5 Common 401K Pitfalls
Participating in your company's retirement savings plan is a great first step, but that alone won't guarantee a comfortable retirement. When thinking about your financial goals and retirement savings, keep these 401(k) considerations in mind:
A 401(k) plan alone is not sufficient. Your goal should be to contribute the maximum annual limit: $16,500 for people under 50 years of age and $22,000 for investors 50 and older. Contributing at that level isn't realistic for everyone, but some contribution is better than nothing. Start contributing as much as you can afford and make it a goal to increase that amount annually. Some plans allow you to implement an automatic increase each year in the percentage of pay you contribute. Take advantage of this or consider increasing your contribution by the amount of any pay raise you receive.
Don't use your 401(k) plan as a savings account. It can be tempting to cash out your 401(k) plan to get through a "rough patch." But withdrawing from your 401(k) plan today not only puts a dent in the balance that will compound over time, but if you're not yet at retirement age you will likely incur a tax penalty in addition to income taxes. Try to leave your 401(k) alone to grow until retirement. Use other cash assets for those inevitable rainy days. If you don't have one, make building a sufficient emergency fund a priority.
Don't invest your 401(k) in a vacuum. Far too many participants fail to consider outside investments when they invest their 401(k) plan dollars. Do you have old 401(k) accounts, IRAs, taxable accounts, or a spouse's retirement plan? Your 401(k) should be invested as part of your overall financial plan, which includes all investments. Failing to do this might result in an overall investment allocation that takes too much or too little risk based on your situation.
Not fully participating in the company match program. A company match is free money. If your plan matches half of your contribution up to 6 percent of your pay, do everything you can to ensure that you are contributing at least 6 percent of your pay. The 3 percent match represents a 50 percent return on your investment regardless of how the investments in the plan perform. A cautionary note: the first point still applies. Contributing enough to receive the maximum match does not ensure that you are saving enough for retirement.
Defaulting to a target-date fund. Using one of the target-date options offered by your plan may be a good option for you, but don't automatically assume that this is the case. TDFs are not a "set it and forget it" option. Investigate how the funds invest, what they invest in, and the underlying expenses. How will an investment here dovetail with investments you hold elsewhere? Also, don't assume that the fund with the target date closest to your anticipated retirement is the right one for you. Your situation may call for a different allocation; it is OK to use a fund with a closer date or one that has a date further into the future if that fund is more appropriate for you.
Your 401(k) plan can be a great vehicle for retirement savings. However, you need to take a proactive role in managing your account to ensure that you are maximizing this benefit.