How You Can Avoid Common 401k Mistakes
Here are eight common 401k mistakes to watch out for
With traditional pensions on the decline, the responsibility of funding your retirement now rests more heavily on individual savings. Majority of employees now have access to a 401(k) or 403(b). These accounts offer the potential to reduce your current taxable income while building your savings consistently.
But if you're like most people, you skimmed through your company's benefits documents, set your 401(k) to the default contribution amount, and probably bought a target date fund.
That’s not the end of the world, but here are eight common mistakes I see all the time with employer sponsored retirement accounts:
Not contributing enough to receive the company match:
I’ve talked about leaving free money on the table before. Yet I’m still surprised how many people do not take full advantage of their employer match or aren't contributing to a 401(k) at all. Had a guy tell me this week, “I’m probably going to pass on the 401k match at this point.”
Your 401k is not the end all be all. But contributing enough to receive an employer match is a no brainer.
Never Increase Contributions:
When was the last time you increased your retirement contributions? Many plans allow you to set up automatic contribution increases annually. A 1% annual increase may not seem like much, but this strategy can significantly transform your retirement savings over the long haul:
Too Conservative with the Investments:
Become comfortable taking risk in long-term retirement accounts. While not everyone has the stomach to be invested in 100% stocks, your 401(k) is the ultimate set-it-and-forget-it account. With time on your side, taking on more risk can lead to greater rewards in retirement. Quit being so conservative…
Maxing out 401k too early in the year:
If you are able to max out your employer sponsored retirement plan, congratulations. Just make sure you aren’t maxing this out early in the year. Why? You may be missing out on employer match money:
Here is a good example (I updated #’s to be applicable to 2024):
Let's say that you get paid every two weeks, or 26 times per year. The contribution limit for 401(k)’s in 2024 is $23,000 for those under 50.
So, if you wanted to max out your contributions over the entire year, you’ll contribute $884 per pay period ($23,000 / 26 = ~$884).
We’ll also say that your employer makes a dollar-for-dollar 4% matching contribution to your 401(k) and that you earn $100,000 per year (to make it easier to follow). With this info we know that your employer is contributing nearly $154 per pay period on your behalf ($100,000 x 4% = $4,000 and $4,000 / 26 pay periods = $154).
Therefore, you’re able to capture the entire $4,000 employer match over the course of the year meaning the total contribution to your 401(k) would be $27,000 ($23,000 + $4,000).
However, if you were to contribute $1,768 per check you will essentially max out your contributions for the year after only 13 pay periods.
Under certain plan documents, this will cost you money.
In this case, your employer will still match your contributions, but at the same rate as they did in the previous example, or $154 per check throughout the year. Once you’ve maxed out your contributions, the employer matching contributions stop, too. You’ll only receive about $2,000 and forfeit the other $2,000.
This can be plan specific but you want to understand how your company matches your contributions and if they do a “true-up” at the end of the year.
Missing Out on Roth 401k Option:
Most employer retirement plans now offer a Roth 401k option. Yes, you don’t get any immediate tax deductions as you are contributing after-tax dollars. But even if you are contributing 1-2% annually into a Roth 401k, that adds up over time and creates a bucket of tax-free income in retirement.
Over 50? Take Advantage of Catch-Up Contributions:
Feel like you are behind? Then take advantage of catch-up contributions starting in the year you turn 50 years old. For 2024, you can contribute an additional $7,500 into your plan above the $23,000 standard limit.
Review Beneficiaries:
Have you put beneficiaries on your retirement accounts? If you already have, when was the last time you reviewed them? I don’t care if you are young and healthy. You never know what can happen. Don’t let this be you:
Read full story here.
Don’t Cash In Your Accounts:
You may be tempted to cash in your 401k account when leaving an employer. If this account is 100% pre-tax, the entire account balance will be considered ordinary income for that year. Not to mention if you are under 59 1/2 you will most likely be hit with a 10% penalty as well…
Do a rollover, not a cash distribution…
By avoiding these mistakes, you can better ensure your 401(k) helps you achieve your retirement goals.
Reach out to me if I can help review your retirement plan.
Disclosure: This material is for general information only and is not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.
All indices are unmanaged and may not be invested into directly.
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1Must have a high-deductible health insurance plan that is eligible to be paired with an HSA. Those taking Social Security benefits age 65 or older and those who are on Medicare are ineligible. Tax penalties apply for non-qualified distributions prior to age 65; consult IRS Publication 502 or your tax professional.
2This assumes that a diversified portfolio may earn 7.0% over the long term. Actual returns may be higher or lower. Generally, consider making additional payments on loans with a higher interest rate than your long-term expected investment return.
3Income limits may apply for IRAs. If ineligible for these, consider a non-deductible IRA or an after-tax 401(k) contribution. Individual situations will vary; consult your tax professional. Source: J.P. Morgan Asset Management analysis. Not intended to be a personal financial plan.