Do you know how to choose the best options for your 401K plan? I am frequently asked this question by my clients, and many of them choose a Target Date Retirement Fund since it is a default choice. This may not always be the best option for most people. With these funds, you select a date that is closest to the year you think you will retire, and someone else manages your mix of stocks and bonds. As you approach retirement, the allocation of stocks and bonds will become more conservative. They do not, however, take into consideration your risk tolerance, and many times, the original date that was chosen is no longer the date that you might be retiring. If you are age 60, for example, and decide to retire earlier, it would make sense to shift your assets into a more conservative mix than if your target date retirement fund was chosen to retire at age 67. The other issue is that people may have a long horizon after retirement to draw down on their assets, and if the asset allocation is too conservative, the money will not grow at an appropriate rate to fund the remaining retirement years.
If you decide to manage your own portfolio, you will need to re-balance at least annually to make sure that your allocation mix does not vary too far from your original investment goals. You also need to consider whether you should select a traditional 401K, which is tax deferred, or a Roth 401K. The traditional 401K allows you to contribute to your 401K on a tax deferred basis, so that you can lower your taxable income. When you withdraw the money in retirement, it is taxable income. Conversely, the Roth 401K is not tax deferred when you contribute, but is not taxable when you withdraw funds in retirement. Roth 401K's are a smart strategy for clients who estimate that they will be in a higher tax bracket in retirement. A traditional 401K can help for people that are in high tax brackets now, and want to reduce their taxable income and use the cash flow for either investing or saving for a home.
It is a good idea to consult your financial adviser to develop a strategy for which type of 401K you should choose, and what investments should be selected. If you would like to schedule a telephone call to discuss your unique situation, please contact me.
About the Author
Patti Hughes is a Chicago Fee-Only Financial Planner. Lake Life Wealth Advisory Group provides comprehensive and objective financial planning, retirement planning, and investment management to help clients organize, grow and protect their assets through life’s transitions. She is a fiduciary, and does not sell products or earn commissions, so she truly acts in the best interests of her clients.