3 Common 401(k) Mistakes to Avoid
, by Rob Kaufman
Although retirement might seem far away, it sneaks up on you. Before you know it, you'll be at the age where you start to wonder where your income will come from. Once you retire, how will you pay your bills? Will you be able to go on vacation? What about your medical bills?
To help secure your financial future, it's always best to start planning for retirement as early as possible. Saving money in your company's 401(k) is one of those ways. However, many people make mistakes when it comes to their 401(k) and might lose thousands of dollars because of them.
Let's look at the top 3 mistakes and talk about how to avoid them.
Not saving enough.
Let's start with the question, "When your company enrolled you in their 401(k), how much of your paycheck did they set up for contributions?" Was it 3%? 4%? 5%? As an FYI: those amounts are quite low.
Here's the second question, "If the starting amount contributed upon enrollment was in this low range, did you ever increase it?" If the answer is "no", it's time to reevaluate your strategy.
According to the investment firm Vanguard, the 2018 average rate of 401(k) contributions was 6.9%.1 This number is also very low and will most likely not create enough savings for you over your lifetime. The minimum contribution level should be 10% with a final goal of 15%. Remember, this increase doesn't have to happen all at once. Do it gradually... 1% increase this quarter... another 1% increase the next quarter until you reach your highest possible goal.
The difference in your net pay will be barely noticeable and when the time comes for retirement, you'll be happy to have made the change.
Just matching the match.
Many companies offer their employees a "match". That means, for example, if you contribute 4% to your 401(k), your employer will match that contribution. In this case, your contribution plus the match can allow you to increase your annual salary by an extra 4%.
The first thing to know is that if you don't contribute enough to get a match (based on the rules of your company's plan), it's like turning down a raise. So be sure to, at a minimum, meet the match.
Typically, companies put a cap on the match (usually around 6%). If possible, meet the capped match so that you can enjoy the benefits of having your company invest in your future. But don't stop there! If you can contribute more, do it. Remember, your goal is 10% to 15%. So even if you're not getting a match that high, it doesn't mean you shouldn't save as much as you can.
Borrowing from your 401(k)
Simply stated: if you want to take money out of your 401(k) to go on a vacation or buy a boat - don't do it. There are rules about paying back your 401(k) money and most of them work against you.
But what about emergencies? What happens if you lose your job or catastrophe hits and your 401(k) is the only option you have? If your employer lets you borrow from your 401(k), you may be able to take out a tax-free loan if you meet certain criteria. However, you must repay the loan within five years. If you just want to take out a small withdrawal, be advised that the withdrawal is subject to 20% withholding for taxes and a 10% penalty if you're under 59 ½. Now, if your plan allows for a "hardship distribution" (i.e. money needed for medical care, funeral expenses and payments to help prevent eviction from one's home), then the same penalties do not apply. Unfortunately, this type of distribution permanently lowers your balance.
Again, age often creeps up on us without us even realizing it. So, start planning for the future now and avoid these 401(k) mistakes to help make your financial future as secure and carefree as possible.
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