Contributing to a 401(k) is one of the best ways to save for retirement. Not only does it offer tax benefits, but many employers match contributions, essentially offering free money toward your future. However, despite its advantages, many people make mistakes that can undermine the growth of their retirement savings. Here’s a look at some common 401(k) mistakes and how you can avoid them.
1. Not Contributing Enough to Get the Employer Match
One of the biggest mistakes you can make with your 401(k) is not taking full advantage of your employer’s matching contributions. Many companies offer a match, typically up to a certain percentage of your salary. If you’re not contributing enough to get the full match, you’re leaving free money on the table.
How to Avoid It:
Make sure you’re contributing at least enough to take full advantage of your employer’s match. For example, if your employer matches up to 5% of your salary, ensure that you’re contributing at least 5% to your 401(k). If you’re not sure what your employer offers, check with HR or your plan administrator.
2. Ignoring Your Asset Allocation
Your asset allocation — the mix of stocks, bonds, and other investments in your 401(k) — plays a critical role in how your retirement savings grow. A common mistake is either being too conservative (especially when you’re younger) or too aggressive as you approach retirement. Both approaches can reduce your potential returns or increase your risk unnecessarily.
How to Avoid It:
Choose a diversified mix of assets based on your age, risk tolerance, and retirement goals. As you get closer to retirement, gradually shift toward more conservative investments. If you’re unsure how to allocate your assets, consider using target-date funds, which automatically adjust the asset mix as you approach your target retirement date.
3. Cashing Out or Taking a Loan
Cashing out your 401(k) when you change jobs or taking a loan from your account can have serious financial consequences. Early withdrawals are often subject to taxes and a 10% penalty if you’re under 59½, and loans can leave you with less money compounding for retirement. If you fail to repay the loan, it could be considered a withdrawal, leading to taxes and penalties.
How to Avoid It:
When you change jobs, roll your 401(k) into your new employer’s plan or an IRA rather than cashing out. Avoid taking loans from your 401(k) unless it’s an absolute emergency. Remember, your 401(k) is meant for your retirement, not short-term financial needs.
4. Not Increasing Contributions Over Time
While starting with a small contribution is better than nothing, many people make the mistake of not increasing their contributions as their income grows. Over time, this can significantly reduce the growth of your retirement savings.
How to Avoid It:
Aim to increase your contributions every time you get a raise. Even small increases can have a big impact due to the power of compound interest. If possible, work toward contributing the maximum allowed by the IRS, which is $22,500 for 2024 (or $30,000 if you’re 50 or older).
5. Ignoring Fees
Many 401(k) plans come with fees, including management fees and administrative costs. High fees can eat into your investment returns over time, reducing the amount you’ll have saved for retirement.
How to Avoid It:
Review your plan’s fee structure and understand what you’re paying for. If your plan has high fees, consider speaking with your HR department about lower-cost investment options. In some cases, you might be able to invest in low-cost index funds or exchange-traded funds (ETFs) that carry lower fees.
6. Not Rebalancing Your Portfolio
Over time, the performance of your investments will cause your asset allocation to shift. For example, if stocks perform well, your portfolio may become too heavily weighted toward equities, increasing your risk. If you don’t rebalance, you might end up with a portfolio that no longer fits your goals.
How to Avoid It:
Regularly review and rebalance your portfolio to maintain your desired asset allocation. Many 401(k) plans offer automatic rebalancing options that adjust your investments to the correct proportions on a set schedule.
7. Delaying Contributions
Some individuals delay starting their 401(k) contributions, thinking they’ll catch up later. This is a critical mistake, as the longer you wait, the less time your money has to grow through compound interest.
How to Avoid It:
Start contributing to your 401(k) as soon as possible, even if it’s just a small amount. The earlier you start, the more time your investments have to grow. Over the long term, even small contributions can add up to significant savings.
Maximizing your 401(k) is crucial for securing your financial future. By avoiding these common mistakes — such as missing out on employer matches, neglecting asset allocation, or taking early withdrawals — you can ensure your retirement savings are on the right track. Stay proactive, increase your contributions over time, and regularly review your plan to get the most out of your 401(k).