College Grads: Avoid these 401(k) Mistakes at Your First Job

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RetireCollege graduation is rapidly approaching for many students. Soon, graduates will be starting new jobs, and learning about how to operate in the “real” world. They will be leaving internships and classes behind and trying to figure out how to navigate the pitfalls of the modern workplace.

Money decisions need to be made at this point, including what to do with the money that is being earned. One of the most important decisions is to decide to invest in a tax-advantaged retirement plan, like a 401(k).

If you want to outlive your money, it’s important to take advantage of youth and time. However, it can be daunting to handle the decisions that come with a 401(k). Kevin Gahagan, CFP, CIMA, and Principal of Mosaic Financial Partners, Inc. offers four mistakes that young professionals often make. If you want to make the most of your 401(k), avoid this pitfalls:

1. Not Participating

“This is probably one of the most common mistakes made,” Gahagan says. “While tight finances may make the idea of making plan contributions challenging, after accounting for federal and state tax rates and withholding, it probably costs around 80 cents from take home pay to save a dollar.”

This means that your money is more efficient. And it’s even better if there’s a match. “The benefit of participating is tremendously greater,” Gahagan continues. “Subject to the matching program, you get an immediate return of your investment of anywhere from 50 to 100 percent.”

2. Leaving Contributions in Cash

“Many plans have a ‘conservative’ default option that invests incoming contributions in a fixed income type of investment,” Gahagan points out. “For young participants, this type of default is too conservative.”

Instead of using the default option, consider other alternatives. With time on your side, you can better overcome market setbacks.

3. Failure to Invest in Stocks

“For those with a long investment horizon, stock investments should be a dominant component of a portfolio,” Gahagan says.

Stocks offer the potential for better returns during the building phase, and over time, stock market volatility tends to smooth out, creating a trend of gains in many cases. While there is still the chance of loss, over time, that diminishes.

4. Failure to Increase Contributions

Too many young professionals just set an automatic contribution to a retirement account and forget about it. This is a mistake. It’s a good idea to get started with whatever you can afford to contribute, but you need to remember to increase your contributions.

“Regardless of the rate that you begin your savings,” Gahagan says, “you have the ability to increase that contribution amount from year to year as you receive increases to your salary. Dedicating some portion of your salary increase to increasing your retirement plan contribution is the easiest way to increase your savings.”

Don’t Withdraw from Your Retirement Account

Another mistake that many young professionals make is using a retirement account as an emergency fund. While it might be easy to get a 401(k) loan, or take an early withdrawal, this can result in fees and penalties. And, even if you repay a loan with interest (to yourself) with no IRS penalties, you still can’t make up for the lost earnings due to the time your money wasn’t in the account.

With careful planning and consistent savings, you stand a greater chance of building a lasting nest egg.

(Photo: Philip Taylor)

{ 8 comments, please add your thoughts now! }

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8 Responses to “College Grads: Avoid these 401(k) Mistakes at Your First Job”

  1. JoeTaxpayer says:

    With all the talk of understanding the expenses within the account, I’d caution – Look closely at the fees involved. Much above .8% – 1.0% per year, and I’d be inclined to deposit only up to the match. Above that, just save in an IRA or post tax account.

    If you are starting life in the 15% bracket, consider the Roth 401(k) if offered. You’re likely to earn your way to the 25% over the years, and can flip to the standard pretax 401(k) then (a bit at a time, of course).

  2. Another mistake that recent grads make is doing more than the matching percent. For most recent grads, the smart money beyond that is in a Roth IRA, especially if they quickly start a family and have a house with a mortgage, because their income and tax bracket are lower than they will be again.

  3. admiral58 says:

    College grads should try to get at least the match and invest in a Roth 401k until they’re about 30 years old.

  4. It’s also important to look at what it would actually take to reach retirement goals. After they have started saving they should take some time so see what they would generate for them in retirement income and over time, like you mentioned, increase their contributions.

  5. I see so many parents who withdraw funds from their 401K to pay for their child’s college education. it makes me sad to see this, but it also makes me sad that these parents do not plan better as young adults, and young parents. Not to say that you must fund education for your child, but if you do choose to do so, please do not take away from your own retirement!

  6. Nice post Miranda. As both a financial planner and the father of a 2010 college grad working in her first job I couldn’t agree more. College grads and all younger workers have the greatest retirement savings asset of all, the gift of time. This is a gift that can never be replaced and one that shouldn’t be wasted.

  7. Great article. I usually suggest to my friends to invest up to the match, max your roth, then max 401k. I’ve been working on maxing my 401k now that my roth is maxed, and I do it by increasing my contribution half of my total salary increase every year. It’s worked ok so far. Great article!

  8. Kathryn says:

    Great advice, especially in today’s economy. If you leave your current employer and have a loan from your 401K outstanding and do not have enough money to pay it back or get conventional financing within short period of time (mine was 60 days) the balance becomes taxable distribution with an additional 10% penalty – it cost me nearly $2,000+ because I had to get a loan to pay the tax on time.

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