Preparing For Your Next 401(k) Open Enrollment
Open enrollment season is one of the shortest—in most cases, employees have only a few weeks to research their options and make a decision on things like their 401(k) contributions, health and dental insurance, disability coverage, and dependent care benefits. Often, missing this open enrollment deadline can mean forgoing benefits for the next year, absent a change in circumstances like marriage, divorce, job loss, or the birth of a child. Don’t let open enrollment catch you by surprise this year. Review the factors listed below to ensure that you’re taking full advantage of your retirement options.
Your Company Match
Failing to take advantage of a match on retirement contributions can mean leaving free (and tax-free) money on the table. Unlike wages and other fringe benefits, matching retirement contributions aren’t taxable to the employee. This means that an employee who earns $50,000 per year with a 5% retirement match is giving up $2,500 per year in tax-free income if they fail to contribute an equivalent percentage of their salary to a 401(k) or other retirement account.
Although it can be tempting to cut out retirement contributions entirely in order to pay off high-interest debt or save up for a big-ticket purchase, many financial professionals advise that workers contribute to their retirement at least up to the match.
Taxable vs. Tax-Deferred Options
If your employer offers both taxable and tax-deferred retirement options, you’ll want to evaluate your tax burden to determine whether one or the other (or splitting the difference) makes the most sense in your situation.
The 2017 enactment of the Tax Cuts and Jobs Act¹reduced the top marginal tax rate for many households, but these changes aren’t permanent. Many have chosen to take advantage of these changes by temporarily diverting pre-tax retirement savings into a post-tax account like a Roth IRA or Roth 401(k). By paying taxes on these contributions now, at a presumably lower rate than will be assessed in the future, these individuals will be able to make tax-free withdrawals in the future.
On the other hand, it can sometimes make sense to make pre-tax contributions to reduce your taxable income. If you’re repaying student loans on an income-based plan or otherwise have an incentive to keep your adjusted gross income (AGI) as low as possible, funneling all your retirement contributions into a pre-tax account can reduce your tax rate.
Investment Options and Fees
Not all retirement plans are created equal. It’s important to evaluate the investment options available to you, and the fees you’ll be paying, before setting your contribution level. If your plan’s fees are higher than average or if it doesn’t offer a good array of retirement options, it may make sense to contribute only up to any match and then use a self-directed IRA or Roth IRA for the rest of your retirement savings.
Important Disclosures:
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
The information provided is not intended to be a substitute for specific individualized tax planning or legal advice. We suggest that you consult with a qualified tax or legal advisor.
All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.
The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.
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