If You Want Your 401K to Grow, Stop Doing These 6 Things
Are you counting on your 401(k) to fund your dream retirement? If so, make sure you're not making the following common mistakes. By avoiding these pitfalls, you'll ensure that you end up with the most money possible. (See also: Optimize Your IRA and Your 401(k))
Stick to the Default Contribution Percentage
If your employer automatically enrolls you in your 401(k), that's a great thing. More employees usually end up participating in the plan than if they had to sign up on their own. Sticking to the default contribution rate, however, is not that good. The average default contribution rate for plans with automatic enrollment is just 3.4%.
There are two reasons why this won't help your 401(k) grow.
1. Too Low to Earn the Full Employer Match
This may not be the amount that'll get you the full matching contribution from your employer. On average, most workers would need to contribute an average of 5.1% of pay to get the full match their employers are offering. The employer match is extra money your employer will give you for free, as long as you contribute your own money first. Since you're entitled to this money as part of your compensation package, it wouldn't be wise to pass it up.
2. Falls Short of the Contribution Limit
This may not be the amount that'll get you contributing up to the full IRS contribution limit. The contribution limit is the most amount of money you can invest in a single year. And the more money you put in now, the more money you'll have later. In 2014, you can contribute a maximum of $17,500. If you're age 50 or over, this amount increases to $23,000.
In order to contribute at the 3% rate and still reach the maximum of $17,500, you'd need to be making about $590,000 per year. So if your salary is less than that, find ways to contribute more than 3%. Because the more money you invest now, the more you'll have later.
Stick to the Default Fund Choice
If your employer automatically enrolls you in your 401(k), they may also choose the fund you're invested in. Sometimes, this isn't the best choice.
Check to see if the default fund is either a money market or stable value fund. If it is, you may want to switch to another fund. These funds aren't designed to really grow your money. Instead, their purpose — as their name suggests — is simply to keep the value of your money stable.
Better investment choices include stock and bond index funds. For more help on choosing the best fund, check out The Bogleheads' Guide to Investing.
Put Too Much Money in Your Company's Stock
Professionals recommend no more than 5% to 10% in a company's stock. And there's a good reason why.
Remember what happened to Enron? Employees who put most of their retirement funds in their company stock not only lost their jobs — they also lost their retirement money.
Rather than investing most of your money in your company's stock, it's better to ensure that your money is properly diversified.
Borrow From Your 401(k)
The main reason not to do this is because if you take out a loan from your 401(k), then that money is no longer working towards your retirement needs. In other words, you lose the power of compounding.
Also, if you leave your job, you'll generally be required to repay the loan balance within 60 days. If you don't, the unpaid balance is considered as defaulted. This means you'll need to pay a 10% penalty on top of owing income taxes on the defaulted amount if you are not at least age 59 ½. (See also: This Is When You Should Borrow From Your Retirement Account)
Cash Out If You Leave Your Job
By cashing out, you not only get taxed and penalized, but similar to borrowing, you also lose the earnings that money could have generated.
Worst of all, you probably won't even get all of your money: If you haven't reached age 59 ½, your employer is required to withhold 20% for the IRS. On top of that, you'll need to pay a 10% early withdrawal penalty.
So for every $1,000 you cash out, you would only receive about $700. The other $300 would go to the IRS.
Settle for High Fees
Most employees don't realize it, but there are costs associated with investing in your 401(k).
These include fees to pay brokers, accountants, administrators, and fund managers just to name a few.
How much can all of this add up to?
In Fight For Your Money, David Bach found that when you add in these fees and hidden charges, the average 401(k) plan actually costs employees between 3% and 3.5% of what they've got invested each year.
So what should you do?
Ask your company or 401(k) provider for a breakdown of the fees you're being charged. If they are much more than 3%, complain.
By ensuring that you don't make these mistakes, you'll increase your chances of building a nice, large nest egg for your retirement.
Are you making any of these 401(k) mistakes? Any others we should be aware of? Please share in comments!