7 Tips to Help Maximize Your 401(k) Returns

With a 401(k), your contributions are tax-deductible, and you might get an employer match to boot. You also won’t be taxed until you make withdrawals in retirement. Many 401(k)s are set up as target-date funds, meaning they automatically rebalance your asset allocation to become more conservative as you get closer to retirement. That can make life easier, but there’s one significant downside. It’s easy to forget about your 401(k) and not actively manage it.

At Opal Wealth Advisors, we can manage your 401(k) for you so that it supports your long-term investment goals—and positions your portfolio for the strongest potential returns. Here are seven ways to help make that happen.

1. Contribute More—and Make Saving Automatic

The more money you put into your 401(k), the more you may benefit from compound interest. That’s what allows you to earn interest on interest. We recommend contributing 10% to 20% of your income to help build your nest egg faster. 401(k) contributions are also made on a pre-tax basis and will reduce your taxable income today.

If setting aside 20% feels like too much, start smaller and gradually increase your contributions over time. For example, you might start by saving 15%, then bump it up by 1% every six months until you get to 20%. Automating your savings can ensure that it gets done with little effort. You might also run into extra cash by way of a work bonus, tax refund or inheritance. This “found money” can help pad your 401(k). In 2023, you can contribute up to $22,500 (or $30,000 if you’re 50 or older).

2. Maximize Your Employer Match

Many employers offer a 401(k) match as an employee benefit. It’s basically free money and is a powerful way to grow your savings. In 2020, the average employer match was 4.5%, according to Vanguard. Some employers provide dollar-for-dollar matches. However it’s structured, it can add up significantly over time. Employers can kick in up to $43,500 in 2023.

Reach out to your company to clarify if there’s a 401(k) match—then contribute at least enough to lock it in. When it comes to retirement saving, every little bit helps.

3. Open a Roth 401(k) and Enjoy the Tax Advantage

With a Roth 401(k), contributions are made with after-tax dollars. While you won’t get a tax deduction on the money you put in, you can enjoy tax-free distributions if you’re at least 59½ and have had the account for five years or more. That’s no small thing and can significantly reduce your tax burden in retirement, especially if tax rates rise in the future.

Like a traditional 401(k), early withdrawal penalties apply, and you must begin taking required minimum distributions at age 73. Check with your employer to see if a Roth 401(k) is an option. If you aren’t sure which type of 401(k) is right for you, Opal can model out both scenarios to help you make the best decision.

4. Consider a Mega Backdoor Roth Conversion

Contributing to a Roth IRA can be a great way to supercharge your retirement savings and enjoy some tax diversity in retirement. Your money grows tax-free, and you won’t be taxed on distributions you take in retirement. There are no early-withdrawal penalties. You can also tap your investment earnings beginning at age 59 ½, as long as you’ve had the account for at least five years. A major hurdle is that contributions to a Roth IRA are phased out for higher earners. That can present a challenge for high-net-worth individuals.

A traditional backdoor Roth conversion is a common workaround. This involves converting money from a traditional IRA into a Roth IRA. There’s no limit on how much you can convert, though you’ll be taxed on any pre-tax funds you move over. If your 401(k) plan allows, a mega backdoor Roth conversion can be an even better strategy. Some 401(k)s allow you to make after-tax contributions on top of the pre-tax money you put in. This money can then be moved into a Roth IRA. In some cases, you can contribute an extra $43,500 in after-tax funds to a 401(k).

Mega backdoor Roth conversions are complicated, so it’s best to work with a financial professional. Opal Wealth Advisors understands the complexities and can provide expert guidance through this process.

5. Choose the Right Investment Mix

Your asset allocation is a huge part of maximizing your 401(k) returns. Many employees take a hands-off approach with their 401(k) and never check to see how their money is actually invested. At Opal Wealth Advisors, we look at each client’s age, risk tolerance and financial goals—then suggest a personalized asset allocation that makes the most sense for them. You want to stay well diversified while positioning your portfolio for growth. That usually involves a mix of high- and low-risk investments across different asset classes. In other words, there is no one-size-fits-all 401(k) allocation.

6. Think About Asset Location (Not Just Allocation)

This is a tax strategy used to shelter tax inefficient assets. The idea is to spread assets out across accounts that have different tax treatments. It involves three main types of accounts:

• Tax-exempt accounts: Roth 401(k)s and Roth IRAs fall in this category. Since you’ve already paid taxes on your contributions, your money will grow tax-free, and you won’t be taxed on distributions.
• Tax-deferred accounts: This includes traditional IRAs and 401(k)s. If contributions are tax-deductible, you will be taxed when you eventually take money out.
• Taxable accounts: Brokerage accounts are a good example. There are no special tax breaks, so you’ll be taxed on capital gains, interest and dividends during the year they occur.

The right financial advisor can review your portfolio for tax inefficiencies, then recommend the best places to hold different types of assets to help reduce your tax liability.

7. Avoid Early Withdrawals

It’s best to avoid early withdrawals whenever possible. If you run into a financial emergency, Opal Wealth Advisors can help you strategize and ideally find liquidity elsewhere. Pulling money out of your 401(k) early has major disadvantages:

• Early withdrawal penalty: In most cases, you’ll encounter a 10% penalty if you tap 401(k) funds before age 59½.
• Distributions are taxable: Money you take out of a 401(k) is taxed as ordinary income.
• Retirement income consequences: Any withdrawals you make now will eat into your retirement income. You’re also robbing yourself of potential investment returns in the future. Your money can’t grow if it isn’t invested.

There are lots of ways to maximize your 401(k) returns. Opal Wealth Advisors can do the heavy lifting for you to identify opportunities to help you save in the most tax-efficient way. We’re dedicated to helping our clients manage their 401(k)s with confidence. Contact us today to get started.

Sources: IRS.gov, NerdWallet.