The Best Gen-X retirement guide for 401(k) planning strategies

Last updated on April 28th, 2023 at 10:10 pm

It’s time you learned all about 401(k) planning and how your future self will thank you. Learn from someone who has managed companies offering 401(k) plans to employees. We will take a deep dive into what the 401(k) plan is and what is not. When to use a traditional IRA and when to use a Roth IRA and when more than one will work.

Most important of all of the things we will talk about is that you need to make a commitment to your own retirement planning and stick with the savings portion that involves funding your retirement. The method of your retirement savings is just as important as your overall retirement plans.

Gen Xers are my specific target group although what will be said here can help most people with decisions regarding retirement accounts. Make no mistake, the 401(k) plan is a retirement program, it is designed to help you achieve financial security.

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“The Best Gen-X retirement guide for 401(k) planning strategies” is #5 in Generation X 20 Years to Retirement Series. Read all of the articles by clicking on the button at the bottom of this article and join our interest list for our educational course “Generation X Retirement Strategies”

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A bit of history about 401(k)

I remember when Congress passed legislation authorizing the 401(k) plan. A bit of history may put this program into perspective for Gen Xers who were toddlers when the plan went into effect.

Many Baby Boomers and most of their parents were covered by defined benefit programs called pensions. Companies found that they could dissolve their pensions and eliminate this contingent liability by offering a 401(k) plan. The matching contribution was their way to make the flip. Unfortunately, their contribution was small compared to the cost of the pension plans. Companies experienced a windfall with the 401(k).

Often during the early phases, companies offered both. For many years the cost was higher since they were contributing to both a 401(k) and a pension. They had set rules that new employees would not qualify for the pension plan so this helped.

Some companies offered long-time employees the opportunity to cash out their pensions with a one-time payment. I know people who were paid several hundred thousand dollars.

Employers match now fully invested

The prudent employees opened retirement accounts through brokers and insurance companies. Too many spent the money and found that they were left with nothing even as they entered their 60s. Some Baby Boomers were able to retire with both 401(k) and a pension.

Also at the time, the employer contribution to the 401(k) plan was not yours unless you stayed with the company for at least 5 years. If you left the money stayed behind.

Congress has made many changes to the 401(k) plan and today the employer must make a contribution. In fact, there is a test to be sure that the senior managers do not benefit more than the other employees. If this were to be the case, the company would have to make a contribution to every employee in the company even those who never paid in.

401(k) plans were designed as the “primary” source of income

It took several years before I fully understood how the 401(k) plan worked for the employer and employee. One year we had to pay all employees because the plan was out of balance. This meant actually opening plans for employees who did not contribute.

I was not happy about this because It was and is my belief that the employee should be invested in the program. Years later when I sold the company, we had to notify all of the former employees who had left over the years that they had to transfer their funds elsewhere.

Another thing you should know is that the 401(k) plan was intended not only to replace pensions, it was to be used as the primary, not secondary method of funding retirements. Yes, the primary. Social Security benefits were to be secondary. Actually, that’s what Congress intended back in the 1930s when Social Security was created. The Social Security Trust Fund was created to “supplement” retirement.

Your 401(k) plan is yours alone

Understanding that your individual retirement account is your primary vehicle for retirement, what you will learn here will serve you well in the future. By the way, the term “individual retirement account” means this is yours and yours alone.

Your 401(k) was not created for another person such as a spouse. Your spouse should start their own 401(k) plan. The main reason for this is that there are limits on what you can save. Married working couples can have twice the savings upon retirement. A great reason for 401(k) planning.

Ok, let’s start with the fact that 401(k) plans are employer-sponsored plans. If you are self-employed, we will get into that area in a future installment of the Gen-X 20 Years to Retirement series. Employer-sponsored means that the employer pays the costs of maintaining the fund to the fund provider.

401(k) plans are not administered by the employer

A company is hired by your employer to offer the 401(k) plan to their employees. This company is the main contact, once started, your employer steps out entirely. Employers are expected to promote the use of the plan but not give any advice about how it works or what investments to choose. Employers will usually set up a meeting where the plan provider explains any changes or new offerings.

A typical 401(k) plan will be administered by a company such as State Street, Fidelity Investments, Charles Schwab, and others. The plan will follow Federal guidelines which require the plan provider to act as a Fiduciary. What is a Fiduciary? There are two types of financial advisors, a Feduriary and all others.

The plan administrator is a “fiduciary”

The fiduciary must by law ensure that their handling of your funds is first to benefit you and second to benefit the provider. The fiduciary can never offer you products to invest in that they know are not suitable for 401(k) plans. They have to balance risk vs reward. Also, a fiduciary can not accept commissions or remuneration from any companies they work with including brokers, finance companies, etc.

Fiduciaries earn all of their income from the fees paid by their employers. Because a fiduciary is paid by your employer and not subject to earning commissions, they can focus on your best interests.

The financial institution can provide a limited amount of advice at no charge to the employee. This helps understand the specific investments available.

You will have a choice of pre-selected funds to invest in

You will be provided with a list of funds and investments that you can choose from. These funds are carefully selected. It’s been my experience that they are usually highly rated but not always the highest rating for a variety of reasons with the risk being the most important. I recall for years wondering why some of my choices were not performing as well as some offered by the brokerage.

Sometimes their choices are based on the cost of the fund or choice. You must be careful that the funds you choose to invest in will not charge high fees. Usually, funds in 401(k) plans offer reasonable fees but do not take that for granted.

Your holdings are subject to fees charged by the brokers that manage the fund. For example, you may have a mutual fund that specializes in the tech field. That fund will own actual shares in many companies. The brokers buy and sell those stocks all year in an attempt to increase the return of the overall fund.

There is a cost for this service and it is passed along to the mutual fund owners, that’s you. Some funds charge very high fees when they know the returns are very high but often very risky. Your 401(k) provider is supposed to help you by keeping these funds from your portfolio.

Real Cost of Investments

You already know that your employer pays the cost of the 401(k) plan provider to administer the program. Did you know that every time you buy or sell funds there is a fee? Fees charged on funds in most 401(k) plans are low compared to buying through a brokerage.

For example, Fidelity Select Technology Portfolio at this writing is 0.15% of the amount traded. The highest fee in the top 10 funds is 0.75% per trade. The lowest is Vanguard Total Stock Market Index Fund at 0.03%. It’s fine to move funds from time to time but keep in mind that there is a cost to you for selling and buying. You will not see this cost because it is deducted from the yield. Just keep in mind during your 401(k) planning process that you need to look at the cost of trades.

Decisions you need to make

Your employer-sponsored retirement plan will provide the selections and you will have to make the following decisions:

• How much will I contribute each payroll period
• Select which funds or investments you will contribute to. You can contribute to one or all.
• Allocate based on a percentage of the contribution that each of your investment selections will receive
• Make provisions for any bonus funds or out-of-cycle contributions
• This process is called planning for the best 401(k) performance.

The amount that you will contribute from your income will be considered pre-tax dollars. If your gross pay was $2,500 for a pay period and you selected to contribute 4% to your 401(k) plan, your employer would deduct $100 before applying your federal and state income tax rate to the remaining $2,400.  If your employer for example will match your contribution up to 4% of your gross salary, then you would have an additional $100 going into your 401(k) plan.  

There is a maximum amount you can contribute each year

This additional “match” is free money.  It still astounds me that so many people do not understand the idea of free money.  The good news is that as long as your employer is matching your contribution, the faster you reach your savings goal.  There is always a hitch.  There is a maximum amount you will be allowed to divert from your annual salary.  

That amount changes each year with inflation adjustment.  If you are under 50, you can contribute $22,500.  If you are over 50, you can bump that up to $30,000.

One more catch, when you look at how much money you have in your account, do not consider it all yours.  Why?  Your partner, Uncle Sam is asking for payback.  All those years you hit your income limits for 401(k) deferrals to reach your retirement goals, your good old Uncle was waiting in the wings.  

When you start to take funds out, He wants his share.  Having said that, there are strategies to reach your financial goals by outsmarting the tax collector. You can accomplish this through “financial planning”.

Pre-tax money will permit faster growth

Remember another thing, the tax advantages of pre-tax money including your employer’s match, will permit your money to grow faster.  Reinvesting dividends and interest will benefit from the compounding effect.

Employers usually provide employees with calculators to determine how their contribution will affect their take-home money. In some cases, you can make a contribution that has no effect on your take-home amount. Why? Because of the tax effect. Typically people just starting a 401(k) plan are earning at lower levels than they will later with raises and promotions.

Often these young investors can not afford to make any maximum contribution. They use the calculator to determine what level of pain they can stand. After all, they have plenty of time to save.

Gen-Xers have time to save for retirement

Generation X has less time to save. This is why members of Gen-Xers need to get their planning done and make those maximum contributions now as their income is going up.  As a Gen-Xer, you understand that as the years have gone by, your income has grown.  This is in part to the additional experience you have gained plus promotions and cost of living allowances.  

The longer you have been in the workforce, the more you should have been able to save.  You should be making the maximum annual contributions by age 50.  Retirement savers are not all created the same and some have made poor choices in their earlier working life so at age 50 you may still be struggling to make the maximum annual contributions. As your 401(k) fund increases you need to keep your planning process in mind.

Let’s move on to the choices you will make for the funds that you choose.

The following are typical choices in an average 401(k) plan:

• Money market fund – This is where you park funds that you have not yet committed to other funds.  Money market funds pay dividends in the low single digits and the rate will fluctuate with an index such as the prime rate.
• Real estate investment trust or mutual fund – A basket of real estate companies that hold income properties in various market sectors.  These funds pay dividends and can appreciate
• Target date funds – A mix of securities and asset classes that include equities and fixed-income instruments.  You select these funds based upon a target date for retirement e.g. 2043
• Company stock – Often 401(k) plans offer company stock sometimes at a discount.
• S&P 500 Index fund – This is an index of the top 500 stocks it’s a broad indicator of stock performance and helps to reduce risk
• U.S. Large cap fund – A mixture of some of the largest U.S.-based corporations, and lots of stocks reduces risk.
• Foreign fund – There may be a fund based on foreign stocks.  These may pay good dividends
• Index funds – Your 401(k) plan may offer one or more index funds.  These are popular because the cost to manage these funds is lower.
• Treasury – This can be a fund or investment in treasury notes or instruments
• Total Bond fund – These funds are an accumulation of corporate and government bonds that pay dividends.

There are many more categories but the above are usually representational.  Most financial advisors will tell you to spread your funds around.  Do not make a big investment in your company stock, buy others as well.  

The following is a representation of how you would utilize invested funds:

• 15% Money market fund
• 10% Company stock
• 5% Real Estate 
• 20% Index fund
• 15% Bond fund
• 20% Target date fund
• 15% U.S. Large cap

The above is a representation of how you allocate funds by percent.  Do not run out and use this example.  The idea with your selections is to make choices for the initial fund and then you have another choice to make after you have made your initial allocation as follows:

• 5% company stock
• 40% money market fund
• 40% index fund
• 15% bond fund

After the initial distribution assuming you have funds to start, you must tell your employer how much from each paycheck will be allocated where.  You may not want to change the allocations of your initial lump sums because the market dropped and you want to stay as you are so that when it comes back, you will have equalized your losses.  

When the market is in turmoil you can park your money in a money fund.

In the interim, you want to protect your funds so you are pushing them to money instruments and the safety of an index fund.  It may take a year or two before the market recovers enough to sell off any of your initial investments and move the funds to another.  

Keep in mind that your 401(k) is not a brokerage account.  Don’t attempt to use your 401(k) plan like a brokerage account.  Your investment options should be sufficient to lock in some choices for a while.  I recall many times when my employees would experience a major downturn in the stock market and then sell all of their positions.  Planning your 401(k) investments is the best way to improve the performance of your funds.

Unfortunately, those of us who are not brokerage employees never move fast enough.  Most of the people I recall lost money when they sold.  Then after a time as always the market rebounded.  Select funds and investments where you want contributions to go. It’s best to just leave the funds alone and only infrequently balance them.

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Effective 401(k) Planning Pays Off

Your employer deducts $1,000 per month from your payroll check. Market returns are 7% per year

Year	Starting Balance	Dividends	Deposits	Ending Balance
1	$12,000	$840	$0	$12,840
2	$12,840	$908	$12,000	$26,748
3	$26,748	$978	$12,000	$41,526
4	$41,526	$1,050	$12,000	$57,376
5	$57,376	$1,124	$12,000	$74,100
6	$74,100	$1,199	$12,000	$92,799
7	$92,799	$1,276	$12,000	$112,775
8	$112,775	$1,355	$12,000	$133,530
9	$133,530	$1,436	$12,000	$155,166
10	$155,166	$1,519	$12,000	$177,885
11	$177,885	$1,604	$12,000	$191,689
12	$191,689	$1,691	$12,000	$206,380
13	$206,380	$1,780	$12,000	$222,080
14	$222,080	$1,871	$12,000	$238,851
15	$238,851	$1,964	$12,000	$256,615
16	$256,615	$2,059	$12,000	$275,374
17	$275,374	$2,156	$12,000	$295,120
18	$295,120	$2,255	$12,000	$315,975
19	$315,975	$2,356	$12,000	$337,831
20	$337,831	$2,459	$12,000	$361,680

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As you can see, the ending balance increases each year due to the combination of the starting balance, the deposits, and the dividends. The dividends are paid out quarterly, so the amount of dividends earned each year is based on the ending balance at the end of the previous year. As the ending balance increases each year, so do the dividends earned. As a result, the ending balance increases each year.

However, it is important to note that this is just an estimate. The actual ending balance will depend on a number of factors, including the actual interest rate on your investments, the amount of money you withdraw each year, and the length of time you invest for.

Small business owners can have their own 401(k) plan

If you are reading this and you are a small business owner, please read our article on self-employment 401(k)’s.  About investment advice.  Always remember that past performance is not always an indicator of future performance.  Business owners need 401(k) planning even more than individuals because it’s a bit more complex.

Your fiduciary will provide assistance at no charge to you any time you request it.  There is no need to hire a financial advisor if all you have is a 401(k) plan at least prior to retirement. Charles Schwab offers excellent services for self-employed. Click here for information about their self-employment 401(k) and Roth IRA plans.

Leaving your employer, no problem – 401(k) planning again

Time to discuss that rollover.  When you leave your company, there is a time frame for you to move your funds from your 401(k) to an IRA called a “rollover IRA”.  The process is simple as follows:

• Determine who you will use as an IRA provider such as Charles Schwab.
• Open an account with Charles Schwab and give them information about your 401(k) plan
• You will be required to obtain a transfer form from your existing 401(k) provider authorizing the move from their program to Charles Schwab
• The two financial providers will coordinate the transfer.
• You may have a choice to transfer just dollars or the actual funds and stocks.  You must ask both programs if they can affect your choice, cash is always available but moving equities may or may not be possible.
• If you have not moved equities meaning that you sold everything in your old fund, you need to make new elections for your funds.  This is a time to rebalance your portfolio.
• IRAs are different than 401(k)’s you will now be able to buy anything offered by Charles Schwab.
• Schwab will set up mandatory distributions for your funds automatically.  When you reach 73, they will notify you on their website to make a selection.  More on this later.

No tax event when you roll over a 401(k)

No tax event is created when you roll over (transfer)4019k) funds to an IRA.    Now that your financial situation has changed because you are retired, you have some decisions to make if you have not already done so.  

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Drain your 401(k) plan after retirement

Drain your 401(k) as fast as you can, after retirement. Before you click off, this is what we mean. . Calculate your income and determine if you will owe income taxes. In every year where you are below the threshold to pay income tax, withdraw funds from your 401(k) until you hit the income tax threshold. Put those funds into your Roth IRA. 

Moving your funds is a great way to avoid taxes is like taking the funds from one pocket and putting them into the next except you will be taking out for example $10,000 and putting $10,000 back. No loss of principal due to income tax obligations.

For example, you have a Social Security income of $25,000 and a dividend income from your 401(k) of $10,000. Your gross income of $35,000 after the standard deduction is applied will be below the threshold to pay federal income taxes. It’s time to withdraw as much as you can from your 401(k) until you hit the income tax threshold.

If you will not pay income tax until you earn for example $45,000, you could withdraw another $10,000 from your rollover 401(k) and exactly hit the threshold. You pay no federal taxes on your withdrawal. 

Move your 401(k) rollover funds to a Roth IRA, part of planning

Let’s discuss where to put those funds into an after-tax dollars Roth IRA. In this way over the years, you can drain your 401(k) which has been rolled over by now to an IRA. The idea is to avoid income tax by setting up a strategy to empty your rollover account.

After age 73, there is a mandatory withdrawal and if you are lucky, by the time you have reached that age, you may have moved a substantial amount of funds out of your rollover 401(k). You can actually start at age 59 1/2 but most people will be working at that age so there is no gap to be filled.

 You can see what the minimum required distribution will be by asking your IRA provider or going to the Social Security website where you can calculate it yourself.

I mentioned a Roth IRA above.  On occasion, your government does a good thing.  When Congress created the Roth IRA, they decided to give a gift to anyone who decided to use it.  

What is a Roth IRA?  Read on:

• Roth IRA is an individual retirement account where you can save for retirement
• All funds deposited into the Roth IRA are after you have paid taxes on the funds.  This is not a pre-tax fund like the 401(k)
• Capital gains, appreciation of the value of holdings, and other income are NEVER taxable.  Correct, NEVER.  
• There are limits on how much you can contribute each year to a Roth.  $6,500 for those under age 50 and $7,500 for those over 50
• You can take the principal out at any time without paying taxes or penalties
• You can not take out any income generated tax-free until you are age 59 1/2 or older (this is the hitch, there is always a hitch)
• Exceptions to penalty-free withdrawal are first-time home purchases, college expenses, and birth or adoption expenses.  I recommend you leave it there and use other funds.
• Funds in the Roth IRA are typically held in a brokerage account.  Charles Schwab offers Roth IRA  and you can make the same choices as with a rollover IRA.
• If you have your Roth IRA at the same provider as the rollover IRA, you can move funds directly between accounts without fees.  Lots of rules apply including the taxability of the rollover IRA
• No mandatory distributions at age 73, keep on depositing and investing.

Self-directed IRA

Let’s go further into investment options as part of your overall 401(k) planning strategies.  You should know about the “Self-directed IRA”.  This is a special IRA where you can invest in residential rental real estate or gold for example.  The way this program works is that you must establish the Self Directed IRA account with the company that offers this option.  Charles Schwab offers this option.  

This is how the process works:

• Open the Self-Directed IRA account
• Transfer funds to the account from your existing IRA without a tax event
• Transfer funds to the SDIRA from your bank account (subject to maximum IRA annual contribution)
• Identify the property, make an offer, and notify the SDIRA how much you need for earnest money, down payment, and closing costs
• The property can be purchased with a mortgage, the SIDRA pays the other costs mentioned above
• Your rental property closes. 
• Rent the property
• Rents come to you.  Deduct all operating expenses
• Remit 100% of the profit to the SIDRA.
• You are not permitted to take anything from the transaction without paying income taxes.

Basically, you are moving funds you have in your accounts to another account and then using some of your capital to buy the property.  As the rental income comes into the SDIRA, you will be able to reinvest those funds.  

The idea is that the rental income will continue to grow while the investment property increases in value through appreciation and equity build-up.  This is just another way for you to diversify your funds.

You may need a financial adviser if your finances are complex

If you feel comfortable making these financial decisions without help, great.  Keep in mind that should you decide to use a financial advisor, most do not have experience with residential rental real estate.  

Even fiduciary-created financial plans are not likely to include residential rental real estate.  You can tell your fiduciary advisor that you want to add a rental property to your portfolio and if they are truly working for you, they will agree.  It’s all about your percent return on investment.  

Back to that Roth IRA strategy.  During your working years, there is a great strategy that lots of people utilize as follows:

• Make the maximum contribution to your employer 401(k) until you meet their match point.  E.g. 4% of your gross salary.
• The employer will max out their contribution at this point
• Begin making contributions to your Roth IRA or Roth 401(k) until you have maximized the deposits per the rules usually at about $6,500 check to be sure
• Stop making contributions to the Roth IRA when you hit the limit then back to your employer 401(k) until you hit that limit of about $30,000 again check to be sure of the annual limit.
• Take advantage of any catch-up contribution when you reach 50+

What has this 401(k) planning strategy accomplished?

What have you accomplished with this strategy?  A lot.  This is part of your retirement strategy that you have put into action.  You are going to receive the maximum free money.  You have deferred income allowing taxes you would otherwise be paying to work for you and you have maximized your Roth IRA which means you will never pay income taxes on the income and growth in that IRA.

 At the end of the year, you have invested the most allowed by law.  This does not mean you stop saving or investing.  If you have more to invest, look at residential rental real estate.  

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10 Best Performing funds in 401(k) plans for last five years)

Rank	Fund	Symbol	Average Annual Return (5-year)
1	Fidelity Select Technology Portfolio	FSPTX	17.7%
2	T. Rowe Price Blue Chip Growth	TRBCX	16.7%
3	Vanguard Primecap	VPMCX	16.4%
4	Vanguard Target Retirement 2030	VTHRX	15.9%
5	Vanguard Wellington	VWELX	15.7%
6	Fidelity Contrafund	FCNTX	15.5%
7	American Funds Growth Fund of America	AGCAX	15.4%
8	Dodge & Cox Stock	DODGX	15.3%
9	Vanguard Total Stock Market Index Fund	VTSAX	15.2%
10	Vanguard Growth Index Fund	VUG	15.1%

The table above shows the 10 best-performing plans. Your 401(k) may or may not offer these plans. Use the research tools available through your 401(k) plan provider to help make your choices.

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Early withdrawal – an ugly term

There is an ugly term that you should not ever hear “early withdrawal.”  Do not take funds from your retirement accounts.  You are building retirement security and removing funds for any reason (there may be a good reason but I don’t know what it is) will set your plans back.  In the long term, keep thinking of your future self.  Consider those golden years. 

Don’t consider borrowing from your 401(k) or making an early withdrawal if you want to sustain yourself in retirement. Read this article about robbing your 401(k) first. By the way, during your 401(k) planning strategy please leave out removing funds until you are 59 1/2 or later.

This wraps up the first article on this very important topic, how Gen-Xers can use their 401(k) and Roth accounts as part of their retirement planning.  There is much more on this topic so I have decided to create a part 2 to expand on more aspects of investment strategy.  

In part 2, I will get into the health savings account, and discuss student loan debt, insurance products, and more.  Please return.  Don’t forget to read our other articles in Generation X 20 Years to Retirement series.  You can reach the series by clicking on the button below.  Subjects range from Social Security to the Retirement Budget Tool.  There should be a weekly installment on Mondays until the series is finished.  Thanks for dropping by.

A word about ESG, “feel good funds”

ESG funds are now being offered to 401(k) plans. Many fiduciaries do not like this. All of the choices you have in your 401(k) plan are designed to produce the best results for you. This means that no matter which you choose the purpose of the 401(k) plan is to grow wealth for you. The regular plans offered can help do this except for ESG funds.

“Environmental Social Governance” funds should have no place in your 401k planning process. Why? Because they are not created to be profitable. They are created to make you feel good that the funds are invested in companies that do not cut trees, create chemicals, make anything that uses fuel, etc. These feel-good funds are underperformers and have much higher fund costs.

You would be better off donating to your favorite Save the Earth non-profit at least you know what you are giving up. Read this article before you make this move.

Disclaimer

Disclaimer: The Generation X 20 Years to Retirement Series including this article is intended to be informative.  Laws and regulations change and the economy is in transition.  Use the information wisely as a guide.  It is not definitive and you are encouraged to do your own research and if necessary seek council from appropriate professional advisors including Feduricary Financial Advisors, Certified Public

Accountants, attorneys specializing in retirement law, and your 401(k) provider.  RetireCoast is not responsible for your actions as a result of anything you have used in this article to make decisions about your funds or retirement. We are not responsible for your failure to create a 401(k) planning strategy.

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