401(k) Strategies for Mid-Career Professionals
As a mid-career professional, you've likely been contributing to your 401(k) for some time. But are you maximizing its potential for tax savings now and in the future? Here are eight strategies to consider.
1. Traditional 401(k) vs. Roth 401(k): Which Is Right for You?
One of the first decisions to make when considering your 401(k) strategy is whether to contribute to a traditional 401(k), Roth 401(k), or combination of both. The key difference between the two account types lies in how and when you pay taxes.
Traditional 401(k): Contributions are made with pre-tax dollars, reducing your taxable income for the year. The tax benefit is immediate, which can be appealing if you're in a higher tax bracket now. However, withdrawals in retirement are taxed as ordinary income—an important consideration if you expect to be in a similar or higher tax bracket in the future.
Roth 401(k): Contributions are made with after-tax dollars, so there’s no upfront tax break. However, withdrawals in retirement are tax-free if certain conditions are met. A Roth can be beneficial if you expect to be in a higher tax bracket during retirement or if you want to minimize your taxable income in your later years. Additionally, having a Roth 401(k) can help insulate you against future changes in tax laws, as the tax-free nature of withdrawals provides a layer of protection against potential increases in tax rates down the line.
2. Tax Diversification: Balancing Pre-Tax and After-Tax Contributions
Just as you diversify your investments, it can be wise to diversify your tax strategy. By contributing to both a traditional and Roth 401(k), you can help create tax diversification, providing flexibility to manage your taxable income in retirement. This approach gives you the option to choose between taxable and tax-free withdrawals depending on your financial situation.
Having both accounts offers flexibility if you’re uncertain about where your tax rate, income, and spending will be in retirement. As a retiree with both Roth and traditional 401(k) accounts, you can use this strategy to manage your marginal tax bracket.
With this strategy, you can have more flexibility to adapt to changes in tax laws, income levels, and retirement goals, helping you manage your finances more effectively throughout retirement.
3. Contribution Limits and Employer Matching
Maximizing your 401(k) contributions is one of the most straightforward strategies to grow your retirement savings. In 2024, the contribution limit for those under 50 is $23,000, and $30,500 if you’re 50 or older. If your employer offers a match, be sure to contribute at least enough to receive the full match—it’s essentially free money that boosts your retirement savings.
When contributing, consider how much you can afford to save now versus the long-term benefit of compounding growth. Remember, even small increases in your contribution rate can have a significant impact over time.
4. Investment Choices and Risk Tolerance
Mid-career is often an ideal time to review your investment choices within your 401(k). Your risk tolerance, investment goals, and time horizon may have changed since you first started contributing.
Growth-Oriented Investments: If you have 15-20 years until retirement, you might prioritize growth by allocating more toward equities. While this approach carries higher risk, the potential for higher returns could increase your retirement nest egg.
Conservative Investments: If you're closer to retirement or have a lower risk tolerance, shifting some of your portfolio to more conservative investments, like bonds, may help protect your savings. This balance can help you avoid large losses as you near retirement.
Target-Date Funds: For those who prefer a hands-off approach, target-date funds can be a convenient option. These funds automatically adjust your asset allocation based on your expected retirement date, gradually shifting from a growth-oriented mix to a more conservative one as you approach retirement. While not a one-size-fits-all solution, they can offer a simple way to manage your 401(k) investments in alignment with your retirement timeline.
5. Regularly Rebalance Your Portfolio
Market fluctuations can shift the allocation of your 401(k) investments over time. Regularly rebalancing your portfolio helps ensure that your asset allocation remains aligned with your risk tolerance and retirement goals.
For example, if a strong stock market has increased your equity exposure beyond your desired allocation, rebalancing allows you to sell some equities and buy bonds to maintain your target mix. Many 401(k) plans offer automatic rebalancing options, which can simplify this process.
If you're invested in a target-date fund, it may already handle rebalancing for you by adjusting the asset mix over time as you approach your retirement date. However, it’s a good idea to check with your 401(k) provider to confirm how these funds are managed and whether they align with your overall retirement strategy.
6. The Role of a Fiduciary Financial Advisor
Working with a fiduciary financial advisor can be valuable when navigating complex 401(k) decisions. A fiduciary advisor acts in your best interest, providing unbiased guidance tailored to your financial situation. They can help you:
Develop a comprehensive strategy that balances current tax benefits with long-term growth.
Evaluate the tax implications of traditional vs. Roth contributions based on your income and retirement goals.
Choose the right investment mix within your 401(k) that aligns with your risk tolerance and time horizon.
An advisor can also assist with broader financial planning, such as coordinating your 401(k) strategy with other retirement accounts and investment goals.
7. Strategies Beyond Your 401(k) Contributions
Once you’ve hit the annual contribution limit for your 401(k), it’s time to consider other tax-advantaged and growth-oriented options to continue building your retirement savings.
Individual Retirement Accounts (IRAs): After maxing out your 401(k), IRAs can be a great next step. Depending on your income and eligibility, you can contribute to a traditional IRA or Roth IRA. If you’re not eligible for a Roth IRA due to income limits, a backdoor Roth IRA conversion may be an option to explore.
Health Savings Account (HSA): If you have a high-deductible health plan, consider contributing to an HSA. It offers triple tax benefits: Contributions are tax-deductible, growth is tax-free, and withdrawals for qualified medical expenses are tax-free. After age 65, HSA funds can be used for non-medical expenses without penalty, though they’ll be subject to ordinary income tax.
Taxable Brokerage Accounts: While not tax-advantaged like a 401(k) or IRA, a taxable brokerage account offers flexibility. You can invest in a wide range of assets without contribution limits or withdrawal restrictions. With the right investment strategy, such as holding investments for more than a year to benefit from long-term capital gains tax rates, a taxable account can be a useful component of your overall retirement strategy.
After-Tax Contributions to Your 401(k): Some employer 401(k) plans allow for after-tax contributions beyond the standard limit. This can be a powerful strategy if your plan permits in-plan Roth conversions, allowing you to convert those after-tax contributions to a Roth 401(k) for future tax-free growth.
Final Thoughts
Your 401(k) can be the cornerstone of your retirement strategy. By carefully considering the balance between tax savings now and in the future, maximizing contributions, selecting the right investments, and regularly rebalancing your portfolio, you can work toward a financially comfortable retirement. Partnering with a fiduciary financial advisor can help you navigate these decisions and develop a strategy tailored to your unique goals.
Schedule a complimentary, 15-minute chat with a fee-only, fiduciary financial advisor today to discuss your personal situation.
This material was written in collaboration with artificial intelligence (ChatGPT) derived from sources believed to be accurate. This information should not be construed as investment, tax, or legal advice.
Parkshore Wealth Management is a family-owned, independent, fee-only Registered Investment Advisor with offices in Granite Bay and Folsom, CA, and Lehi and Logan, UT. We partner with financially responsible individuals and families who are eager to take positive steps that will allow them to use their money to build the life they desire. The firm is led by Harold Anderson, CFP®, and Daniel Andersen, CFP®, both members of NAPFA, the country’s leading professional association of fee-only financial advisors.