If your employer offers a 401(k) plan, you probably already know that you should be contributing to it. But while having a few dollars transferred from each paycheck to your retirement fund is better than nothing, it's not enough -- and you're missing out on key benefits that could help you save thousands more by the time you retire.
And if you're behind on your savings, you're not the only one. The average amount employees in their 60s have stashed away in their retirement fund is just over $170,000. While that may sound like a lot of money, it will likely only cover a few years -- especially if you have a more expensive lifestyle.
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Fortunately, there are a few easy ways to increase your savings. And you can start by recognizing some of the most common mistakes that are holding your 401(k) back.
1. Not contributing enough to earn the full employer match
If you're already contributing to your 401(k), that's a great start. But if you're not contributing enough to earn your full employer match, you're leaving money on the table.
Contributing a little bit extra to earn that full employer match can dramatically boost your savings by the time you retire. For example, say you're earning $50,000 per year, and your employer will match 100% of what you contribute up to 3% of your salary.
If you're only contributing 1% of your salary, that amounts to $500 per year (or $1,000 once you include your employer's matching contributions). Assume you continue contributing $500 per year (and continue earning another $500 from your employer). If you're earning a 7% annual return on your investments, after 20 years, you'll have close to $44,000 saved.
If, instead of contributing 1% of your salary, you're contributing the full 3% that your employer will match, that's $1,500 per year -- or $3,000 with your employer's matching contributions -- and you'll end up with about $131,500 after 20 years. So by saving an extra $1,000 per year on your end, you can end up with nearly $100,000 more in your retirement account.
2. Forgetting to update your contribution percentage
When setting up your 401(k) for the first time, you can choose how much you want to be deducted from your paycheck and transferred to your retirement fund. The problem is that many people set their percentage and then completely forget about it.
If, however, you get a raise, get married, or experience another event that impacts your finances, you may need to adjust your contribution percentage accordingly. So if you're still only contributing 1% or 2% of your salary when you could afford to save more, you could potentially be losing money. Even if you're already maxing out your employer contributions, saving just an extra 1% without the employer match can significantly impact your long-term savings.
Say you're earning $50,000 per year and are already contributing 3% to receive the full employer match. If you raise your percentage to 4%, adding an additional $500 per year, your total contributions will be $3,500 per year. After 20 years, you'll have saved just over $153,000 -- or about $20,000 more than if you had contributed just 3% of your salary.
3. Not understanding how much you're paying in fees
Over 92% of Americans don't know just how much they're paying in 401(k) fees, and those fees can cost you tens (or hundreds) of thousands of dollars over the course of a lifetime.
There are several different types of fees you can incur. There's the expense ratio, which covers basic operating expenses, but then there are also trading fees and potential shareholder fees, as well as other plan-specific fees that vary based on your individual 401(k) plan.
Even if each of these fees is minuscule at only a fraction of a percent, when combined, they add up quickly. And when you consider the fact that you'll (hopefully) have invested hundreds of thousands of dollars by the time you retire, even paying 2% in fees can cost you thousands.
To figure out how much you're paying in fees, your best bet is to talk to your plan administrator. You can also dig through your plan's prospectus, or the document that outlines all the specific details of where your money is going. Note, though, that this document is typically lengthy and difficult to read -- and you may end up more confused than you were when you began.
For equity mutual funds, the average expense ratio is about 1.31%, according to an Investment Company Institute study, and most 401(k) participants in the study only had to pay about half those fees, with employers covering the remainder. Discuss with your plan administrator what fees you're responsible for and whether your employer covers any of them; if the costs are too high and outweigh the benefits, it may be time to shift your investments somewhere less expensive.
Your 401(k) is a powerful investment tool -- but only if you use it to your advantage. By making the most of your 401(k), tiny adjustments can lead to monumental gains in the long run.
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