The American 401(k) is a very powerful retirement-planning option. Properly utilized, a 401(k) can help provide for a comfortable retirement. There are certain 401(k) mistakes that can derail your retirement dreams. Here’s what they are, and how to avoid them.
Love Your 401(k)
What is a 401(k) plan? A 401k plan is an employer-sponsored retirement plan that is available to almost 80% of the working American population. Contributions by employees are made before taxes are withheld, allowing the full amount to be invested. Additionally, most companies will match a portion of employee contribution.
In recent years the average corporate 401(k) match has been almost 3% of an employee’s salary. That’s free money and instant gain on your investment!
Yes, there are a lot of great reasons to love your 401(k). If both people in a two-income household were to max-out their 401(k) contributions through their prime earning years, they’d retire with around $4.6 million dollars. Think you could retire comfortably on that? I know I could!
But there are a few common mistakes people make that derail those retirement dreams.
Avoid These 401(k) Mistakes
As awesome of a retirement vehicle the 401(k) is, there are several mistakes made by far too many people. Below are the most common of those mistakes so you can understand and avoid them – and maximize your 401(k) benefits.
Mistake #1: Not Contributing To Your 401(k)
To get the benefits of a 401(k) plan, you need to contribute to the plan.
It’s a no-brainer to contribute at least enough to benefit from your employer match. Right?
Studies show that less than half of people with a 401(k) available to them actually contribute. That’s right, 59% of 401(k)-eligible people are passing up free money. Not only that but they’re missing out on one of the best tax-deferred ways to build wealth for a comfortable retirement.
Invest what you can. You can always increase the amount later, but definitely get started with something. If possible try to invest enough to get the
match free money.
Remember too that the contributions are tax-deferred. Taxes aren’t paid until later in retirement. Let’s say you pay 25% in federal and 5% in state income taxes right now. Contributing $500 monthly into your 401(k) only impacts your take-home pay by $350.
The tax breaks make it easier to find money to contribute than many people realize.
Mistake #2: Poor Choice Of 401(k) Investments
I’ve seen this happen: An employee makes an excellent decision to put money in their 401(k) plan. They don’t take the time to review their investment options and just randomly pick a few mutual funds for their money.
You might get lucky doing that, but likely you won’t.
Spend at least a minimal amount of time thinking about your investment portfolio in consideration of your goals and your risk tolerance.
The investment choices don’t have to be complex. In fact, here are three investment portfolio options that use just three funds or less!
The point is – consider your options and choose funds to achieve your goals.
Automatic Millionaire: Real-Life Specifics
Mistake #3: Borrowing From Your 401(k)
You can borrow up to 50% of your 401(k) balance and the interest paid goes back into your own account.
Sounds great, right? Not necessarily.
Sure, this option is better than taking out high-interest loans, but it can also seriously slow progress toward your retirement goals.
Consider: interest payments you make on a 401(k) loan are paid with after-tax money. You’ll also pay taxes again on that interest when you withdraw it in retirement. Interest on 401(k) loans effectively become double-taxed.
Understand too that if you leave your job you will need to quickly pay back the loan. Generally, people have 2-3 months after leaving a job to fully pay back a 401(k) loan.
Of course, when you’ve borrowed against your 401(k) you don’t benefit from gains on that amount while the loan is outstanding. So not only are you paying taxable interest but you’re missing out on any growth in the market.
Mistake #4: Taking An Early 401(k) Cash-Out
Withdrawing money from a 401(k) before you turn 59.5 can be costly!
First, you’ll have to pay federal and state income taxes at your current tax bracket rate. Then you will also be required to pay a 10% penalty on top of taxes. That $10,000 withdrawal could look a lot like $6k or less after taxes and penalties.
Unfortunately, a lot of people make this mistake. Back in 2011, the IRS collected $5.7 billion dollars in early-withdraw penalties. That’s almost $6 billion dollars that would otherwise have gone toward providing a comfortable retirement for many Americans.
There are a few ways to avoid the penalty, but as you can see from the huge amount of fees collected, not many people qualify for the avoidance.
Slow and steady got me to $500k
In Closing: Avoiding 401(k) Mistakes
Avoid these 401(k) mistakes to maximize your plan’s benefits. Taking the proper steps now can help assure a comfortable retirement when the time comes.
As a fee-only financial advisor, I can help you clarify your dreams and priorities, then develop an actionable plan to achieve your goals. Having a financial plan for your life includes much more than just investing, but intelligent investing is definitely part of the solution. Just select Start Here and let’s talk about how I can help you maximize your money to achieve the life of your dreams.
Do you have a 401(k) available? If so, are you contributing to it? Let us know in the comments.