Top 401k Mistakes
The 401k is one of the most popular options available for those working toward retirement. These accounts, which are provided by employers, give employees the opportunity to make tax deferred contributions from each paycheck. This means that the funds used for contributions are not taxed upon entering your 401k but taxed later upon withdrawal. Additionally, about half of employers offering a 401k will match employee contributions to a certain threshold (the average employer match in 2019 was 4.7% according to Fidelity). These benefits have helped grow the overall 401k market to nearly 6.9 trillion dollars as of March 2021.
If given the proper attention throughout your career, your 401k has the potential to be one of your largest sources of funds in retirement. However, people often make costly mistakes with their 401k which can lead to an underfunded account when reaching retirement. To help avoid these missteps, we have highlighted our top ten 401k mistakes to consider as you prepare for retirement.
10. Ignoring Small Plans From Prior Employers
Every bit counts when it comes to saving for retirement. That is why it is important to make sure you are not forgetting any old accounts from former employers. The money you contributed during your time with the previous employer is yours to keep and you can easily roll that money into your current 401k, or a similar tax-deferred account with an online broker such as Fidelity or Vanguard. To find your old 401k plan, simply contact your previous employer to start the process. They should be able to direct you to the proper department or channel to transfer the funds. If your previous employer has gone out of business, or you are unable to contact them for any reason, you can search for abandoned plans in the Department of Labor’s database.
9. Leaving Your Job Before Becoming Vested
Bad managers, low pay, or nosy coworkers are all valid reasons to seek new employment. However, staying put in the same job for a little while longer may pay dividends (figuratively and literally). Most employers require employees to remain at a company for a certain period before vesting the company’s portion of 401k contributions. Vesting is typically gradual, meaning the employee may be entitled to 25% of the employer’s contributions after year one, then 50% after year two, and so on until the employee receives the full amount over a given time (in this example, 4 years). If the employee leaves before that time, they may only be entitled to a portion of the employer’s contribution. Before accepting a job offer, you should know what the vesting schedule looks like and what an early departure would look like if things do not work out. If you have multiple offers available to you, but one has a more favorable vesting schedule, you may want to take that into consideration.
If you find yourself with an itch to leave your current employer (it happens) you should first research how much money you would potentially be leaving on the table. It may be worth staying around for a little longer if it equates to a considerable amount remaining in your 401k.
8. Setting and Forgetting
Think about this suggestion in two ways. First, you need to understand that your 401k is an account that holds marketable securities that may rise and fall in value depending on numerous factors. It is important to make this observation as there is often confusion surrounding exactly how a 401k works. In fact, according to CNBC, approximately 63% of Americans do not understand how these accounts operate.
The second point pertains to the longevity of the account itself. If you opened your 401k in your 20s, and you plan to work through your 60s, that is an incredible amount of time to consider. The investment choices you made when you started your career may fall out of favor over time and potentially lead to underperformance compared to other areas of the market. Make it a point to periodically check in on your investment choices to ensure they reflect your risk tolerance as well as your expected retirement date.
7. Ignoring High Fees
Yes, you are most likely paying fees on your 401k. While these fees (often referred to as expense ratios) are slightly lower than working with a professional money manager or private wealth advisor (according to TD Ameritrade, the average 401k fee is .45%), they are still being deducted from your account. While there may not be much you can do from a plan administration perspective, you do have control of the fees associated with your investment selection. While fees vary, you should aim to opt for an investment with an expense ratio that is below 1%.
6. Failing to Diversify
A notable mistake people make is failing to diversify. As an example, it is common for employees of a company to concentrate a large portion of their retirement portfolio in their employer’s stock. Participants guilty of this type of under-diversification often enjoy owning company stock because they feel as if they have more control over something that is well known. Unfortunately, falling victim to this type of confirmation bias can lead to a concentration risk in your retirement portfolio.
5. Waiting to Get Started
It is easy to postpone planning for retirement, especially for those who may be just starting their careers and are potentially facing burdensome student loan obligations. Despite the tight budget, contributing to an employer-sponsored plan in your 20s can make a tremendous impact upon reaching retirement. The old adage, “the best time to plant a tree is 20 years ago, the next best time is now,” rings true in this scenario. If you have not participated in your company’s 401k program, the time to begin is now.
4. Withdrawing Early
Life happens. A job loss, health scare, or major home and auto repairs can all be events that may lead you to explore an early 401k withdrawal. Unfortunately, making this mistake can have long-term implications to your retirement. For starters, you will only see about 70% of the total withdrawal amount. You will owe approximately 20% of the amount in taxes and the IRS will also impose a 10% penalty. This could negatively impact your retirement portfolio in the long run. As an alternative, make sure your emergency account is funded to cover 4-6 months of expenses. You may also want to explore adding a personal line or a home-equity line of credit to help cushion against costly life events.
3. Not Getting a Full Employer Match
One of the biggest benefits of participating in an employer sponsored plan is a possible contribution match by your company. Plan specifics vary from company to company but it is common for an employer to match 50% of your contribution, typically up to 6% of your salary. This means that participants would need to meet the 6% threshold to take advantage of a full employer match in this scenario.
2. Not Giving Your 401k a Promotion
As your salary increases over time, so should your contribution rate. While it may not be feasible for you to reach the contribution limit ($19,500 in 2021, $26,000 if you are 50 or older) right away, a small increase, such as 1%, can go a long way in retirement. Especially if your horizon is further down the road.
1. Not Knowing Your Needs in Retirement
In retirement, we often say that people are more likely to run out of lifestyle rather than running out of money. Unfortunately, the former can be equally worrisome as the latter. To mitigate these concerns, you should have a firm grasp on important items such as fixed and variable expenses, housing, health care, and inflationary pressures. The sooner you understand these concepts the better, as you have more control over the success of your 401k earlier in your career.
Written by Nelson Greene, Wealth Advisor