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Are You Making These Mistakes with Your 401(k)?

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401kThe 401(k) is a financial took to help you save for retirement but just like any tool, it is only as efficient as the operator. How much do you really know about your 401(k)? If you’re like most, you were handed a packet from your employer and told to pick the funds based on the information found in the difficult to read prospectuses or you were told to check the box that would allocate your money how the company sees fit.

It’s not your fault. Employees are led to believe that throwing money at their 401(k) will ensure a suitable amount of money at retirement but that isn’t always true. These few tips may help you to make your 401(k) more efficient.

Don’t Overdo It

Like anything else, too much of any one thing is rarely a good idea and that’s true of your 401(k). It’s best to contribute the maximum amount up to the amount that your employee will match but not much more. 401(k)s are often full of high fee mutual fund choices that could severely degrade your available funds after decades of saving.

Instead, consider opening an IRA where you or a trusted financial professional have more choices of how that money will be put to work.

Don’t Think Micro

You’ve heard of diversifying but some people with numerous retirement accounts mistakenly believe that diversifying applies to each account. Instead, diversify all of your accounts as if they were one. Your IRA may hold your bonds which are usually tax at ordinary income tax rates and your brokerage account may hold stocks since you’ll probably hold them for a long period of time which triggers no tax until you sell.

Speaking of Multiple Accounts

If you have multiple retirement accounts from different employers, consolidation may be well advised. Not only is one or two accounts much easier to manage than multiple, small accounts, pooling the money may open up more options for how the money is invested. Consider consolidating multiple accounts in to one IRA. There are no tax penalties providing all of the money goes directly to your new IRA.

Waiting too Long to Get Paid

It may seem like a long way off right now but once you reach 70 ½ you have to start taking money from your 401(k). Depending on the size of your balance, you may end up in a higher tax bracket if you take a large amount from your 401(k) along with other sources of income like social security. Start taking money from your 401(k) as early as 59 ½ to avoid the tax consequences. A trusted financial planner can help you decide when to start taking distributions to avoid the tax penalties.

Not Staying Disciplined

If you’re young and haven’t seriously thought about retirement, the time is now. Contributing a small amount to your 401(k) today while receiving the company match will turn in to a lot of money once it has compounded for decades. Retirement will sneak up on you faster than you think.

Get Help

Retirement planning is complicated and you only have one chance to save for your later years. This is one time where the do-it-yourself investor should get help from a financial planner. While it’s true that there are some planners who give the field a bad name, there are many more who will help you to maximize your contributions and retire with security. Regardless of your age, now is the time to get on the right path.

(Photo: urban_data)

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9 Responses to “Are You Making These Mistakes with Your 401(k)?”

  1. matt says:

    Understand what you are trying to say with #1 but its not always true. I have great choices. The big oversight in that tip is forgetting to tell people to head back to their 401k after maxing an IRA. Up to the match plus IRA isn’t much unless your company matches at a high level.

    • Scott says:

      Agree with Matt here. There’s a limit to tax-advantaged IRA contributions so you have to go back to your 401k if you want to contribute beyond that limit.

  2. daenyll says:

    My company has no match, so I’ve got 6% to 401k and 6% to IRA, and once student loans are paid off I’ll reevaluate

  3. Keith says:

    My company has no 401(k) match but does contribute 5% of my salary to a pension plan if I am employed at the company through December 31.

    I still max out my 401(k) simply because it lowers my taxable income. My wife and I carry no other debt (house is paid off and credit card bills are paid in full each month), so this helps a bit.

    I don’t see myself staying with the company until retirement (20+ years), so I will rollover my 401(k) to an IRA when that time comes.

  4. Evan says:

    Why would waiting beyond 59 1/2 to take money out be a 401(k) Mistake? It is still growing tax deferred at that point and it is likely you’ll still be working full time thus taxing every dollar coming out at your highest marginal rate.

  5. yourPFpro says:

    Generally, I recommend 401k contribution to the employer match, Roth IRA contribution, then back to the 401k. This allows you to diversify from a tax perspective, which I think is often overlooked.

    For younger investors, I think the rate of savings is much more important than the funds you are invested in.

    • Texas Wahoo says:

      More and more employers are offering Roth 401ks, so the tax diversification is less of a determinant in that case (as you could just as easily invest in the Roth 401k and a Traditional IRA).

  6. timparker says:

    Thanks for the thoughts. First, a 401(k), by it’s nature, has less choices and at least some of them are likely to be inefficient. There are numerous studies that show the inefficiency of these vehicles. 87.3% of the average of 18 funds in a program are actively managed meaning high fees.

    The best part of a 401(k) is the employee match but in some cases, the company is getting a percentage of that money back from the firm brokering the 401(k)

    Next, let’s not forget that contributing up to the employee match and then $5,000 in to the IRA shouldn’t leave much left. The average 401(k) match is $3,000 making the total amount $8,000 or 16% of the median American salary. That isn’t happening in the majority of cases and if the stats are true about the amount of credit card, any extra should go to that depending on the person’s age.

  7. Vic says:

    Other caveat is that many use their 401K as trading accounts.

    Vic


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