The more effort you put into building your retirement savings, the more you stand to gain in the long run. Your 401(k) plan can be truly instrumental in helping you meet your long-term goals, so be sure to steer clear of these mistakes that countless Americans make.
Continue Reading Below
1. Starting too late
Though it's estimated that close to 60% of workers have the option to participate in a 401(k), only 38% of the total workforce actually contributes to an employer-sponsored plan. If you've yet to fund your account, what you may not realize is that for every year you hold off, you lose out on major growth opportunities. Thanks to the power of compounding, your 401(k) can help you turn a series of relatively modest contributions into a rather impressive sum over time -- especially since you won't have to pay taxes on your investment gains along the way. But the longer you wait to start making regular contributions, the less likely you'll be to meet your retirement savings goals.
IMAGE SOURCE: GETTY IMAGES.
The following table illustrates this exact point by showing how much you stand to accumulate if you begin saving $300 per month at various ages:
TABLE AND CALCULATIONS BY AUTHOR.
While there's clearly a big difference between kicking off your savings efforts at age 25 versus 50, notice the impact of starting at 25 versus 30. Though we're only talking about contributing an extra $18,000 ($300 per month x 60 months) over the course of those five years, failing to save that amount will leave you with $312,000 less in retirement income. You're better off making consistent contributions as early as possible in your career -- even if that means giving up a portion of your first paycheck. The sooner you start, the better positioned for retirement you'll be.
2. Passing up an employer match
Most people aren't too quick to turn down free money, but if you don't contribute enough to capitalize on whatever 401(k) matching incentive your employer offers, you'll be doing just that. It's estimated that 92% of companies offering a 401(k) are also willing to match employee contributions to a certain degree, yet 25% of workers don't put in enough of their own money to take advantage of this perk. As a result, workers leave a good $24 billion on the table each year.
What does that mean for the average saver? Though each company is different, data tells us that the typical 401(k) plan participant who doesn't kick in enough to get that match will lose out on $1,336 per year. Over the course of 30 years, that's $40,000 in lost income without accounting for investment growth. Apply the average annual 8% return we used in our table above (which is a realistic assumption for a stock-heavy portfolio), and passing up $1,336 a year actually means losing out on a whopping $151,000 in three decades' time. Ouch.
While you may not be in a position to max out the current annual 401(k) contribution limits -- $18,000 a year for workers under 50 and $24,000 a year for those 50 and over -- at the very least, make sure to put in enough to get your full employer match. Otherwise, you're just kissing free money goodbye.
3. Taking early withdrawals
If you need money and have nowhere to turn but your 401(k), you'll probably be tempted to tap your account early to tide yourself over, but you should know that doing so could be a major mistake. Though there are a few rare exceptions, generally speaking, any time you withdraw money from a 401(k) before reaching age 59 1/2, you'll be subject to a 10% early withdrawal penalty on top of the income taxes your distributions will trigger at any age. And because 401(k) withdrawals are taxed as ordinary income, you could lose a serious chunk of your distribution to the IRS alone.
As an example, say your effective tax rate is 25% and you withdraw $10,000 before turning 59 1/2. Not only will you lose $2,500 to taxes, but you'll lose an additional $1,000, or 10%, for taking that early distribution.
Troublesome as that may be, there's another equally disturbing consequence to taking early withdrawals -- not only will you be reducing your nest egg but you'll be limiting its ability to grow. Say you take a $10,000 withdrawal at age 30 because you feel you need the money and wind up retiring at 65. You're not just shorting yourself $10,000 for retirement; rather, your ending account balance will be $148,000 lower due to all of the compounded growth you'll have lost out on. Once again, this number assumes an 8% average yearly return on investment, but even if your portfolio doesn't perform quite as well, you should be aware that cashing out any amount early will mean losing out on an even greater sum in the long run.
Now if you're truly desperate for cash and out of options, withdrawing funds from your 401(k) is generally a better move than racking up high-interest debt. But unless it's a true emergency, you're far better off leaving that money alone until you actually retire.
Holding off on contributing to a 401(k), passing up employer matching dollars, and withdrawing funds early are all good ways to derail your retirement savings efforts. If you're among the millions of Americans who are lucky enough to have access to a 401(k), be sure to avoid these ill-advised moves at all costs. Otherwise, you could end up putting your retirement at risk.
The $16,122 Social Security bonus most retirees completely overlook If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $16,122 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after.Simply click here to discover how to learn more about these strategies.
The Motley Fool has a disclosure policy.