Like most people, you’ve probably switched jobs at some point in your career. If you’ve done this a few times, you may have several outstanding retirement plans, like a 401(k), 403(b), etc. In the flurry of paperwork between leaving your former employer and starting a new job, you should have been given the option to either leave the retirement plan as-is (default), transfer it to an individual retirement account (IRA), move it to your existing employer retirement plan or cash it out. If these plans aren’t consolidated after each job change, whether to an outside rollover IRA (or Roth IRA if you made after-tax contributions), or to your current employer retirement plan, they can start to accumulate and become more of a frustration later to deal with.
Consolidating your retirement plans has several benefits:
Investments align with the asset allocation your financial plan recommends
When you enroll in a new employer’s retirement plan, they ask how you’d like to invest the proceeds. You may not have even made a choice and were put into the default investment option. In the past, the default option was the stable value or money market fund, which is not designed to help you grow your assets; instead, it preserves the value with minimal interest. Nowadays, the default options are target date retirement funds that at least have a more diversified breakdown of assets between stocks and bonds.
Importantly, your financial plan may require that your investments be more aggressive (stocks) or conservative (bonds) than how your dormant retirement account is invested. Regardless of the account’s size, you want all of your investments functioning in a cohesive manner, as that investment allocation will drive the long-term returns necessary to achieve your financial goals. (more…)
When switching jobs, it can seem overwhelming to review all of the documents related to your new company’s employee benefits. These plans include choices for medical, dental, vision, retirement, life and accidental death and dismemberment, short-term and long-term disability and many other additional benefits that may be useful.
With all of these options to navigate through, combined with the anxiety of starting a new job, it can help to focus on making a few key decisions.
You don’t want to leave free money on the table, so enroll in your company’s 401(k) plan as soon as you are eligible, and set your contribution percent (deferral rate) to at least the minimum required to receive the full employer match. This may mean contributing 6% to receive the employer match of 3%.
If you don’t start out deferring at a rate above the matching percent, let’s say 3% to 6%, then try to increase your deferral rate by 1% every 6 months to increase your retirement savings. You can also make a plan to increase your contribution rate when you receive any raises.
If you’re given the option between a Traditional (pre-tax) and Roth (after-tax) 401(k), consider your age and income level, and whether you’re already contributing to an outside Roth IRA. The employer match will always be to the Traditional 401(k) portion, so you can decide whether your contributions are pre-tax or after-tax for your portion. If you think your tax rate will be much higher in retirement than it is now, Roth 401(k) contributions make sense. Sometimes splitting your contributions 50/50, where 50% goes into the Traditional portion and 50% goes into the Roth portion, is the perfect medium. This way, you receive a tax deduction for half of your contributions now, while the other half is contributed after taxes and can be withdrawn tax-free in retirement.
Health care plan
Some companies give you multiple health care plans to choose from, while others give you just one option. These options may include an HMO, PPO, POS, or high-deductible health plan (HDHP) paired with a health savings account (HSA). If you’re deciding between an HMO, PPO or POS, make sure you’re comfortable with the in-network doctors available to you and your family, as well as the level of deductibles and out-of-pocket maximums. It doesn’t make sense to choose the least expensive health plan if you can’t afford the deductible.
If it’s available, select the high-deductible health plan paired with an HSA. It can provide the best overall value of any health plan available. If the total of your and your employer’s contributions reach the maximum you can contribute, then you receive a unique tax advantage because payroll taxes, federal income taxes and most state income taxes won’t be deducted from these contributions. They grow tax free, and withdrawals can be made tax free for qualified out-of-pocket medical expenses, including dental and vision. And, unused funds in the account are not forfeited at the end of each year like with a flexible spending account, so you can invest and allow these funds to grow.
More information about the benefits of using an HSA can be found by reading my article, A New Perspective on Health Savings Accounts.
Life insurance and accidental death and dismemberment
It’s a good idea to have life insurance that’s 10 times your income, especially when you have young dependents to provide for. Group plans may not let you go higher than 5 times your income, so acquiring the remaining coverage through an individual term policy may make sense.
Be aware that group life insurance through work is contingent upon your employment at the company, so if you are no longer working there, you may experience a loss of coverage. An individual term policy would avoid this, but may be more expensive than group benefits.
Even though the chance of having an event where accidental death and dismemberment (AD&D) pays out is slim to none, it’s still a worthwhile benefit if it doesn’t cost more than a few dollars a month. Most benefits plans sign you up for it automatically.
Short-term and long-term disability
Usually you’re automatically enrolled in short-term and long-term disability benefits. However, if you’re given the choice, select the option where you can pay these premiums with after-tax dollars, versus pre-tax dollars from your paycheck. These premiums are often less than $25 to $30 each pay period, and are paid pre-tax, meaning not subject to tax. Paying for these premiums after tax permits you to receive benefits tax-free if you ever need to file a claim. Since these premiums are small and have minimal tax consequences, receiving tax-free benefits if you have a claimis substantially more favorable.
Employee stock purchase program
If your employer offers an employee stock purchase program (ESPP) where they allow you to buy their stock at a 10% to 15% discount during stated periods in the year, considering enrolling with up to 10% of your paycheck. To avoid concentrating too much risk in your company, i.e., human capital plus financial capital, it makes sense to sell this stock as soon as possible to pocket the after-tax gain from the discount and any appreciation to help diversify. That 10% to 15% discount is considered compensation and taxed as ordinary income. Additional profit is taxed as short-term or long-term capital gains depending on how long you end up holding the stock.
Other popular benefits like legal aid, group long-term care insurance and identity theft protection can also be valuable benefits, but make sure you aren’t already receiving these benefits through another source. Group long-term care insurance is becoming more common, but it’s worth shopping around to make sure you’re getting a favorable rate. Also, one caution about group long-term care is that the insurance provider doesn’t have to get permission from the state regulators to raise premiums like they do for individual policies.
When evaluating benefits, we recommend contacting an advisor to review your options.
Deciding how to best prioritize your savings can seem overwhelming, and the decisions you make can lead to very different long-term outcomes. It’s especially difficult to know where to start with all of the different account types and savings vehicles available to you. As with all goals, developing a plan you believe in and can consistently apply will greatly improve your success rate.
Use the following steps as a starting point for prioritizing your savings. If a step doesn’t apply to you, simply move on to the next step.
Step 1 – Contribute enough to your 401(k) to receive the full employer match
This is one of the few places in life where you can receive money by simply participating. Some employers require you to contribute 3% of your salary to receive a 100% employer match. This means your contribution is effectively doubled, at no extra cost to you. A few plans will match 50% up to 6% of your salary. In other words, you have to contribute 6% to receive their 3% matching contribution. Contributing this amount from each paycheck can put stress on a tight budget, but there’s no better alternative.
Step 2 – Pay down your highest interest rate credit cards
With the sky high interest rates charged by credit card companies, it makes sense to attack these debts before moving to the next step. Since credit card interest rates can be anywhere from 12% to 24%, it’s unlikely you will find an investment that can earn a return anywhere in this ballpark, let alone while taking on outrageous risk. Consolidating your credit card debt and even seeking help from a debt counselor may be appropriate if it’s a problem.
Step 3 – Build up at least three months’ worth of emergency cash
When you have unexpected expenses, like those associated with a job loss or a major house repair, an emergency fund can help fill the gap so you don’t have to turn to credit cards or withdraw from a retirement account. Holding three months’ worth of expenses in an emergency fund at the bank is a good start. For some, it may be necessary to have three months’ worth of your take-home pay or six months of expenses.
This fund should be increased over time as your income and living expenses grow.
Step 4 – Max out health savings account (HSA)
If your employer offers an HSA, this is an amazing savings vehicle used to pay medical expenses now and in retirement. These contributions are not subject to federal and state income taxes, or payroll taxes and withdrawals for medical expenses are tax-free. The excess cash in the account, usually balances in excess of $3,000, can be invested and grown over the long term. Considering this recent Fidelity study, which found that a couple in retirement spends $245,000 on healthcare, not including the cost of long-term care, saving in tax-advantaged accounts for these expenses is a must.
Think of an HSA account like any other retirement account. To accumulate the necessary funds to cover medical expenses in retirement, it makes sense to pay out of pocket for reasonable healthcare expenses while still employed to allow the HSA account to grow.
Step 5 – Contribute to a Roth IRA retirement account
Since contributions to this account grow and can be withdrawn tax-free in retirement, contributing to a Roth IRA makes a lot of sense. This is especially true when you consider the impact of compound interest over long investment periods for those earlier on in their career.
You can also withdraw Roth IRA contributions tax-free for an emergency or for a house down payment, and this can be done at any age. Be careful, however, to avoid touching earnings since they lead to tax consequences. Lastly, keep in mind that if your income is above IRS limits, your ability to contribute to a Roth IRA may be reduced or eliminated.
Step 6 – Save for house down payment
The number of first time home buyers is starting to pick up. Having at least a 5% down payment saved up in addition to your emergency fund is a good starting point. If you plan on buying a home in the next three years, keeping these funds in cash versus investing in stocks is a prudent move.
Once you own a home, increasing your emergency fund to six months expenses will be necessary as roof repairs and miscellaneous expenses that always seem to come up as a homeowner can quickly eat into your savings.
Step 7 – Pay extra toward your student loans
Since many are graduating with significant student loans these days, paying extra toward these loans can lead to significant savings. This is especially true with unsubsidized government student loans and private loans that have interest rates greater than 6%. Since there isn’t a guaranteed 6% plus return available, prioritizing paying off these student loans is a must.
Step 8 – Max out 401(k) plan
Being able to contribute the maximum consistently without jeopardizing your finances or being at risk of having to take an early withdrawal pays off long-term. Not only will you receive the tax-deduction up front on any contributions, the funds will grow tax-deferred throughout your career, providing a greater balance to draw from in retirement.
Step 9 – Contribute to a 529 College Savings Plan
If you have children or expect to have children, there’s never a better time to start saving in a 529 plan. The funds in the plan grow and can be distributed tax-free for college and graduate school expenses. This article discusses the benefits of 529 plans further.
Because your children might receive grants or scholarships to cover their higher-education expenses, we always prioritize retirement savings first.
Step 10 – Invest in a non-retirement account
Now that you’ve maxed out your tax-advantaged accounts, excess savings can be invested in a taxable account. These funds can be invested and used to accomplish a long list of long-term goals. Whether you’re saving toward a future vacation home, early retirement or a child’s wedding in five years, these extra savings can make a big difference.
This list isn’t a one size fits all, but it can provide a framework for developing a long-term savings plan that you can expand upon each year. The earlier you can progress through these steps in your career, the better chance you have of being financially fit and having a high probability of success when you retire.
Whenever you leave a job, whether it’s your choice or not, there are many details and changes competing for your attention, and it’s easy to overlook the disposition of your employer-sponsored retirement plan such as a 401(k), 403(b) or 457.
You don’t actually have to do anything, but doing nothing is usually not your best choice. Making the right choice can let you add many thousands of dollars to your retirement nest egg. Making the wrong choice can unnecessarily squander some of your savings to the tax man and deprive you of future earning power.
You may get some very general guidance from your employer. But employers are prohibited by law from giving you specific advice. The custodian of your retirement plan (Vanguard or Fidelity, for example) has little incentive to overcome a basic conflict of interest: Even though your investment options will be restricted if you leave your money where it is, that’s exactly what your custodian hopes you will do.
This is a choice you need to make on your own. Fortunately it’s neither complicated nor difficult. In addition, you don’t have to do it immediately (although the lack of a deadline is a mixed bag if it leads you to procrastinate and then become complacent). (more…)