Tax forms for 2020 will soon arrive in our inboxes and mailboxes. It is time to begin preparing our tax returns, and hope that our tax withholding and estimated payments will satisfy our tax obligation.
It is also time for a quick 401k checkup.
Remember, deferrals from your salary are not currently subject to income tax – federal or state. They are still subject to FICA (Social Security & Medicare) taxes.
Some checkup questions include: How much are you deferring? When was the last time you increased your deferral? Are you maximizing your employer’s match?
The higher your deferral, the lower your taxes. And hopefully, the larger your fund will be when you retire. A great strategy to increase your deferral percentage is to incrementally increase each quarter. A 0.50 percent quarterly increase will result in an annual 2 percent increase in your deferrals.
This is also a great time to review your 401k investments. When you receive a year-end statement – either by mail or digitally – take a look at how your funds are currently being invested. Are you being too conservative or aggressive?
If you are 35 years old and your funds are going into a money market, you may be too conservative. If you are 65 and planning on retiring in 2021, and your portfolio is invested in just a small-cap stock fund, you may be too aggressive.
Many employers offer “target date” funds as a 401k investment option. The investment manager for this type of mutual fund balances investments across multiple asset classes over time. It is typically a fund that invests in other mutual funds.
Volatile assets such as stocks are higher the farther away from the target date. As the target date approaches, the fund will rebalance toward bonds and other less volatile assets.
So how do you pick a target fund? A 45-year-old typically is 20 to 25 years away from retirement. So, this individual would pick a 2045 target date fund.
This fund would currently be heavily weighted toward stocks. As 2045 approaches the fund will rebalance away from stocks toward bonds. When the target date is reached, the portfolio will be balanced between stocks and bonds. As the target date passes, the manager of the fund will continue to increase holdings in less volatile investments.
A target date fund is a simple investment choice. Nearly every 401k plan offers target date funds. A Vanguard study indicates 77 percent of participants are using at least one target fund. Most 401k investors don’t have another investment in their retirement fund. You don’t need to rebalance your portfolio on a regular interval or adjust your asset allocation as you get older.
A target date fund does not eliminate investment risk, but it does help manage that risk, especially as one transitions toward retirement age.
Target date funds are a great way to manage your retirement portfolio.
One key to successful retirement investing is consistent contributions over time – your salary deferrals.
A second key is increasing these deferrals over time.
A third key is understanding investment risk and how it changes over time.
And the fourth key is matching your risk tolerance to your retirement date when selecting investments.
If you would like to further discuss the topic of “target date” funds, we encourage you to contact one of our experienced bankers at Citizens Bank or another financial professional.