g
Printer Friendly Version

editor  
BellaOnline's Home Finance Editor
 

Simple 401k Mistakes

Millions of individuals are enrolled in 401(k) plans which require a greater and more complex level of individual participation and responsibility. Unfortunately, a significant number of individuals are not able to fully maximize the investment potential of their 401(k) and as a result, make seemingly “simple” mistakes which over time can exert a measurable negative impact on the value of their account and ultimately their retirement plans.

There are several common tactical errors:

1. Not contributing consistently. This can be due to any number of reasons with some of the most prevalent being:

• Fear and consternation of market risk or any type of risk for that matter. Some employees may avoid making contributions during periods of extreme market swings and high level of economic uncertainty. This type of strategy provides brief superficial protection and is inherently risky in terms of future outcome. While individuals who cease making contributions are able to sit out the bear market, they also lose the opportunity to dollar cost average and purchase lower priced shares. They may also miss the critical early rise of the bull market.

• Unable to make contributions due to other more pressing immediate financial concerns (e.g., their spouse or partner lost their job, the need to pay off credit card debt or assume the responsibility of their child’s student loan debt). All of these are valid reasons. However, making even a nominal contribution is still productive in the long-run. Situations will inevitably arise and somehow there will always be a legitimate reason not to contribute to a 401(k).

• Wanting the money for present gratifications and not viewing saving for retirement as a top priority. Admittedly, this is a far more difficult challenge to overcome. For younger workers in their 20s who choose not to contribute diligently and consistently, they will miss out on the immense advantages to be achieved from the compounding of interest and tax-deferred growth at an earlier age. Individuals who begin making contributions in their 30s or even 40s will be continually struggling to catch-up. Their money will have less time to grow. In some cases, individuals who waited too long to begin their contributions may become tempted to take inordinately greater risks with their money in the pursuit of higher yields.

• Failing to take advantage of the match offered by your employer. It is absolutely amazing, given the amount of public discourse on the importance of retirement planning and 401(k) plans, just how many employees still fail to take full advantage of the match offered by their company, thereby “throwing away” the opportunity for critical, tax-deferred growth of their money during their prime working years.

• Neglecting to take advantage of the “catch-up” contribution permissible in many 401(k) plans for those aged 50 and over.

2. Poor asset allocation. When it comes to asset allocation and rebalancing with regard to 401(k) plans, employees have to take a proactive, informed approach as the onus of responsibility is shifted from the employer to the employee. Yet, a significant portion of individuals lack the interest, energy or time to become informed about the investment options in their 401(k). A 401(k) that is too heavily concentrated on equities can be vulnerable to a sudden market downturn. Likewise, a portfolio that leans towards low-yielding, fixed-income investments will not provide the sufficient growth of capital needed to generate future income. Having too much in company stock is also another strategic misstep. Some financial planners recommend that no more than 5-8% of company stock should be held in a 401(k). Even though your company is achieving stellar performance today, its success cannot be regarded as a permanent situation. A sound 401(k) plan presents a multitude of diverse choices including several mutual fund families as opposed to just one and an opportunity to build a portfolio drawn from a wide range of assets (e.g., bonds and stocks). Look at the range of investment choices and determine your asset allocation in relation to your time horizon, risk level and tax bracket. Periodical reallocation will be necessary to accommodate changing market conditions and stage of life.

3. Borrowing from a 401(k). A 401(k) should never be a substitute for an emergency fund. Money needs time to grow. By borrowing from your 401(k), you are actually stealing from yourself and losing out on tax-deferred growth. Moreover, this can be an acute disadvantage if the money is withdrawn during a bear market. The value of the account may not be easily recouped. Furthermore, taking out a loan has financial costs. If you are continuing employment with the same employer, the loan needs to be repaid with interest usually within 5 years. If you change employers, the loan must be paid generally within 60 or 90 days. If the loan is not paid on time, and the individual is under 59½, in addition to the 10% penalty, there will be income taxes on the unpaid balance. Not all employers permit employees to borrow from a 401(k). Payments on a 401(k) loan are generally deducted from the employee’s paycheck on an after-tax basis.

4. Cashing out on a 401(k) plan before retirement. If you are under 59½ and change employers, you should be aware of all your 401(k) options such as rolling it over into an IRA, leaving the money in the existing plan, transferring the balance to your new employer’s plan if the company accepts transfers, or taking the cash value of the account. Some employees may be inclined to cash out on their 401(k) plan once they terminate their employment. They may want to spend the money on a vacation or a new car. A 401(k) is a tax-deferred savings vehicle meant for retirement. It should never be regarded as a “sudden windfall.” Considering how little most people are actually saving towards retirement, cashing out of a 401(k) is the least viable and a more costly choice as the money will be subject to the mandatory 20% federal withholding, a 10% early withdrawal penalty and income taxes.


For informational purposes only and not intended as advice. Every attempt at accuracy is made, however, the author does not claim that the content is free of factual errors.

Home Finance Site @ BellaOnline
View This Article in Regular Layout

Content copyright © 2013 by Reshma Vyas. All rights reserved.
This content was written by Reshma Vyas. If you wish to use this content in any manner, you need written permission. Contact Sandra Baublitz for details.



| About BellaOnline | Privacy Policy | Advertising | Become an Editor |
Website copyright © 2014 Minerva WebWorks LLC. All rights reserved.


BellaOnline Editor