Getting the Most from a 401(k)

Many of your more affluent clients may not think hard about their 401(k) plans. They get the paperwork, choose some investments, and hand in their selections to human resources without looking at the fine print.

But the devil is always in the details.

By not reading carefully, many clients could be missing out on “free money.” 

“If you contribute too little to your 401(k), you may not get the full employer match. On the other hand, if you contribute too much, too fast, you can shortchange yourself,” says Robert J. DiQuollo,  president of Brinton Eaton, a financial planning firm in Madison, N.J.

Consider an executive making $20,000 a month who contributes 20% to his or her 401(k), with a 5% company match. He or she will reach the IRS’s annual contribution limit of $16,500 in May and can’t contribute for the the rest of the year. 

If your company only matches based upon your own contributions, you may limit your match.

In the example above, the executive receives a company match of only $4,500, if the executive frontloads his or her contributions.  If the executive had chosen a 7% contribution rate instead, he or she would not have reached the $16,500 until December and would have received the full company match of $12,000 — $7,500 more — just by knowing the rules. “Know the fine print in your 401(k) plan so you get the maximum amount of ‘free money’ available through the company match,” DiQuollo says.   

Penalty-free withdrawals.  

Other clients may be shifting retirement money to liquid accounts out of worry that they’ll need emergency expenses. In one poll by MetLife, 58% of investors with $200,000 or more in investable assets said they kept retirement savings in liquid accounts for that reason.

Some of these clients are anticipating an early withdrawal.   If they remove money from their 401(k) or 403(b) plan (for nonprofit employees) before age 59½, they normally have to pay a 10% tax penalty in addition to ordinary income tax on the distribution. But if they leave or lose their job, they can withdraw money penalty-free from their plan starting at 55.  That can be valuable for people taking early retirement or who are long-term unemployed.  

Another option is withdrawing money for education expenses. Children and grandchildren have more time to develop earning power and pay off college loans, so many advisors warn parents against jeopardizing their old age for the sake of the next generation. But their clients may want to consider a withdrawal to fund educational expenses for a career change that will boost their own earning power or ability to work happily later in life.  The same might be true of a spouse in a sturdy marriage.  

The school must meet federal student aid program requirements. Once enrolled, they can use retirement money to pay tuition and fees and buy books, supplies and other required equipment.

The required minimum distribution is not always required.  If your client is retired and has 401(k) or 403(b) plans with previous employers, they must take required minimum distributions annually from each plan starting at age 70½.  But if they’re still working for the company, they may not have to take a distribution from that employer’s plan.  That’s an advantage over an IRA, DiQuollo says.  With IRAs, required minimum distributions are always required beginning at age 70 and a half.

Another often-neglected point: When your clients leave a job, they’re generally best off rolling money in their former’s employer’s plan into an IRA.  Most plans do not allow clinets to make a partial cash withdrawal from a 401(k) when they no longer work at the company. And the chances are, as an advisor you can help your client choose better investments than those available in a 401(k). If your client has had several employers, rolling all of his money into a single IRA account can simplify record-keeping.. An IRA rollover also enables an investor to continue making contributions rather than waiting to be eligible for a new company’s retirement plan.

For reprint and licensing requests for this article, click here.
Retirement planning
MORE FROM FINANCIAL PLANNING