Most American workers have employer sponsored 401(k) retirement plans and depend heavily on its tax-deductible and employer-matching features to virtually double their retirement savings each month. But 401(k) plans are not fool-proof, as Beth Braverman explained in a recent article in The Fiscal Times.com… these all-important retirement plans have a few pitfalls that I want my listeners to be aware of so you get a lot more out of your 401(k).
401(k) plans are not fool-proof… and have a few pitfalls that you must be aware of so you can dramatically increase your retirement savings
Seven 401(k) Pitfalls
Pitfall #1. Not investing enough.
80% of all American employers offer matching 401(k) contributions that kick-in after an employee contributes a certain minimum amount. After that minimum, employers match contributions up to a certain dollar amount. So the more you put in, the more your employer matches till it reaches the maximum contribution match. So it’s imperative that you know how much to put in to get every single dollar from your employer up to the maximum matching limit.
On average, employer contributions amount to 4.3 percent, or about $3,500 per employee per year, so make sure you get the full matching amount from your employer. Otherwise, you’ll literally leave thousands of dollars of free pre-tax investible money on the table each year, and lose out on hundreds of thousands of dollars over the next 20-30 years.
Moreover, financial planners say workers should save at least 10 percent of their income for retirement. And older workers who have gotten a late start may need to save even more than that by prioritizing retirement savings.
In 2015, workers can contribute up to $18,000 in pre-tax dollars to their 401(k) plans, with workers age 50 and over able to put in an additional $6,000 “catch up” contribution. One easy way to increase your savings is to sign up for auto-escalation, a benefit offered by a growing number of employers. This will automatically ratchet up your contribution by a pre-determined rate every year. If you don’t want to commit to that, consider increasing your contribution manually whenever you get a raise; that way it will be less noticeable in your paycheck.
#2. Tapping into your 401(k) too early.
While you can start making penalty-free withdrawals from your 401(k) at age 59 ½, you’re actually better off leaving your funds invested to take advantage of a few more years of compounding on a nicely grown portfolio – so don’t rush to cash in but continue growing your retirement kitty.
#3. Not paying attention to fees.
Research shows that many investors don’t pay enough attention to investment fees associated with their 401(k) funds… but, as I have said many times, even a few percentage points in fees can add-up and significantly reduce the impact of compounding over a 20-30 year period… so audit your 401(k) holdings and retain only those funds that offer compelling value after accounting for fees. And, ideally, look for funds that carry no more than 1 percent in fees.
#4. Making the wrong investments.
A lot of times, employees invest a large proportion of their 401(k) back into employer company shares… but that’s a big diversification no-no because you typically don’t want your paycheck and your retirement tied to the same entity… so make sure your 401(k) assets are well diversified because the wrong asset allocation can limit your ability to grow or protect your nest egg. No matter how great you think your company is, limit that investment to no more than 5 percent of your portfolio.
Also, about 60% of all 401(k) plans include online tools or one-on-one investing advice to employees as part of their benefit package – so take advantage of this benefit. And if you don’t have access to such guidance, try using an online asset allocation tool, or go with a target-date fund that automatically rebalances your portfolio based on your expected retirement date.
#5. Cashing out.
Even if your 401(k) hasn’t added up to much before you leave your job, resist the urge to drain it when you leave because that will cost you a boatload in taxes and fees. With the rate at which workers, especially younger millennial workers, change jobs, cashing out can quickly become very expensive and blunt your savings. Instead, roll the funds into an IRA or a new 401(k) – and let compounding continue to do its magic.
#6. Borrowing against it.
It is often tempting to take advantage of a 401(k)’s borrowing feature that lets participants borrow a certain amount of money at below-market rates. It’s a nice feature but save this for an absolute worst case scenario. And know that if you take a loan, you’re also missing out on gains you could have earned with that money. Plus, if you lose your job or choose to leave, most plans require that you immediately pay back any outstanding loans or pay a penalty – so this could make matters even worse. So exercise extreme caution and do all you can to not borrow from your 401(k).
#7. Ignoring the Roth 401(k) option.
More than half of all companies offer an option to make Roth 401(k) contributions – with after-tax money – but less than 11 percent of all employees take advantage of these features. Roth 401(k)s are great because they allow investors to pay taxes upfront on the contribution but make tax free withdrawals in retirement.
And, unlike a Roth IRA, there are no income limits on Roth 401(k) contributions. For high earners, that’s an opportunity to pay potentially lower taxes now on money you’ll use later.
So make sure you re-visit your 401(k) plan’s investments, features and benefits. If you have any questions, most HR departments can help you out with the basics and refer you to a financial planning expert for detailed questions around asset allocation, etc. So do all you can to get the most out of your 401(k) retirement account.