How to properly use a 401(k)

In order to reach full retirement, you must be at least 65 years old. This benchmark, provided by the U.S. Social Security Administration, serves as only a guideline and many individuals retire before, or after 65.

For younger generations, talk about retirement seems like a dream, especially if they've only just entered the workforce. Other generations are likely counting the days until they stop working and can spend the rest of their lives exploring the world and relaxing.

However, that exploration will only occur if you've managed to properly save while working. Based off recent trends, the average person does not have enough money saved for retirement. According to a May 2015 survey from Transamerica Center, individuals in their 20s only have about $1,600 in savings. This number steadily increases by age, and those who are 60 and older have approximately $172,000 in retirement savings, on average.

Unfortunately, that is not enough. According to The Motley Fool, savings take a hit when families grow and other expenses, such as paying for a college education, begin to pop up. Money for retirement shouldn't come solely from a savings account, because due to currently low interest rates, you won't earn much money.

Instead, you'll want to start building your retirement funds through a 401(k), if you haven't already. But you should keep in mind there is a proper way to go about taking full advantage of the retirement account.

Sign up immediately
If you just started at your first post-college job, do not hesitate to sign up for your company's 401(k) plan. You should be in a rush if they offer 100 percent matching, because after all, you wouldn't realistically turn down free money. Turn on automatic deposits so a portion of your paycheck is transferred to your 401(k) account. As an added benefit, this money is taken pre-tax, so less of your income will be taxed. You'll also receive the added benefit of not having to remember to make deposits.

When it comes to investments, Bankrate advised you choose a plan that is aggressive. If you're young, you can recover from potential downturns in the market. As you get older, invest in safer bets, such as bonds. However, diversity should be your main goal to guard against the risk of loss.

"As you get older, invest in safer bets, such as bonds."

At a minimum, check your 401(k) at least once a month to make sure your allocations went in. You may then want to think about rebalancing your portfolio. Switching up the mixture of stocks, cash and bonds can lead to improved risk-adjusted returns, according to USA Today.

Avoid early withdrawals
You can begin to take money from your 401(k) when you are 59 1/2 years old. If you withdraw before then, you'll be hit with early-withdrawal penalties, not to mention you'll lose out on compounded earnings while having to pay a higher income tax bill.

Some common reasons why you might be tempted to dip into your 401(k) include:

  • Emergencies
  • Home repairs
  • Child's college education
  • Vacation
  • Debt

To best avoid dipping into your 401(k), create an emergency and other savings account that you'll turn to when need be. As a general rule of thumb, your emergency savings account should have enough money to cover three months worth of expenses. If you're married and your spouse has the same setup, your family should ideally have six months worth of liquid assets.

Additionally, explore other areas to cover future expenses. For example, instead of banking on paying your child's college tuition with retirement money, you may also find it beneficial to start a 529 plan for your child's college education, but this should be started when he or she is still young.

In the short term, you may benefit from dipping into your retirement account, but you'll notice that missing money later in life. If you have a good handle on all of your other finances, you won't even have to think about your 401(k) until six months before your 60th birthday.

"You can begin to take money from your 401(k) when you are 59 1/2 years old."

Stay the course
Saving for retirement can be difficult at time. Unexpected expenses will come up that require a large financial commitment, or make it difficult to set money aside. The lure of withdrawing from your retirement accounts to cover an expense is enticing, but ultimately, one that has to be ignored if you're to properly use a 401(k).

By turning on automatic deposits, you won't have to think about putting money into retirement accounts. This makes budgeting every paycheck easier, as you can start with the most important expenses, such as housing, bills and food. You can then put money into a savings account or certificate of deposit.

The goal is to create enough financial security to prevent you from touching the 401(k) until you're 59 1/2 years old.

For more information on effective wealth management strategies, contact Landmark Bank.

Investment products and services are not FDIC insured, not insured by any federal government agency, not a deposit or bank obligation, not financial institution guaranteed, subject to investment risk, including potential principal loss.

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