401(k): 8 Dangerous Mistakes To Know & Avoid

If you don’t understand how your 401(k) works, you’re putting your biggest retirement account at risk of losing money. Unfortunate events – such as a pandemic or an accident – can wipe out your balance at any time unless you know how to avoid the pitfalls in the first place.

 

By doing so, you can save tens of thousands and keep more money in your 401(k) account.

 

Here are 8 common 401(k) mistakes putting millions of participants in danger. Make sure you know if you’re making any of them to stop sabotaging your retirement.

1. Not having enough knowledge

You don’t want to feel vague and confused when it comes to making your 401(k) decisions. You don’t want to wish you knew something sooner or realize you’re not meeting your goals when you’re about to retire.

 

You’re reading this blog, so you’re one step ahead of those who don’t see the threats coming. You can protect yourself from devastating situations as well as exploit every opportunity to max out your balance.

 

It’s always better to have the knowledge yourself, or turn to a professional 401(k) management service if you have the budget. One 2019 Vanguard study reported a 3% average increase in the value of portfolios of clients who have their accounts professionally managed. You’ll save more time and effort as well as preserve your 401(k) better.

2. Withdrawing your 401(k) early

Every time you cash out your 401(k) early, you’ll lose the potential to grow that money through your investments. You’ll also risk forming a bad habit that disrupts your retirement.

 

You’ll also have to pay a 10% early withdrawal penalty on top of the income tax owed on the withdrawal. A $5,000 withdrawal at age 50 will result in a total of $6,700 ($500 of early withdrawal penalty and $1,200 of income tax) for someone in the 24% tax bracket.

 

An early 401(k) withdrawal should only make sense in an emegency situation. Other than that, you’ll lose your investment gains, pay more fees, and damage your plan.

3. Choosing the wrong 401(k) type for you

There are two types of 401(k): the traditional 401(k) and the Roth 401(k). Their difference is the time you pay the tax.

 

In a traditional 401(k), you’ll be taxed when you withdraw the money in retirement, not when you make contributions. Every dollar, including the tax-deferred growth, will be taxed as ordinary income.

 

In contrast, in a Roth 401(k), you’ll be taxed when you’re making contributions first, but you’ll keep all your withdrawals and the accumulated growth tax-free when you retire later.

 

If you want to pay taxes when you retire or reduce your taxable income now  because you think your tax rate will be lower, you should go with a traditional 401(k). If you want to pay taxes now because you think your tax rate will be higher when you retire, choose a Roth 401(k).

 

You’ll need to understand which 401(k) is the best for your needs to make the right decision for your retirement goals.

4. Not contributing enough

You’re likely missing out on opportunities to boost your savings if your contribution rate isn’t high enough. Higher contribution rates will let you compound and earn more from the investments in your 401(k) over time. The default rate of every contribution is 3%, and you should increase it in line with your salary increases.

 

“If a younger person could start at the 12% rate, they are certainly going to benefit tremendously from the benefit of compounding over time,” says Shannon Nutter-Wiersbitzky, head of participant strategy and development at Vanguard.

 

If you’re afraid of forgetting to increase your saving rate, opt for automatic annual increases. Some plans offer an option to automatically increase your contribution by 1% at a date of your choosing. These automatic increases typically stop at 10-15%.

5. Not maxing out your company match

When your employer offers their match to your 401(k), they simply give you “free money”. You shouldn’t just leave it on the table since it contributes a great portion to your savings and helps you meet your goals rapidly.

 

One typical match is the 50% match; it means your company will give you 50% of your contributions, limiting at the first 6%. If you put in 10% of your paycheck, and the company limits their contribution to 50% of the first 6%, you would still only get 3% matched. You should always aim to put in at least 6% to get all the “free money” your company offers.

 

Keep in mind that you’re not likely to get your matching funds until you’re vested in the account. You’ll still keep your own funds from your paycheck, but you’ll lose a huge amount of money currently making up your 401(k). Vesting can be immediate or may take several years; it’s not recommended to leave your company before vesting.

6. Not knowing the investments in your plan

Every 401(k) account contains some investments, and you’re in serious danger if you don’t know them. A plan with low diversification, high fees, and underperforming investments will leave less money in your account over time.

 

You should periodically see the available investment options and pay attention to the fees. Look for any funds that suit you better than your current ones in terms of fees, underlying investments, and rates. Avoid relying only on the company’s stock to lower the risk of your portfolio. You can consult a professional if you’re not sure about your decisions.

7. Not managing your 401(k) adequately

Don’t leave your 401(k) unmanaged until you retire. Lack of management will make you miss your 401(k) goals and vulnerable to negative situations. Here are three management aspects that you need to consider.

 

The first aspect is to allocate your assets (stocks, bonds, cash, etc.) in your 401(k) portfolio. Asset allocation means where you put your money to work in the market. This should be your first step before any investments since it gets you the highest payoff you can for the money you’re willing to risk. You should divide up your investments among your assets according to your goals, how much you want to risk, and how long you want to hold your investments at any point in time.

 

The second aspect is to rebalance your 401(k) portfolio. Over time, some of your assets may cause your original allocation to be distorted. You will need to rebalance the assets in your portfolio to return them to your desired allocation and suit your investing strategy. It is recommended to rebalance your portfolio quarterly.

 

The last aspect is to keep track of all your 401(k)s if you have many of them at several employers. You can keep your 401(k)s at your old companies if they have good investment options, low costs, or company stocks. Or you can roll over your old 401(k)s to your new employer or an IRA to simplify your financial life and achieve other benefits regarding fees, taxes, and investments. Learn your 401(k) rules, compare fees and expenses, and consider any potential tax impact to make a good decision.

8. Not reviewing your statement

Reviewing your statement may be tedious, but they provide a lot of necessary information that helps you determine if you are straying away from meeting your goals. You could miss out on your account performance, your total savings, interest earned, estimated retirement income, and more.

 

Make sure you review your statement quarterly and ask your plan administrator or a professional if you have any questions. Any significant recognition in your statement could save you from sabotaging your retirement in the future.

Conclusion

If you avoid these 8 mistakes, your retirement will be fully funded and protected from dangers. You’ll make better decisions, avoid the pitfalls, and feel confident in your financial life. And don’t worry if you’ve made any of these mistakes before because there’s still time for you to correct everything.

Good luck on your journey to retirement!