The American 401k is a very powerful retirement-planning option. Properly utilized it can help provide for a comfortable retirement. There are certain 401k mistakes that can derail your retirement dreams. Here’s what they are, and how to avoid them.
Love Your 401k
What is a 401k 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 the employee contribution.
In recent years the average corporate 401k match has been almost 3% of an employ’s salary. That’s free money and instant gain on your investment!
Yes, there are a lot of great reasons to love your 401k. If both people in a two-income household were to max-out their 401k 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 401k Mistakes
As awesome of a retirement vehicle the 401k 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 401k benefits.
Mistake #1: Not Contributing To Your 401k
To get the benefits of a 401k 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 401k available to them actually contribute. That’s right, 59% of 401k-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 401k 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 401k Investments
I’ve seen this happen: An employee makes the excellent decision to put money in their 401k 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 401k
You can borrow up to 50% of your 401k balance and the interest paid goes back into your own account.
Sounds great, right? Not necessarily.
Sure, this option is better than taking out some high interest loan, but it can also seriously slow progress toward your retirement goals.
Consider that interest payments you make on a 401k loan are paid with after-tax money. You’ll also pay taxes again on that interest when you withdraw it in retirement. Interest on 401k 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 401k loan.
Of course when you’ve borrowed against your 401k you don’t benefit from any 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 401k Cash-Out
Withdrawing money from a 401k 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 withdraw 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
Avoid these 401k 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. Reach out and let's talk about how I can help you maximize your money to achieve the life of your dreams.
Do you have a 401k available? If so, are you contributing to it? Let us know in the comments.