3 Common 401(k) Mistakes

The 401(k) is one of the best ways to maximize your retirement savings. After all, if the company matches your contribution, you start off with a 50% to 100% gain right off the bat. That said, many employees are not making the most of the potential locked in their 401(k)s. Here are some of the most common mistakes, according to Vanguard:

• Only about 10% contribute the maximum amount allowed by the IRS, and just 14% make the extra “catch-up” contributions allowed for those age 50 and older.

• One in five has more than 20% of his or her portfolio invested in company stock–a potentially dangerous level of exposure to a single equity.

• Almost 20% invest only in equities, and almost 15% invest only in fixed-income securities–both signs of inadequate diversification.”

There are some good reasons for not contributing the maximum. For instance, many advisers suggest href=”http://www.freemoneyfinance.com/2006/11/the_best_allaro.html”>a specific order for maximizing retirement savings that includes contributing only enough to a 401(k) to get the full employer match, then moving on to a Roth IRA for any remaining savings available. That said, the tips on too much invested in a company stock and limited diversification are certainly issues that can limit the performance and/or increase the risk associated with any 401(k).

For those interested, eHow offers some simple but effective thoughts on how to make the most of your 401(k).

Are you taking advantage of your 401(k)? [Vanguard]

FREE MONEY FINANCE

(Photo: Oneiro)

Comments

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  1. beavis88 says:

    Copied from the (somewhat screwed up) link:

    1. Contribute to the 401k to get the full employer match.

    2. Contribute to the Roth IRA as much as you have left over — to the limit, if possible.

    3. Contribute any remaining retirement savings funds to the 401k (without the employer match at this point.)

    This is sometimes easier said than done given emergency expenses, change of circumstances, etc, but I think generally is good advice.

  2. RandomHookup says:

    What about the folks who leave a job, take the 401k liquidation and just spend it? The percentage of job changers who do this is incredible and it’s a double hit — penalties and loss of the opportunity to defer that retirement money.

  3. Chicago7 says:

    IIRC, the maximum is $15,000 per year and the 50 and older people get to add an additional $5500. With the average salary somewhere around $36,000, is it surprising that only 10% contribute the max?

  4. skittlbrau says:

    Some plans have limitations on contributions that would make your effective max less than the IRS max anyways.

    At my job, you can contribute a max of 18%, so you can only contribute the IRS max if you make about $84k a year. It’s just not feasible for some folks.

  5. Snakeophelia says:

    I have a 403b instead of a 401k – actually, I have two of them (TIAA-CREF and Vanguard), one from each job I’ve worked. I think they work the same as the 401k – the 15K limit is there for the 403b as well. You get those by working with non-profit educational companies, so I don’t have to worry about investing too much in my company’s stock. We have a sweet pension plan in conjunction with the 403b. Someone I work with saw a financial planner and he told her that she couldn’t do anything with her money that would be more profitable than the pension and 403b that we have, so that was comforting to hear.

  6. anatak says:

    @RandomHookup:
    They are out of their minds.

    Roll it to a traditional IRA or SEPP – not to a Roth, not to your new 410k.

  7. skittlbrau says:

    @anatak: well, rolling into a roth isn’t necessarily a bad idea if you can afford the tax hit WITHOUT tapping into what you’re rolling over. I had a friend do it for a rollover of about $5k (only at his job for a year). At 23, it can make sense to tax diversify.

  8. Chicago7 says:

    If your only option is to contribute to a 401(k) in your company stock, then you should definitely only contribute up to the match point (see Enron). But if you have a lot of options, stock funds, mutual funds, etc. why not contribute all you can afford? MOST people will pay less taxes in retirement than they do while working.

  9. skittlbrau says:

    Avoiding taxes now and later are both good. I live in a super-high tax environment (thanks, NYC) but who knows where we’ll be in 40 years?

  10. jackdangers says:

    Is that a photo of some Tom Otterness goodness? The 8th Ave subway station always brightens my day: [www.tomostudio.com]

  11. FatLynn says:

    Let’s see…a mutual fund company that administers many 401(K) plans is telling people to invest more in their 401(K). Great job, consumerist!

  12. nequam says:

    @FatLynn: You’re not serious with that comment are you? Are you questioning the advice of investing in a 401k plan?

  13. Peekaso says:

    It forgot to add the average rate of return for most, which is horrible.

  14. tcp100 says:

    @FatLynn: Ok FatLynn, i’m probably one of the most critical and bitchy commenters on here, but I don’t see your point. Ben’s 100% on target here.

    Saving money is bad since when? Say wha? You been readin’ Kiyosaki or somethin’?

    @PEEKASO: Rate of return for what? A 401k / IRA can hold mutual funds, ETFs, stocks, REITs, CDs, bonds.. It’s up to you. I don’t think you can make a blanket statement on the rate of return on “401(k)s in general”, unless you’re just lamenting the fact that most people are bad investors – in which case it’d apply to any vehicle.

  15. PaperBoy says:

    @BAA — Even if you take the tax hit in rolling a 401(k) balance into a Roth IRA, most young workers (who tend to have small balances, anyway) are going to be better off. The chances that in 20 years are that you will be in a higher bracket, especially if you are unmarried now and plan to get hitched. Most workers in their first job or two are only in the 15% bracket — it ain’t gonna go down when they retire four decades from now.

    Also, it is quite unlikely that Fed tax rates are going to go down at all for the future, given the surging federal budget deficeit and wave of retiring Boomers taxing SS and Medicare. Even the rich are going to lose some of Mr. Bush’s tax cuts.

    Try to think long-term cash flow — what put’s more money in your pocket?

    If taxes are your only consideration, than invest outside of a tax-favored plan. Then you pay ordinary tax on just your investement and only capital gains on your profits. In a traditional IRA or 401(k), you pay regular income tax on all withdrawls.

  16. alpha says:

    @Snakeophelia: You are correct, a 403b is the non-profit version of a 401k. All the same rules apply

    @Chicago7: A second point to being wary if the 401k match goes straight to company stock: Usually they require that you hold it for a certain period before selling it. You can (somewhat) mitigate risk by holding it for just that length of time, then selling and buying something else to diversify. Unless the company really does pull an Enron, you’re still getting “free money”…the stock probably won’t drop 50% (your rate of return due to their match) before you get a chance to sell it.

    Now, THAT being said, I think most companies are getting away from the requirement of 401k going to their company stock…and be wary of any that still do it that way.

    @Peekaso: This comment makes sense. I have yet to see a 401k that does not offer at the least a moderate selection of funds. Most these days are with one of the big players and you get access to all kinds of mutual funds and to a brokerage service to by ETFs and stocks.

    @FatLynn: It’s basically FREE MONEY. You’re stupid not to take it. I don’t care if it’s good for the company managing the 401k. It’s good for me to get an instant 50% return on my money, kthx.

  17. j-o-h-n says:

    Is there really a $15k/yr limit to 403b’s?

  18. alpha says:

    @j-o-h-n:
    sort of. the employee contribution is 15k (see [investopedia.com]), however the total compensation limit, including employer contributions is quite a bit higher.

    I believe there’s similar wording for 401k’s…I think last time I checked employer matches up to 6% did not count towards your 15k limit, though ostensibly anything above 6% WOULD

  19. anatak says:

    @baa:
    If you want a Roth, then go get a Roth. There is NO need to take any tax hit for the sake of tax diversifying. You’re just throwing money away.

  20. bohemian says:

    They keep saying to reallocate your 401k investments right now but to what? We already dumped the real estate based funds months ago and put that money into more profitable fund mixes like those that held oil companies in their fund.

    I love the current employer based 401k we have. You can move money from one fund to another to get more out of your investment. My previous one was just a single managed fund. You could not tell what it was invested in and the return was pathetic. We get more return in a month on the new fund (with less cash in it)than we did in a year on the other one.

  21. FatLynn says:

    @tcp100: Saving money is a-ok, and a 401(K) is a great instrument for doing so. However, there is such a thing as putting too much into a 401(K), and investors should be sure they have enough of a highly liquid rainy-day fund, as well as other tools for meeting shorter-term goals. Putting money in your 401(K) beyond maxing your employer match is not a good strategy for everyone, because you are bound to need some money between now and retirement. Obviously the company providing this advice has an interest in the topic, and it’s not the same as mine or yours.

  22. Asvetic says:

    @anatak:
    I don’t think I follow. Are you advocated that a Roth IRA is a foolish investment or are you advocated that anyone that doesn’t invest (PERIOD) is foolishly throwing their money away? If it’s the latter, I agree, if it’s the former, I disagree.

    I have a Roth, and yes I pay taxes up front, but I also have 30+ years of tax free earnings and returns to look forward too.

  23. FatLynn says:

    @Asvetic: I am saying that you can’t reduce sound investment strategy to a one-page article, because it is different for everyone. It is important, as consumers, to think about who is providing the advice and why.

  24. Asvetic says:

    @FatLynn: Sorry, I wasn’t challenging you, Nequam was. I was challenging Anatak‘s response.

    But, you should also consider that just because the adviser is in the business to make money from providing this service, does not mean they don’t have your best interests in mind. Investing is intimidating and confusing for most people and if a trusted investment firm is willing to make sense of it, especially for free, I’m willing to listen.

  25. capturedshadow says:

    My Roth IRA is back up to half of what I initially invested in it 7 years ago. (tech heavy mutual funds) While my house value has doubled. Sure, I will save taxes by going with more ROTH investment in the future, but I think I will be putting more into real estate directly and taking my chances with taxes.

  26. BarelyFitz says:

    @Chicago07 has it right; the maximum contributions to 401k are pretty high, and I don’t see a problem that more people are not “maxxing out”.

    Personally I have a single income with a wife, two kids, and a mortgage, so I figure I’ll pay my taxes now and max out my Roth first, then the 401k.

  27. bonzombiekitty says:

    I have roughly half my 401k in company stock. Solely because I don’t have a choice over that. Whatever my company matches goes into company stock and I contribute up to the max my company will match (10% of my salary).

  28. anatak says:

    @Asvetic:
    No, you don’t seem to be following. Let’s go back a couple steps.
    401k = pre-tax dollars
    traditional IRA = pre-tax dollars
    SEPP = pre-tax dollars
    Roth IRA = after-tax dollars

    All are great. When you leave a job with a 401k, you’ll want to do something with it. Rolling that 401k to a SEPP or traditional IRA is quite easy as they are all pre-tax deductions. That means that you pay no taxes on those deposits until you withdrawal. Take your money out early and you are looking at a penalty + your tax rate, though there are some exceptions. The Roth is after-tax dollars, meaning you pay taxes on the contributions, but not the growth. This is a pretty sweet deal that you should take advantage of.

    To RandomHookup’s question of “What about the folks who leave a job, take the 401k liquidation and just spend it?”, I responded, “They are out of their minds. Roll it to a traditional IRA or SEPP – not to a Roth, not to your new 410k.” BAA then added, “well, rolling into a roth isn’t necessarily a bad idea if you can afford the tax hit WITHOUT tapping into what you’re rolling over. I had a friend do it for a rollover of about $5k (only at his job for a year). At 23, it can make sense to tax diversify.”, indicating that his friend paid the taxes out of pocket, and still rolled the full amount over. While diversification is a good thing, you don’t need to pay for that privilege, which is why I responded with, “If you want a Roth, then go get a Roth. There is NO need to take any tax hit for the sake of tax diversifying. You’re just throwing money away.” See, if Baa’s friend wants to diversify with a Roth, then that’s great. Go set one up. The friend would be money ahead to just roll the old 401k into an IRA on the open market (with tons of investment choices), and then open a Roth separately. Then you get tax and investment diversification without eating the taxes no matter how you pay for it.

    Make more sense?