Stern Advice - 5 ways to hack your 401(k) in 2014

NEW YORK Wed Jan 8, 2014 1:37pm EST

NEW YORK Jan 8 (Reuters) - Don't look now, but your 401(k) retirement account is probably humming along nicely. Not only did the investments in it do extraordinarily well in 2013, but the folks who run those accounts made considerable improvements.

Employers got more generous with their contributions and plan managers added some new and better investment choices and recommitted themselves to holding down fees.

"The entire market is getting better," says Mike Alfred of BrightScope, a research firm that monitors 401(k) plans. His best advice? Workers should make sure they are taking advantage of generous new plans and provisions by contributing as much of their own money as possible into the plans.

Here are other ways to take advantage of those new improved 401(k)plans now.

- Recalculate your contribution. Companies have been reinstituting matching contributions that they dropped during the financial crisis and recession. They are also making their contributions larger. At a minimum, make sure you are contributing enough to get the full match for 2014.

And if you can afford to do so and your plan is a good one, arrange to put in more than that with every paycheck. You can contribute as much as $17,500 of your pre-tax income to your 401(k). If you are 50 or over, you can contribute an additional $5,500. If you are over 50 and in a combined 42 percent federal-state income tax bracket, you can save yourself $9660 in 2013 taxes alone by contributing the maximum.

- Don't just rely on the auto-pilot. Almost 60 percent of companies are automatically enrolling their workers in their 401(k) plans and setting up their investments for them, reports consulting firm Aon Hewitt, and that's usually a good thing. But the bulk of companies doing this are only "auto-enrolling" their workers at a 3 percent of salary contribution level. Many can afford more, and should raise their contributions above that level.

Furthermore, almost all of this auto-invested money is going directly into target date mutual funds that automatically allocate contributions among stocks, bonds and other assets, based on the age of the contributor. That may not be the mix you prefer, so if you are being auto-enrolled, take some time to look over your plan's fund choices.

- Take a careful look at those target funds. The theory behind target date funds is that younger investors can afford to take more risks than older investors. These funds, sold as single-fund answers to retirement investment questions, mix a multitude of investments into a single fund, with the allocation pegged to the risk profile of the age group it is aimed at. So, for example, a target date 2040 fund would be aimed at workers roughly 40 years old and slated to retire in another 26 years.

But they are complex instruments. Some target date funds have higher fees than other funds, because they are essentially funds of funds. Some may be too conservative - putting too much money into bonds, for example - and some too risky - making big bets on stocks - for the tastes and situations of individual investors. And they may be insufficiently diversified as well.

But "target funds are continuing to get better and better," says Alfred. They are lowering their costs and adding additional asset classes like commodities and real estate to their mixes. So - check your target fund. See if it compares favorably to the rest of your 401(k)'s offerings. If you like it but think it is too risky or not risky enough for you, you can switch to a fund with a different target date - aiming younger or older than you actually are - until you get the risk profile right.

- Do a cost review. Check the funds you hold and the alternatives you don't for their total fees. In general, it is good to keep fees as low as possible. To accomplish that, you can take these three steps:

(1) Fill the core of your portfolio with a very low cost index fund, such as a total stock market index fund or a large stock index fund.

(2) Use proprietary and institutional funds when they are offered. These may look like funds created just for your company, or they may simply say "institutional" in their name. They are popular with employers and generally offer investors diversity at rock-bottom prices.

(3)Choose low-cost alternatives whenever you have a choice of multiple funds that aim at the same asset category.

- Go independent. The most notable change in 401(k) plans is the rapidly growing number of employers who are adding brokerage windows to their plans, allowing employees to buy, sell and trade their retirement funds almost without limit. Roughly 40 percent of companies now offer these in-plan brokerage accounts, compared to 29 percent in 2011, says Aon Hewitt. They are designed for sophisticated do-it-yourself investors and not everyone will want that much power, says Rob Austin, director of retirement research at Aon Hewitt.

But here's one way to use a brokerage account if you have sizeable assets in your plan: Compare the brokerage account offerings in the low-cost indexed arena with the ones your 401(k)plan offers. You may find it worthwhile to move a significant sum into a very low-cost, indexed exchange-traded fund within the brokerage account. That may not work for your regular contributions, where the brokerage account may charge a fee or commission every time it transfers money into an investment.

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