5 Important 401k Rules You Should Never Forget


After the beating most investors took last quarter, I have a feeling that when 401k statements get mailed out in the coming days, most will be left unopened and dropped in the trash. It was just that kind of quarter.

But with one quarter left in 2015, this is a good time to review some ironclad 401k rules that you’d be well advised to remember.

For most working Americans, the 401k plan is the linchpin of their savings and the single biggest piece of their overall financial plan — yet because they are “boring” and automatic, they tend to get ignored.

That’s a major mistake, and one that can cost you a comfortable retirement. So this week, take time to review your plan, and keep these 401k rules in mind.

1. Investing In a 401k Does Not Necessarily Mean Investing in Stocks

Whenever I push clients to really take their 401k plan seriously, I often get the following reply: “But Charles, I don’t want to be invested in stocks right now.”

And my reply is simple: “Who said anything about stocks?”

“401k plan” does not mean “stock mutual funds.” A 401k plan, just like a brokerage account or an IRA, is merely a type of account. It can hold stock funds, bond funds, cash and — if your 401k’s limits allows for a self-directed option — you might even be able to hold nontraditional investments.

If you don’t want to own stocks right now, then don’t. But keep stuffing cash into your 401k plan so that it’s ready to deploy when you need it.

2. Returns Are Only Part of the Equation

This brings me to the second point. Let’s say that you hate the stock market right now due to high valuations, high volatility or because that last stock broker just looked at you funny. Pouring as much money into your 401k plan as you can, even if it sits in low-yielding money market funds, still makes all the sense in the world.

Investment returns are only one part of your effective returns. There are also tax savings and the employer match to consider.

If you’re in the highest tax bracket, you’re shelling out nearly 40 cents of every dollar you earn to the IRS. Therefore, earnings that you’re able to shield from the IRS in your 401k effectively “earn” 40% right off the bat in tax savings.

And if your employer matches, that’s potentially another 3% to 6% for your retirement. And again, you haven’t put a single dime at risk in the market yet.

3. 401k Funds Are Usually Protected from Creditors

You’re never really 100% lawsuit-proof. Even if you have your wealth squirreled away in elaborate business entities or even in an offshore bank, an aggressive enough creditor with a sympathetic judge can still put your assets at risk.

Well, 401k money is about as judgment-proof as legally possible. It would be extremely difficult for a creditor to get a piece of your 401k plan.

So, before you hire a swanky asset-protection attorney to hide your cash, keep as much as possible in your 401k plan. It’s a cheaper alternative and probably more reliable.

4. Always Remember That Money Is Fungible

This might sound obvious, but a dollar in your left pocket is just as good as a dollar in your right pocket. A dollar is a dollar. They all spend the same.

Well, you can apply the same logic to your 401k savings. Let’s say that you want to save the maximum $18,000 to your 401k plan (or $24,000 if you’re 50 or older), but that’s just not a reasonable target at your current income level. But let’s say you have plenty of after-tax savings built up over the years sitting at the bank.

Well, you can max out your 401k contribution and dip into your regular, after-tax savings to plug any gaps in your budget. Remember, a dollar is a dollar. It doesn’t matter if it comes out of your paycheck or out of your savings account.

5. 401k Money Doesn’t Need to Stay 401k Money

Finally, let’s say that you really want to invest in something nontraditional that will never be available in your company 401k plan, like a hedge fund or a real estate investment.

Well, guess what — you might be able to deploy your 401k money.

Depending on your plan’s 401k plan rules, you might be able to do what is called an “in-service” rollover to an IRA. In this case, you would move a piece of your 401k into a separate IRA account and then use the IRA funds to make the investment. This would be a nontaxable event, so long as you fill out the paperwork correctly.

Not all 401k plans allow for in-service rollovers. Traditionally, you had to quit or retire to move your cash without tax consequences.

But a growing number of plans now allow them, so if this is something that could benefit you, ask your company’s HR department or the 401k administrator.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog. 

Photo credit: 401(K) 2012


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