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December 10, 2018

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City National Bank

Best practices for managing your 401(k) and IRA

City National Bank 401k and IRA native

According to a 2016 report from the Economic Policy Institute, almost half the families in the United States do not have a retirement savings account. Many of today’s retirees are living off defined benefit plans, such as Social Security or pensions, but an increasing number of future retirees will depend on defined contribution plans—401(k)s and IRAs.

“401(k)s are fairly general, but there are a number of pitfalls and mistakes that people make with them,” said Paul Couch, Vice President and Senior Finance Advisor at City National Securities.

Learning how to take full advantage of your plan and optimize your benefits now can help ensure a healthy balance come retirement age.

Common types of retirement plans

Traditional IRAs, Roth IRAs and 401(k)s are common examples of defined contribution plans, which are tax-favored retirement accounts. The funds in these accounts vary based on the amount of money contributed and the earning-performance of the investment. These plans tend to assume more risk than defined benefit plans, which guarantee a certain amount based on a fixed formula.

In 2016, the Pew Charitable Trusts reported that 51.6 percent of employees had access to defined contribution plans, whereas only 12.2 percent had access to defined benefit plans. While 401(k)s and IRAs were not intended to be the dominant method of retirement planning, they can certainly fill that gap when managed responsibly.

• 401(k): The most common employer-sponsored retirement plan, a 401(k) allows participants to contribute pre-tax income which is typically matched by the employer (up to a certain percentage). Taxes are only paid once the money is withdrawn during retirement.

Contribution limit for 2018: $18,500

Income limit: None

• IRA: Unlike 401(k)s, individual retirement accounts (IRAs) are usually not employer-sponsored and can be created by the individual. Traditional IRA accounts take pre-tax contributions, and participants don’t pay taxes until the money is withdrawn during retirement.

Contribution limit: Generally $5,500. For participants 50 and older, up to $6,500

Income limit: None

• Roth IRA: Roth IRAs differ from traditional IRAs and 401(k)s because Roth accounts require post-tax contributions, but the withdrawals during retirement are tax-free—even on earnings.

Contribution limit: Generally $5,500. For participants 50 and older, up to $6,500

Income limit: Less than $135,000 (for singles) or $199,000 (if married and filing jointly)

Roth 401(k) options

“Many 401(k)s offer a Roth option, allowing participants to use after-tax dollars on a tax-deferred basis,” Couch said. Roth 401(k)s are especially beneficial for younger employees, so if your company offers a Roth option, take it.

Pro tip: “A Backdoor Roth is a great option for people whose salary exceeds the income limit for Roth IRAs. This approach lets you open a traditional IRA, which has no income limit, and then immediately convert it into a Roth IRA. You want to make this conversion immediately after your contribution,” Couch said.

Tips for optimizing your 401(k)

1. Know what you’re contributing: Evaluate your contribution levels, your company’s match and the overall contribution limit.

“You may not be capitalizing on all the benefits you could be,” Couch warned. Review your contributions each year and make changes when necessary.

2. Take advantage of your company’s match: Most companies match 3-6 percent of the employee’s gross salary, so make sure you’re taking advantage of it.

If your employer matches up to 6 percent, you should be contributing at least 6 percent as well. “If you’re not meeting your company’s match, you’re leaving free money on the table,” Couch said.

3. Contribute as much as you can: “Many people accept the default contribution percentage, but don’t settle for that if you can do more,” Couch said. Treat your company’s match as your minimum contribution and strive to hit the maximum contribution if possible.

Keep in mind, the $18,500 contribution limit for 401(k)s only refers to your contribution—whatever the company matches will be compounded on top of that.

4. Don’t use it until retirement: One of the most detrimental things anyone can do with their retirement plan, besides simply not having one, is tapping into the funds early.

“Don’t be forced into an early distribution or take loans out against the plan if you can avoid doing so. Make sure you have other savings available for emergencies—your 401(k) should only be your absolute last resort,” Couch said.

There’s typically a 10 percent penalty for withdrawing prior to retirement, in addition to the income taxes due at the time of withdrawal.

Maintaining your 401(k) during job transitions

Companies that match 401(k) contributions do so under specific terms. Oftentimes, there’s a minimum amount of time you need to be employed by the company in order to receive their match.

“When you take a new job, know how long the vesting schedule is in their 401(k) to ensure you’re getting the full match amount,” Couch said. Further, when you leave a company, Couch recommends taking your employer-sponsored 401(k) and rolling it into a personal IRA.

A common mistake people make when leaving a company is taking the 401(k) distribution themselves—and getting stuck with a 20 percent tax penalty. Putting it into an IRA in your own name avoids this problem.