If you’re interested in saving for retirement, a 401k plan can’t be beat. These employer-sponsored plans let employees save tax-free and choose from a range of investment options. The tax-free savings effectively lower your taxable income, which may save you even more if it causes you to fall into a lower tax bracket. The key is avoiding common 401k mistakes people make.
Not only that, but many employers will match your 401k plan contributions; often 50 cents for every $1 of yours, but sometimes dollar for dollar, up to a certain percentage of your salary. A 401k matching contribution is an excellent benefit, as it’s more money in the bank.
Can you make mistakes with a 401k plan? You bet. Here are six of the most common mistakes to avoid:
Starting Your 401k Too Late
It’s all too easy to say to yourself, “Well, I will save in a 401k eventually I just won’t start the contributions now.” But putting it off can lead to months and years going by before you actually take the plunge. Even starting small contributions immediately will help your retirement savings immensely. Like a mighty oak tree that starts off as a small acorn, your retirement savings need time to grow. Starting late means they won’t have that time.
Not Maximizing the Match
Almost one-third of employees don’t maximize their employers’ match. If your employer offers a matching 401k, read the fine print carefully when deciding how much to contribute. Some plans have a default option for 3% savings and a 3% match. But the company may match higher percentages than that. Some will match up to 6%. It’s to your financial advantage to match the highest percentage the company offers. It’s more money for you in retirement — and by not taking it you’re leaving free money on the table.
Not Taking the 401k With You When Changing Jobs
Although 401ks are employer-sponsored plans, they don’t need to stay with the employer. If you change jobs, you can roll your 401k over into either the new employer’s 401k or a new retirement plan. While some companies allow you to keep your 401k in their plans, there are drawbacks. You may have more investment option choices elsewhere. Fees may be more advantageous elsewhere. Finally, out of sight, out of mind is a concern; over time, you could forget you have that money.
Failing to Rebalance Annually
Rebalancing refers to adjusting asset allocations based on their performance over the year. You should rebalance your investment portfolio every year. Some experts even suggest rebalancing each quarter.
Say, hypothetically, that you have 75% of your 401k in stocks and 25% in bonds. If the stocks have a good year, they will rise in price. That could mean, at the end of the year, that stocks have become 85% of your portfolio. If you want to keep the stock allocation at 75%, you’ll need to rejigger the extra 10% back into the bond funds.
Not Diversifying Your 401k
All investments should be diversified. It’s the old “don’t put all your eggs in one basket” rule. If you have a 401k that’s entirely in the stock market, you’ll suffer if the stock market enters a bear market. If your 401k is all in your company stock, what happens if the business has a bad year? Your salary and your retirement funds — not to mention your employment — could all be at risk.
Not Factoring in Fees When Choosing Investments
Another common 401k mistake people make occurs when picking funds for their 401k. Most funds charge fees, which come out of your accounts for the year. The US Department of Labor requires investment fees to be disclosed, but most people fail to notice. Over time, higher fees will affect your account balance much more than lower fees. If your stock fund charges 1.5% every year to manage it, while another fund only charges 0.5%, you’ll make more money with the latter if the investment performance is roughly equal.
A 401k, especially if it is a matching one, is one of the best company benefits employees can have. It saves money tax-free, lowers taxes on your income, and helps build your retirement fund quickly. Unfortunately, when it comes to managing their plans, many people unknowingly make costly mistakes that can affect their nest egg. Don’t be one of them.
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I worked for a nonprofit where benefits far outweighed raises and promotions. My employer gave an 8% match if we put in 5%. And still, I lost track of how many co-workers were not in the plan. I don’t get it. Even when someone was promoted in my department they only got a slight bump in pay, not nearly close to 8%.
Nice article, Anum!
It really is hard to believe how people can leave free money on the table.
Borrowing from your 401K could be the 7 mistake. I enjoy your articles.
This is a topic that’s close to my heart and I agree with everything you said here. Well done!