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A 401(k) can be a great way to save for retirement, but a few wrong decisions can derail your progress. Not planning or lacking awareness of key fundamental aspects of your 401(k) can cost you, causing you to work longer to afford the retirement you’ve envisioned or to downsize your retirement dreams. Fortunately, it only takes a little planning to avoid the worst 401(k) mistakes.
Here are the biggest mistakes you can make with your 401(k) and how to avoid them.
1. Not making saving a habit
Not contributing enough, not contributing consistently and not increasing contributions over time in line with your salary increases – they’re all going to bite you at retirement time. You can save as much as $22,500 in your 401(k) in 2023 ($23,000 in 2024) and then compound it over time. And those age 50 and older can put away an additional $7,500, really helping to juice the compounding.
It’s easy to set up your 401(k) and have contributions withdrawn from your paycheck, so you don’t even need to think about it again. Plus, some plans allow you to make automatic annual increases.
Many plans offer an automatic option that increases your contribution by 1 percent annually at a date of your choosing. Some people select the effective date of their salary increase, meaning they contribute a higher proportion of a higher salary. These automatic increases are typically capped once they reach 10 percent, though some plans may allow them to go up to 15 percent.
If you’re between jobs and can’t make contributions to a 401(k), consider saving in an IRA.
2. Not knowing what you’re invested in
You’re making a gigantic mistake if you’re not aware of what your contributions are invested in, the fees you’re being charged or the performance of your investment funds.
Many employees accept the default investment option, typically a target-date fund – based on their projected retirement age – when signing up for a 401(k), and never think anymore about it.
That’s a mistake, and it’s important that you periodically look at the investment options in your 401(k) plan, with a specific focus on fees. Most 401(k) fees are borne by the plan participants, and those high fees leave less in your account to compound over time.
Your 401(k) plan is required to send you an annual fee disclosure statement. Pay attention to it, and if your 401(k) fees are high, consider investing just enough to qualify for your employer match while saving other funds in an IRA with the opportunity to invest in low-fee funds.
3. Not getting your full employer match
Many employers provide matching funds if you contribute to your 401(k), giving you extra incentive to save. For example, an employer may offer 50 percent matching on your contributions up to 6 percent, meaning that you’ll receive as much as 3 percent of your salary as an employer match. The match is subject to a vesting period that could last several years.
Not contributing enough to qualify for your company’s match means you are leaving free money on the table, and experts routinely advise workers to max out the free money in their 401(k). Taking full advantage of an employer match helps you compound your money that much faster.
4. Changing jobs before becoming vested in your 401(k)
While your employer may match funds in your 401(k) account, you’re not eligible to keep that money until you are vested. Vesting can be immediate or may take several years, and if you leave your current employer before your matching funds vest, then you’ll lose them. Of course, you’ll be able to keep any funds that you contributed from your paycheck.
So be sure to check your company’s policy before making a decision to leave. It would be a shame to unknowingly walk away from your employers’ contributions and any associated investment growth.
5. Not knowing the difference between 401(k) account types
Workers typically have two options when it comes to account types – the traditional 401(k) and the Roth 401(k) – and the differences are significant when it comes time to plan your retirement.
In a traditional 401(k), your contributions are made before tax, meaning you won’t pay tax on money going into your account. But when you withdraw the money in retirement, you’ll be taxed.
Depending on your tax bracket, the tax savings for pre-tax 401(k) contributions could be huge.
In contrast, contributions to a Roth 401(k) are taxed at the time they are made, but you can withdraw those funds in retirement tax-free, meaning you keep all the accumulated growth.
You’ll need to understand which is the best for your needs and financial goals.
6. Taking an early withdrawal from your 401(k)
One of the most ruinous things you can do for your retirement is raiding your piggy bank, whether that means cashing it out or taking a loan or hardship withdrawal.
Cashing out your 401(k) plan before age 59½ means the withdrawal will typically be subject to a 10 percent penalty, on top of the income tax owed on the distribution. And while many plans allow hardship withdrawals or loans, there may be a fee associated with these options. If not, at a minimum, you’ll miss out on any investment gains your money would have earned.
7. Checking your balance every day
One of the surest ways to derail your investment returns is to check your account too frequently. Checking your account daily or even weekly may make you feel anxious that your balance isn’t growing – or worse – is shrinking. This practice could cause you to stray from your plan by reducing your contribution or stopping it altogether.
Instead, stay the course with your long-term investing plan and invest with that mentality.
8. Investing too heavily in company stock
Your financial livelihood is already tied up with your employer since you earn a paycheck there. But if you invest heavily in your own company’s stock, you may not be diversified enough and end up relying much too much on a single company financially. When it comes to funding your golden years, you don’t want to leave anything to chance.
How much is too much? The Financial Industry Regulatory Authority (FINRA), the finance industry’s self-regulating body, recommends not holding more than 10 to 20 percent of your 401(k) in your own company’s stock.
FINRA warns of the dangers of under-diversification and also notes that some companies limit your ability to buy and sell the stock. FINRA says: “Employer-matched stock, in particular, often comes with restrictions. Some companies require employees to hold the stock until they reach a certain age, or until a specified date.”
9. Failing to rollover old 401(k) accounts
Changing jobs is a regular part of many people’s careers, but it can lead to one of the biggest 401(k) mistakes if not handled properly – failing to rollover old 401(k) accounts. When you switch employers, it’s critical to have a plan for your existing 401(k) account.
You might opt to leave it where it is, roll it into your new employer’s 401(k) plan, or roll it into an IRA. Neglecting to take one of these steps can lead to several negative consequences. For instance, leaving your account with a previous employer, especially if it’s a small one, might require a move or risk a forced cash-out, which could lead to tax implications and penalties. Furthermore, if you have accounts scattered across various past employers, it can become challenging to keep track of funds and maintain a unified investment approach.
Avoiding these 401(k) pitfalls is possible if you educate yourself and take steps to actively participate in your retirement planning. Fortunately, it doesn’t take a lot of time to learn what you need to know, and the sponsor of your 401(k) plan may have resources, including advisors, to help you understand the key points of your plan.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.