Here is 9 common 401k mistake that people make:
1) Not participating in your 401k - many people choose to either ignore this or don’t bother to read their company benefits. They don’t realize the benefits of contributing to a 401k.
Some of the 401k benefits are:
- 401k qualifies for tax deferral from federal and state tax.
- May lower your tax bracket, depending on your income and how much you contributed. (For 2014 you can contribute up to $17,500 and age 50 and above may contribute an additional $5,500).
- Automated savings your contribution will go straight to your funds before you even get your paycheck.
2) Pay attention to fees – All funds will charge you a certain amount of fees to manage the funds. It’s your responsibility to find out how much you are being charged. You can find the percentage they charge you in the prospectus of each funds. You don’t want to have your funds you choose paying outrageous fees to the fund manager Joneses lifestyle.
- The rule of thumb normally is to look for funds that charge you less than 1%.
- Recommend low cost index funds; they tend to charge less than 1% in fees.
3) Not contributing enough for 401k match – Most company matches up to 6%, but will vary between companies. This is free money you’re passing up. Read your company 401k policy and make sure you’re contributing enough to get the match. This is money that you will rely on for retirement, so do yourself a favor and contribute to your 401k up to the match or more if you can afford it, you will thank yourself later on.
4) Figuring out your asset allocation - Depending on what funds your company provides, I would recommend a target date fund if available, this is a set it and forget it plan for people who don’t like to pick different funds. That way it will follow a preset allocation and adjust accordingly to your age. If you want to try different funds than you need to figure out which asset class you would like and what’s your risk tolerance.
- Asset classes - Small Cap, Mid Cap, Large Cap, International, just naming a few there are more.
- Index funds or Non index.
- Stocks and Bond allocation (50/50, 60/40, 70/30…)
5) Not rebalancing – Most companies have a rebalancing option, to bring your stocks back into your original allocation you set. You should used this as your advantage and automate this unless you’re using (target date funds). Rebalancing will force you to sell high and buy low that way you’re not trying to time the market.
- Rebalance either semi-annually or annually.
6) Investing in too much company stock – Remember “ENRON”, the collapse of the company ruin many employee retirement nest egg and also lost their job. You rather not lose both your job and the value of your company stocks.
- Don’t hold more than 10% in your company stocks.
7) Picking high performance funds – Remember past performance does not dictate the future, so don’t try to pick a fund that has been doing well 1 year, you never know what it will do next year.
8) Withdrawing to early – This is definitely not a good option at all. Withdrawing before the age of 59-1/2 will result in taxable as ordinary income, also you get smack with an additional early withdrawal penalty fee of 10%.
- Lose potential future investment growth and tax benefits of 401k.
There is some exception the IRS will allow for early withdrawal, but you should consult with your tax professional.
9) Borrowing from 401k – Certain companies will allow a loan from your 401k, but come with limitation.
- You have to pay interest on your loan.
- You lose tax benefit.
- Loss of the power of compounding.
- Loss or termination of job will result in repaying the loan normally 30 - 90 days will vary between companies.
You should leave it alone and find other ways before you try to raid your 401k.
Remember to start early, save, and let the magic of compounding do its job.
Did you make any of these mistakes before?
Any tips you would like to add? Let me know.