20): Well, that's a good point. And I'll tell you that, at the bottom line is the sooner that you start deferring money into this plan that dictates how much you have to save. Now, there's a number of rules of thumb. I would say that, you know, I would love to see everyone contribute at least 10% of their, income into a 401k plan. Um, but it depends, you know, the maximum, I'll tell you this, the maximum for 2020 that an individual can contribute is 19,500, if they're below the age of 50. But if you're above the age of 50, you can contribute up to 26,000 this year. But, you know, we ideally, we like to see people contribute at least 10% of their pretax income into a 401k plan. I think that gives you a good start. Now, as you progress in your career and as your situation change and personal circumstances change, you may have to increase or it's sometimes you have to decrease that amount. But I think a good target would be at least 10%.
Nick Faulkner (06:26): Yeah, I agree. That's, that's good. And I think it really is important to harp on, you know, let's try saving as early as possible cause you know, the power of compounding is incredible. For me it's a lot easier to save something like that because you know, it's taken directly from my paycheck. I never see, I don't have to physically put money into an account myself. You know, we'll talk about an investment elections later, but the money's just simultaneously taken out about paycheck is put into investments that I elected and don't have to worry about it. it just keeps growing and growing and growing as time goes on, it's really, I feel one of the, really, maybe the easiest way to save for retirement, in my opinion
Chip Hymiller (07:07): It absolutely is the easiest it's already there. It's been created. I think most companies, the form is maybe one page that you have to complete and maybe two, if you include the beneficiary designations, but it's a very simple and straightforward way to accumulate wealth over time. For sure.
Nick Faulkner (07:27): Yeah, no, I definitely agree with that. if listen, if you have a match and I've seen it not been use and everyone would say, well, who wouldn't use a match? People don't really understand what, you know, your employer matching your contributions, but everyone, please get that match is it is. I mean, it's like we talked about before we came, had, it's literally free money. Yeah.
Chip Hymiller (07:47): It's the only free it's it is absolutely free money. And your employer wants you to take advantage of that. It's it's, you know, it's a cost to the company, but, lots of studies have shown that employees are happier when they get this match and when they contribute, and start accumulating, this bucket of money, that's available to them in retirement. It's just a great system all around.
Nick Faulkner (08:14): Yeah, I definitely agree. And now let's shift gears a little bit, so there can be some tax benefits associated with 401ks as well. If you could just kind of outline a few or how, you know, contributing to a 401k may improve your tax situation per say.
Chip Hymiller (08:34): Yeah. So every time you can make a contribution into a 401k, you are basically contributing pretax dollars into the 401k. So you're basically not having to pay tax on this money that is deferred into the 401k itself. In addition, when once money is in the 401K it earn dividends and grow over time and that money is also not taxed. So it's, it's the deferred. Now eventually when you, are in retirement and you turn that spicket on to start taking money out of a 401k at that point, it is taxable, but of course you're retired and oftentimes people are in a much lower tax bracket, than in their earning years when they're working. You're basically deferring money, taxable income into this, account when you're in your higher earning years and you're taking money out when you're in your lower earning years. So it's just a great way, to accumulate, funds that are tax advantaged.
Nick Faulkner (09:40): Yeah. I definitely agree with that. That, that is a great way. And I think it's important to keep in mind, we are going to have to pay that tax, you know, eventually if we do traditional 401k route. Now there is another option that a lot of people utilize. You can also under most plans, I would say, I don't know if all of them, but you can contribute to a Roth 401K. Which could you outline, I guess the, the difference between contributing to a traditional 401k and a Roth 401k virtually, I would assume, you know, it's the same as an IRA versus Roth IRA, Correct
Chip Hymiller (10:17): It is. I mean, the, the, the difference between the two is a traditional 401k money goes into that plan pretax. So it's never subject to, income tax when you're in to a traditional 401k. When you defer into a, the Roth segment of a 401k plan, the funds are taxed first, and then they go into the 401k, the Roth. So, uh, the decision of whether to do the traditional or the Roth is really dependent on, personal preferences, one, but it's also depending on your current tax rate versus your expected future tax rate. And there are a lot of people out there who think right now that tax rates are likely to rise just based on the fact that, you know, the countries assume quite a bit of debt and, we're operating at a deficit. And so their expectation is that in the future tax rates may be higher. I don't necessarily agree with that assumption. I think we kind of have to, we don't know what's going to happen with taxes going forward. So really you just have to make the decision as what's best for you at this point in time in your life. And that is for most people, you know, they're better off deferring, money into the traditional 401k component relative to the Roth 401k component.
Nick Faulkner (11:41): Correct. And I guess the situation I would put out there, you know, for me, who I would say would be categorized as relatively young, 25th birthday coming up soon. Um, but for example, hopefully, you know, later in my career I will be making more money than I am now as is the case with most people who work. So for someone in situation like I am, or potentially you, you know, start a new job and you're not making a lot of money right now, it may be better to kind of maybe pick a Roth IRA to contribute money to. Now, if you're in the lower income earning tax bracket, even if you think taxes are going to go up, I think it, you know, a lot of people should think about, is it worth taking a chance on getting tax now I'm probably making less than I will in the future.
Chip Hymiller (12:24): Yeah. Right. And you know, of course the, the match contribution is always going to go to the traditional side anyway. So, you know, some people, may be better off by contributing to the Roth early in their career, and then transitioning at some point, depending on where they are and the tax brackets to, the traditional 401k component. For sure.
Nick Faulkner (12:48): Yeah. Perfect. So now that we've kind of established, what is a 401k, going through like traditional versus Roth 401k. Now let's go into once we've established, which one we want to use, what do we put our money in? Because you do have to select which fund you wanted to go to. I know there are certain plans that have default investment options that if you don't select something that they'll just put it into an investment option for you, but how should people think about, okay, there's 45 funds on a sheet of paper. I know what three of them kind of mean, where should I go from here?
Chip Hymiller (13:29): Yeah and that is the hard part. I'll tell you this, just as some background with 401k plans, there is a fiduciary behind the scenes that decides on appropriate investments to include in the 401K plan. Okay, they have a personal, liability to ensure that they make good choices for the plan participants. To make sure that the investment choices there are adequately diversified there's enough choices, depending on a variety of investment objectives, that internal expenses are in check and all of those things. So there is a committee, that's an investment committee that's behind the scenes with every 401k plan that makes sure that there's a certain quality criteria that's in place for every investment that's held and an eligible to invest for participants. Now, with that being said, you know, there are various risk return, requirements and, attributes and each investment that is within the plan. So you may see, you know, an emerging markets fund. Well, that is a fund that invest in, you know, companies that are domiciled in countries where, they're just, maybe they don't have a solid accounting principles and that of thing. So it's, it is riskier, but keep in mind that there are also investments that, and I know we talked about this beforehand, Nick, but that there are investments that's more geared towards, a target retirement date. And oftentimes those are options. I know that that that's something that people should also consider.
Nick Faulkner (15:14): Yeah. For, for sure. And I guess a little breakdown of what the target retirement date funds are, is that, so essentially there'll be for example, Vanguard target retirement date fund 2040, which is 20 years from now, let's say, so plan to retire in 20 years. And over time, let's say right now, the asset allocation is 80% stocks, 20% bonds, a little bit more aggressive. Still have 20 years to go. And as each year, each year, you get closer and closer to retirement. You want to withdraw on that money sooner and sooner, the investments get a lot more conservative because we don't want to be taken a ton of risks right before we enter retirement going to take the funds out. So that's essentially what a target retirement date fund is brief overview.
Chip Hymiller (15:59): Yup. And that's a good description. And keep in mind that even though this is one mutual fund, inside that fund, there may be 10 other mutual funds with different objectives. So there may be a mutual fund that invest in, you know, US stocks, there might be a mutual fund that invest in US bonds. There may be global bonds. There may be, you know, all kinds of different mutual funds inside. So it's a very diversified choice. And one that I think that most people, especially if you're not very familiar with investing, you know, that's kind of a good default choice, I think.
Nick Faulkner (16:38): Yeah. I think it's, it's honestly a great choice, especially if you're not very familiar with investment options or investments in general. I think that's a great choice. And one thing, I want to mention that you brought up in our previous conversation, um, you know, today, before we popped on, is that we see a lot of people contributing to 401ks, invest in funds that have the best return from the past one year five year, one year, three year, five year when that's not always the best option. I mean, I see it, you know, we see it all the time is, well, why wouldn't I pick this one? It has the best return. Well, because if that was the case in past performance directly predicted every single thing that was going to happen in the future investing would be a lot easier. My opinion.
Chip Hymiller (17:24): Oh yeah. That's a great point. I mean, you know, the markets, the investment markets are very cyclical. And so, you know, one year you may see small cap companies do really well. Well, the next year they may not do as well. And so you really have to pick investments that are fully diversified and a number of funds that occupy different market segments and even have some bond, you know, even, you know, for younger investors, you may want to have at least a little bit of bond exposure. And then, you know, you can also take advantage of the most plans, have an automatic rebalance feature. And so you can go in click this box and let's say you contribute 20% of five different mutual funds. Well, the automatic rebalance will over time automatically, correct your allocation. And so it's kind of a cruise control way to invest in a 401k. That automatic rebalance kind of keeps in check the risk return attributes. rebalances automatically, that's, that's kind of, um, what that does and that's a good choice for most people.
Nick Faulkner (18:33): Yeah. I definitely agree with that. So now we've kind of figured out the investment option. I think the last piece is just, if you could touch quickly on your beneficiary designations when it comes to your 401k, which is potentially maybe the most important thing about your 401k.
Chip Hymiller (18:51): If you get nothing else from this podcast, please get this because I can't, and I know Nick, you and I are sticklers on this every time we're meeting with a client or get a new client and we're reviewing their 401k plan. One of the first things we want to know is who are the list of beneficiaries? I can't tell you the number of times where they're incorrect. Either a person does not have a beneficiary listed at all, or the beneficiary is the wrong person. You know, we found a couple of occasions, many occasions actually, where a ex spouses listed. Or, you know, or a parent is listed in a situation where, you know, you're married and you've got children. And so, you know, that's the last thing you want to do. And that's a huge mistake that people make this very, very common. So just go in and check and make sure that beneficiary designation is what you want because you know, no one expects to die early, but we've seen it happen before. And you know, it's just a bad situation to leave your family in.
Nick Faulkner (19:57): Yeah, I agree. That's, that's a great point. Honestly, check your beneficiary designations on everything.
Chip Hymiller (20:04): Yeah. Life insurance policies as well.
Nick Faulkner (20:06) Yeah, because that, we have seen that a lot where, you know, unfortunately people do get separated some times and their ex spouse is the beneficiary on literally everything. So, and their new spouse is not. So, it can definitely come up. So now that we have all that kind of info, I wanted to end on this topic that a lot of people have questions about. Let's say I start a new job, you know, start a new job, love my job. But in my previous job, I had a 401k that is now inactive, not contributing to now I have a new 401k, what can I do with the old one? Can I roll it into my new 401k? I, you know, can I just leave it there? Should I roll it into a rollover IRA? I guess, what are my options if that 401k does exist? What can I do.
Chip Hymiller (20:56): Well, I think this is something that you need to be very careful about if you're thinking about making a change there. To me, the first thing that you should consider is rolling that account into your active 401k plan. So if the new plan allows for rollovers or transfers into the 401k plan, you should at least explore that and think that through are the investment choices adequate, are they cost effective? will, the new investment choices of the new plan meets your needs. And if so, consider moving that into that account. Um, some people will also think about moving money into an IRA and, you know, that could be good for some people, but it could not be as favorable for others. And there's a number of different, reasons not to roll over into an IRA. And beyond the scope of this podcast, but, you know, be very careful with any changes there.
Chip Hymiller (21:59): You know, I do like at least exploring, rolling over into the new 401k, consolidate the accounts, it streamlines your asset allocation. And let's be honest. I mean, we've people have forgotten 401k plans. You know, they worked at a place for three years when they were in their twenties and now they're in their sixties and they forgotten it. They've forgotten, they've even had it. And so, you know, I just want to make sure that people are aware of, you know, the good thing to do there, and we want to make sure that you consolidate when you can and simplify.
Nick Faulkner (22:30): Yeah, definitely. So I think that's a, that's a great point. It's always better to have less accounts and more accounts in my opinion. I mean, it's just easier to keep up with and all sorts of that. So, I mean, I think that pretty much covers it chip. I know, um, we kind of went through a lot there and hopefully we dissected it pretty well. Was there any closing thoughts or anything you wanted to add to the last portion.
Chip Hymiller (22:55): Nope. I think that the bottom line is contribute to the 401k, get the employer match at the very bare minimum. Um, you use, if you are unfamiliar with the investment side of things, think about the target retirement date funds. They're a good choice for most people and then let the power of compounding work for in your behalf. It takes a little while to do it if you're just starting out, but eventually it's, it's amazing how it works. You look down and, you know, 10 years have passed and you've got a nice bucket of money. That's there, that's for you. And it's just, the strength and the power of compounding is amazing to watch it.
Nick Faulkner (23:36): Yep. Perfect. And two closing thoughts, get your employer match and have her beneficiary designations. If you don't, if you've zoned out for every single thing that we said, listen to those two things, you'll be fine. Alright. Chip. Well I think we covered everything and I appreciate you coming on and, that's Finance in a Flash!