These 3 Painfully Obvious Mistakes Are 401(k) Killers | Smart Change: Personal Finances
Access to a 401(k) can be a boon for workers saving for retirement, but it’s important to remember that this account is just a tool. If you want to get the most out of it, you need to learn how it works so you can use it properly. Failing to understand your 401(k) — or any other retirement account for that matter — can lead to costly mistakes, like the three described below.
1. Skipping a 401(k) match
If possible, make your 401(k) claim your top priority. Try to contribute at least enough to the account to get your full match each year. If you don’t, you’re giving up a bonus that could be worth a few thousand dollars today and possibly tens of thousands or more by the time you’re ready to retire.
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Check with your company’s human resources department if you’re unsure if they offer matching or how their matching formula works. Most employers offer a match of $0.50 on the dollar or dollar for dollar up to a certain percentage of your income. This means that for every dollar you put into your 401(k), your employer will contribute $0.50 to $1.00 on your behalf until you reach the limit. In other words, you can enjoy an instant 50% to 100% return on a portion of your 401(k) contributions.
You should also find out about your 401(k) vesting schedule if you haven’t been in the business for a long time. This determines when you are eligible to keep funds from your employer if you leave the company. Ideally, you can hold out until you’re fully invested so you don’t lose any of your match.
2. Pay high investment fees
All investments charge fees, although not everyone realizes it, because the money comes directly from your 401(k) each year. There’s no way to completely avoid fees, but you can keep your costs down by choosing your investments carefully.
Most companies offer their employees a choice of various mutual funds, and these have expense ratios or annual fees expressed as a percentage of your assets. If you pay an expense ratio of 1%, that means you pay the mutual fund company 1% of all the money you invest in the fund each year. It’s only $1 if you have $100 invested in the fund. But if you have $100,000, you pay $1,000 a year.
You should try to stay within a 1% expense ratio whenever possible, but you may not always have a choice. You are limited to the investment options that your employer offers, and these are not always the most affordable.
If your employer doesn’t offer an investment option that’s right for you, you can talk to them and see if they’ll add other low-cost options like index funds, but they don’t have to.
Your other option is to skip your 401(k) altogether and invest in an IRA, which gives you more freedom to invest in whatever you want. But if you go this route, remember to maximize all corresponding 401(k) contributions first. You can then switch to your IRA and even switch back to your 401(k) if you max out your IRA for the year.
3. Take out a 401(k) loan
Borrowing from your 401(k) may not be as bad as an early withdrawal, but it’s still something you should avoid as much as possible. This will slow the growth of your savings, forcing you to save even more per month in the future in order to retire when you originally planned.
Explore other alternatives before withdrawing money from your 401(k). If you’re looking to buy a house or a car, consider a mortgage or car loan. You might also consider a personal loan to finance other types of purchases or to help pay off high-interest debt. Another option is to just wait and save what you need.
If you must borrow from your 401(k), try to withdraw as little as possible. Check with your plan administrator for the loan repayment deadline and be sure to pay everything back by then. If you don’t, the government will treat the unpaid balance as a distribution, and you’ll pay taxes on it, plus an early withdrawal penalty if you’re under 59 1/2.
When thinking about your 401(k), it’s crucial to have a long-term view. A decision like skipping a 401(k) match or taking out a loan might not seem like a big deal right now, but you’ll feel the consequences of those moves more decades from now than you do right now. Knowing more about your 401(k) and making decisions with your long-term goals in mind can make your 401(k) one of the best tools in your retirement arsenal.
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