Jaspreet Singh: 5 Things You Need To Understand About Your 401(k)

You would think that, given the choice, most employees would choose to enroll in a 401(k) or employer-sponsored plan. However, as a CNBC survey revealed last year that 41% of respondents don’t contribute any money at all and are “missing out on a significant opportunity to improve their financial security for the future.”

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According to the Principal Retirement Security Survey released in June, many employees aren’t sure if they’re eligible, are confused about savings plans, and don’t feel like it’s the right time to save for retirement when their expenses and debt are too much of a burden.

Jaspreet Singh , the self-proclaimed “Money Nerd” of Briefs Media and one of our Top 100 Money Experts, feels that although 401(k)s are the most popular investment and retirement savings tools in the U.S., most Americans don’t take the time to know how they work or if they’re even enrolled.

While Singh is not an official financial advisor, he is an education enthusiast and to his 1.89 million Minority Mindset subscribers, a fresh sounding board for their personal finance questions. Last week, Singh spoke at length about the five things you need to understand about your 401(k) .

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Options and Taxes

When managing a 401(k), it’s important to understand the different options available and the associated tax implications. Although contribution limits are the same ($23,000 in 2024 and $30,500 for employees 50 and older), the primary distinction between your two options — traditional or Roth 401(k) plans — is how taxes are applied.

Traditional 401(k) contributions are made before taxes, reducing your taxable income for the year. They are investments that are tax-deferred until they are eventually withdrawn. When the time comes to start withdrawals (typically between the ages of 59½ and 73), they are taxed as ordinary income.

Roth contributions are taxed up front, so they grow as tax-free investments. Provided you meet the requirements (generally, the account must be at least five years old, and you must be at least 59½ years old), qualified withdrawals will be tax-free as well.

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Fees (Expense Ratios)

You’ll have to decide whether you want to pay taxes now or down the road. But Singh stresses the important of doing your homework, and for many enrolled workers, the fees that are being charged — the expense ratio — are unknown. Regardless of the type or mix of your 401(k), you could be paying significantly more that you realize, and these can significantly impact your retirement savings over time.

“This fee that you’re paying isn’t a one-time fee that you pay today,” said Singh. “It’s a fee that you pay on every dollar that you invest and every dollar of profit that you make for every year that your money is invested in your fund.”

Vesting Controls

When you choose how much money or what percentage of your income you want to contribute to your 401(k), your employer automatically withholds a portion of each paycheck and puts it into the account. Many employers offer a match to your contributions, up to a certain percentage of your salary.

If you’re lucky enough to have an employer-sponsored 401(k) that matches contributions, you need to understand the rules associated with it, namely, the vesting schedule, which dictates when matched contributions by your company become yours to own.

Often a 401(k) will have a graded vesting period (where you gradually earn more of the company’s contributions as you continue to work) or a three-year cliff vesting plan (where you own 0% of your employer’s contributions, but earn 100% of them after three years of service).

Parameters

Additionally, it’s good to know what investment fund your 401(k) in invested in. However, as Singh said, “You have limited control when it comes to investing with your 401(k), because you have to invest your money into whatever those money managers offer you.”

You don’t often get to choose investments that match your risk tolerance and retirement timeline, but rather, whatever mutual or index fund investment options are available.

As such, Singh firmly believes that you should treat your 401(k) as a great starter investment account for your retirement. “This is your ‘beginning to invest fund.’ This is that tax deferred account to get you started with your investments, but this should not be your only or sole investment fund.”

Should the stock market crash and all your money is tied up in your 401(k) managed by a company like The Vanguard Group or Fidelity Investments, you may ending up losing a lot because you’re money isn’t truly diversified.

Alternative Investments

Alternative investments — ones that fall outside of traditional investments, such as stocks, bonds and cash — include a wide range of assets such as real estate, commodities, private equity, hedge funds, art, collectibles or cryptocurrencies — cover a wide range of investments with unique characteristics.

Although they’re often considered options for the young and rich, who believe in their growth opportunities despite their risks, Singh feels everyone should have money outside of their 401(k)s, be it in alternative assets, individual stocks or brokerage funds, self-directed accounts or real estate and business investment ventures.

By understanding your 401(k) options and the associated tax implications, you can make informed decisions to optimize your retirement savings and ensure a more secure financial future. And remember, you can always fund both traditional and Roth 401(k)s, or switch back and forth throughout your time with your employer (depending on the account’s regulations), which will give you a bit more control and the chance to spread out your tax situation in retirement.

This article originally appeared on GOBankingRates.com : Jaspreet Singh: 5 Things You Need To Understand About Your 401(k)