Where and How Should You Invest Your Money Inside Your 401(k) | Retirement Strategies for Single and Married People!

Troy Sharpe:  Where should you invest your money inside your 401K, and how should those funds be invested? These two decisions you make when you’re signing up for your 401K or reallocating  your dollars on an annual basis can really determine how secure your retirement is.

I am Troy Sharpe, CEO of Oak Harvest Financial Group, Certified Financial Planner professional, and host of The Retirement Income Show. In one of our previous videos, we talked about the average savings rate. You need to be  saving as much as you can, of course, towards your retirement, but you need to decide what part of your 401K do you save that money inside.

Most of you have three parts where you can actually save money. You have the pre-tax part where you put money in there, you get a tax deduction today, and those dollars grow tax-deferred. When you  get to retirement, you pull them out, you have to pay income taxes on every single distribution. You have the Roth part most likely. The Roth part is the  tax-free part of your 401K. You get your paycheck, you actually pay tax today on those dollars, and you save it inside the tax-free part. All  the interest you gain in that tax-free part, you’ll never pay taxes the rest of your life on the money you put in or the interest that you earn. The third part  is the after-tax part of your 401K.

Most people mistakenly believe that we are limited as far as how much we can put into our  401K with the number that the government allows us to deduct. If you’re putting money into the traditional side of your 401K, there is a limit on how much you can deduct, but  you can go above and beyond that number and still put money into your 401K and it will simply go into the after-tax part. Whether you put it into the traditional or the Roth, you  can still put more into the after-tax part of your 401K. There’s a big, big benefit of doing so.

The money you put into the after-tax part, it’s up to about $54,000 here in 2020  as far as the total contribution inside your 401K. The deductible part is limited and the money you can put into the Roth is limited depending on your age,  but you can put additional funds beyond that. The after-tax funds, what’s cool about these is it’s a way to backdoor more money into your Roth later in life.

Once you’ve maxed out  your 401K contributions up to the Roth of the traditional IRA part, you can put typically an additional $25,000, $26,000, $27,000 depending on your age inside the  after-tax part. Then when you retire, we can roll those after-tax contributions directly into a Roth IRA. This is really, really important because that’s  a way to get more money inside that tax-free part.

That’s three ways. You can put in the traditional side, take a tax deduction today, the Roth, it’ll be tax-free forever up to the  IRS limit, and then anything beyond that, you can put into the after-tax part where no tax deduction today, it’ll grow tax-deferred, and then at retirement, we can isolate  those contributions and roll them into the tax-free Roth forever. The interest you earned on those after-tax need to go into your traditional IRA.

Where should you invest money? You should be building  a tax-diversified portfolio. What I mean by that is when you get to retirement, you don’t want all of your dollars inside the traditional tax-infested part of your 401K.  You want some dollars inside the Roth as well. This is an individual decision really based on your analysis or working with your financial professional, but most people are going to benefit  tremendously from building a tax-diversified structure where once they get to retirement, depending on what the tax rates are at that time, they can pull some money  from the traditional part, pay income taxes on it up to their desired taxable level, and then take the rest of their income from the tax-free part in  retirement. We want to be building this tax-diversified structure.

Main takeaway there, you have three places where you can put money. The pre-tax, the tax-free, and the after-tax part of your  401K. We really want to be diversifying where we put our funds so when we retire and roll those monies over, we have choices of where we can take our income from in  retirement based on the tax environment at that time.

Now, how do you invest the money? Remember this account you cannot touch until you’re 59 and a half. Do not worry about  what the market is doing day to day, week to week, year to year. If you’re close to retirement, one, two years away, we absolutely should reduce the risk to  protect what it is that you’ve accumulated over the years. If you have 5, 10, 15, 20, 30 years away from retirement, understand the risks involved because investing  does involve risk, including the possible loss of principal, but I am in the firm belief that the younger you are, the more tilted you should be towards almost 100%  equities.

If you’re 30, 35 years old, and the market goes down, that should be when you increase the amount of money inside your 401K or contributions up to as much as you  can. If you’re in your 40s, you still can’t touch that money until you’re 59 and a half. You still need to be tilted heavily towards equities, in my opinion, of course, based on your own risk tolerance.  Bonds are paying us nothing and that is the primary option we have as an alternative to stocks inside the 401K.

We need to compound our money at higher  rates of return over longer periods of time. The only way to do that in this economic environment is to tilt the 401K more heavily  towards equities. Speak with a financial professional, understand the risks of investing in seeing those accounts go up and down in value. Try not to look at it too much.

The younger  you are, you should absolutely because of the economic environment and the timeframe that you have, you should strongly be considering to equity, allocating more towards growth stocks,  less towards these target-date funds, 2025, 2030, 2040. Strong growth stocks is going to give us a really good opportunity to compound that money over  the time we have before we retire. Hit that subscribe button, hit that thumbs up button, and make sure to share this video with a friend or a family member as we help people get more connected  to their money.