NEW YORK (MainStreet) Missing out on an employer 401(k) opportunity is the most obvious retirement savings mistake a worker could make. 401(k)s are an employee-sponsored savings vehicle. Contributions are made directly from someone's paycheck and, depending on the account type, are either taxed immediately or tax deferred.
While increasingly popular, 401(k) plans are not entirely foolproof. Here are seven common mistakes that people make with their 401(k) plans:
1.) Putting too much in your 401(k).
Yes, you can in fact put too much in your 401(k). Many people will pour as much money as they can into their 401(k) plan. But that's not always the best idea. 401(k)s may have expensive funds that will diminish your returns every single year. And even the tax breaks that accompany them may not be in your best interest in the long run. Tax rates are currently at historic lows and are likely to go up in the future. So, you might be taxed at a higher rate in retirement than you would be if you paid the income tax now.
To solve both of these problems, contribute enough to your 401(k) to take advantage of the employer match and then switch to traditional IRA and Roth IRA contributions. Once you max out an IRA, then decide whether it's best to contribute more to your 401(k) or a taxable account.
2.) Not making the proper spending decisions.
While putting too much money into a 401(k) can be detrimental, so is not being disciplined about contributing to your IRAs and taxable accounts. You need to deposit money into these accounts from each paycheck and increase your contribution amount every time you get a bonus or pay raise.
For those of you who know that you will spend every dollar that isn't automatically withheld from your paychecks, the company 401(k) is a much better savings vehicle for you because 401(k) contributions are taken out of each paycheck without fail.
3.) Not caring about saving properly.
The most fundamental mistake someone could make is to be apathetic about saving for retirement and not make the effort or sacrifices needed to put money away. For those who have experienced a financial shock or prolonged financial hardship, the idea of putting money into a savings vehicle may be laughable when they are faced with incoming or overdue bills.
However, neglecting good saving strategies breeds financial apathy. This could lead to problems later on.
4.) Not taking retirement account withdrawals until they become required.
Withdrawals from most traditional retirement accounts don't become required until after age 70.5. But sometimes it's best to withdraw some money from your tax deferred accounts before that age, even if you don't yet need it.
This is because for some people with large 401(k) balances, the required minimum distribution plus Social Security benefits might push them to a higher tax bracket. You can avoid this problem simply by withdrawing some money from your IRAs, penalty free, before the required age. Taking withdrawals early allows you to reduce your overall lifetime tax rate.
5.) Early withdrawal issues.
Conversely, withdrawing too early can also be problematic. It can be tempting to draw upon a well-fed 401(k) at times, particularly in these economic times. While withdrawals are sometimes necessary, early ones should be avoided if possible. Withdrawing funds from a 401(k) before the age of retirement can be met with a 10% penalty.
Funds withdrawn early from a 401(k) are also worth more inside of the account than they are outside of the account. Inside the 401(k), your money is invested and enjoying tax-deferred growth.
Make sure what you need the money for is absolutely essential and that there is no other reasonable way to finance the expenditure before you make the withdrawal. Also, before you do, look through the details of your plan to see if you qualify for any withdrawal benefits.
6.) Maintaining too many 401(k) accounts.
Not everyone moves their 401(k) account to an IRA or their new company's 401(k) plan when they change jobs. Consolidating your retirement accounts doesn't mean you will have more money upon retirement, but it is definitely a helpful step in simplifying your financial plan-allowing you to better manage your finances and make more informed decisions.
401(k)s try to offer incentives such as pre-tax contributions and tax-deferred growth, which can provide enormous value. If you neglect to feed your 401(k), then you will miss out on both any matched contributions and the tax-deferred growth, both of which are enormous value-adds over other savings vehicles.
7.) The importance of diversification.
This mistake comes in two parts:
- Diversifying each account instead of your overall portfolio.
- Not over-concentrating or investing in just one stock.
It's important to figure out an appropriate asset allocation for your investments. But you might not be taking advantage of how some tax rules work in your favor if you try to have the ideal mix of stocks and bonds in every single account. Instead, think of all your financial assets as one giant portfolio and divide them up accordingly, putting tax advantaged investments like stocks in taxable accounts while leaving the bonds in your retirement accounts.
Remember, a 401(k) account offers no special protection against carless investment decisions such as over-concentration in one stock area. A successful portfolio generally invests in a mix of large-cap stocks, small-cap stocks, foreign stocks, bonds, and other types of investments that shift over time.
--Written by Carlos Dias Jr. for MainStreet