Stashing away money in a tax-advantaged retirement account is a must if you want to be financially secure in your golden years.
One of the easiest ways to grow your nest egg is to regularly chip in money to your employer’s 401(k) plan and if there’s a company match, you’ll see your savings add up even faster.
Enrollment is usually pretty straightforward and contributions are automatic but it’s important that you’re actively managing your retirement account. The better you understand how your 401(k) works, the easier it is to avoid these potentially costly mistakes.
1. Thinking the minimum is enough
One of the biggest errors people tend to make with their 401(k) retirement account is underestimating the amount they should be contributing. They assume that all they need to save is enough to qualify for the company match, which is usually anywhere from 3 to 6%.
According to a January 2014 survey from TIAA-CREF, 44% of Americans are saving 10% or less of their annual income toward retirement each year.
The problem is that by limiting yourself to the default contribution level, you’re shortchanging your savings in the long run. Putting in just enough money to take advantage of your employer’s match should be your starting point, not the finish line.
While it might not be feasible to sock away 15% of your pay right now, you can work your way up by increasing your contributions a percentage point or two each year.
2. Not understanding retirement account fees
Like any other investment vehicle, there are certain fees that go along with maintaining a 401(k) retirement account but most people are unaware of what costs are actually involved.
In 2012, the Department of Labor instituted regulations that required greater transparency for retirement plan fees but a 2013 survey from the Employee Benefit Research Institute found that only 53% of plan participants took notice of fee disclosure. Even more dismaying is the fact that less than 10% made any changes to their enrollment as a result.
If it has been awhile since you reviewed your retirement account statement, now’s the time to dig it out. You’ll see a lot of numbers but the most important one to start with is the expense ratio, which represents the amount of fees paid annually as a percentage of your assets.
The lower the number, the better, and anything over 1.5% is generally considered excessive. It may not seem like much but that’s $1,500 for every $100,000 you have saved, which can add up to a lot of money over the course of your working years.
3. One-size-fits-all approach
Reading over a stack of prospectuses is enough to make your head swim and what sometimes happens is that employees pick a target date fund because it seems like the easiest option.
These funds are designed to automatically adjust your asset allocation as you get closer to retirement and they take a lot of the guesswork out of picking investments, which is definitely a plus for newbies.
The downside with a target date or age-based fund is that they’re not tailored to your specific needs or your individual risk comfort level. Some may take a more aggressive approach while others may be more conservative in their asset allocation. That means you could end up taking on more risk than you’d like or potentially missing out on bigger returns. While it may be a little more time-consuming, it’s worth it to review all of your 401(k) retirement account investment options to determine which ones are most closely aligned with your goals.
4. Cashing out retirement account too soon
If you’ve decided to change jobs, you may think it’s no big deal to just cash out your 401(k), especially if your balance is relatively small. This is a bad move for a couple of reasons.
First, if you don’t roll the money over into another qualified retirement plan, you’ll end up having to pay taxes on the distribution, as well as a 10% early withdrawal penalty if you’re under age 59 1/2.
The other issue is that you may be losing out on even more money if you leave your employer before the money in your retirement account is fully vested.
A Fidelity analysis completed on behalf of CNNMoney found that a quarter of workers who changed jobs last year lost out on unvested benefits, averaging just over $1,700 in unrealized savings. While that’s not a huge amount of money, you may be diminishing your nest egg by several thousand dollars if you’re switching employers every few years.
5. Not enrolling at all
Although many employers set up their plans to allow for automatic enrollment, others still require employees to enroll manually.
If the latter applies to you, you’re not doing yourself any favors by waiting to sign up. The longer you defer making contributions, the less time your money has to grow and the more free cash you’re missing out on by not getting the employer match.
Even if you’re getting relatively close to retirement age, it’s still not too late. Once you hit age 50, you can kick in an additional catch-up contribution on top of what you’re already putting in.
For 2014, older workers could save an additional $5,500 on top of the $17,500 maximum contribution limit to their 401(k) retirement account. That extra money can make a substantial difference in your bottom line when it’s time to start making withdrawals.
