401(k)s are one of the most popular types of retirement accounts, but despite their widespread usage, people still make a lot of mistakes with them. You may not realize you're making some of them and others may not seem like a big deal at the time, but this is your life savings you're talking about. It's not something you can afford to take chances with. You owe it to yourself to avoid the following five mistakes.
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1. You're not contributing to it
Your 401(k) is an opportunity to invest your savings so that it grows more quickly. The greater your investment earnings, which depend on your rate of return and how long the money has been in your account, the less of your own funds you have to contribute to retirement. Ignoring your 401(k), even if it's only for a few months, makes your job harder because now there's less time between you and your retirement and your investments have less time to grow.
You're also missing out on a valuable tax break by not contributing to your 401(k). Most 401(k)s are tax-deferred so any contributions you make reduce your taxable income for the year. This could push you into a lower tax bracket where you'll lose less of your money to the government. Roth 401(k)s don't give you a tax break this year, but after you pay taxes on your initial contributions, the money grows tax-free, so there's still a tax benefit to stashing your savings here instead of in a savings account or taxable brokerage account.
2. You're paying too much in fees
Every 401(k) charges fees, but most people don't realize it because the money comes directly out of their account without them ever receiving a bill. Some services, like account rollovers, may have a flat fee, but often, fees are a percentage of your assets. Your investments might have their own fees, like the expense ratios on mutual funds, and then there's your plan's administrative fees, which cover things like record keeping. Typically, larger companies are able to offer more affordable 401(k)s to their employees than smaller companies because they have more employees to divide these administrative costs among.
Try not to pay more than 1% of your assets in fees each year as this could hamper the growth of your savings. Check your prospectus or ask your plan administrator if you're not sure what you're currently paying. Consider asking your employer to offer more affordable investment choices if all its existing options charge high fees.
3. You're not getting your full employer match
Unless you need your whole paycheck to cover your living expenses, you should be contributing at least as much to your 401(k) as necessary to get your full employer match. Every dollar your employer gives you for your retirement is one less dollar that you have to contribute yourself. By skipping it, you're just making the job harder on yourself and missing out on an opportunity to get a little extra compensation for the work you do.
4. You leave your company before you're fully vested in the 401(k) plan
You can't talk about 401(k) matches without talking about vesting schedules. This determines when employer-matched funds are yours to keep if you decide to leave the company. Some companies offer immediate vesting while others offer cliff or graded vesting. Cliff vesting is where you don't get any of your employer-matched funds if you leave the company before you've worked for them for a certain number of years. This cannot be more than three years, according to federal law.
Graded vesting is where your company funds are released to you gradually over time. For example, you might get to keep 25% of your employer-matched funds if you leave the company after one year, 50% after two years, and so on. Graded vesting schedules cannot exceed six years.
You don't have to worry about vesting schedules if you plan to stay with your company for several years or if you've been with them that long already, but if you don't see it as a long-term position for you, understand how leaving early might impact your retirement savings. You might need to save more on your own if you forfeit of your employer-matched funds. Ask your plan administrator if you're not sure what your company's vesting schedule looks like.
5. You make an early withdrawal
401(k)s allow early withdrawals and sometimes loans from the plan, but you should avoid them at all costs. When you take money out of your 401(k), you're slowing its growth and forcing yourself to save even more in the future to compensate.
If you're struggling financially due to COVID-19, you may not have any other options besides withdrawing money from your retirement account right now. It's not ideal, but it's better than going into debt. If you must take money out, only withdraw as much as you need and create a new retirement plan when you begin saving again to keep yourself on track.
Normally, 401(k) loans are a better choice because you can avoid paying taxes on your withdrawals by paying back your loan amount plus interest. That's still an option, but the CARES Act waived the 10% early withdrawal penalty for 401(k) withdrawals taken prior to age 59 1/2 this year and it gives you up to three years to pay taxes on what you withdrew. This could make early withdrawals more appealing for the time being.
A 401(k) is many people's primary retirement savings account, so make sure you're getting the most out of yours and avoid these common mistakes that could make your life harder over the long term.