After having hundreds of conversations with various pharmaceutical executives, I’ve consistently noticed the lack of thought that is given to their 401(k) plans at work.
What most employees don’t realize is that at some point, their 401(k) will most likely be the largest income producing asset they own in retirement. And if invested properly over the long run, this asset could potentially be large enough to support a comfortable retirement.
There are several reasons why 401(k)s make sense for so many people. But the primary reason you should take advantage of your 401(k) is because you can automatically fund your retirement savings by making contributions directly from your earnings at your job. Thus, you don’t have to remember to make contributions!
Not to mention, all the potential growth is tax deferred until you begin to take distributions and you’ll reduce your taxable income now by contributing. Furthermore, if you are lucky enough to receive an employer match, well than, that’s just icing on the cake because you certainly don’t want to pass up free money!
Unfortunately, it has become clear to me that many employees do not give their 401(k) the attention that it deserves considering how crucial of an asset it could be in retirement. Thus, I have put together NINE 401(k) mistakes you might not even know your making.
1. Saving with not knowing how much money you will need in retirement
OK, you are now a participant in your 401(k) plan. Congratulations! But how much money should you contribute monthly? Here is where I see many people pick a fictitious percentage to contribute without really understanding the whole picture.
Before you determine your contribution limits you need to understand what your total nest egg needs to be at retirement. Once you know the pot of money you need, you can determine how much you need to save in today’s dollars to get there.
For some people that might mean contributing 10% of their salary, while others as little as 3%. It’s different for everyone which is why you cannot generically pick a contribution percentage and be self-assured that this will get you to your retirement goals.
2. Just Contributing the Match
A mistake I see some employees make is that they only contribute up to the match even though based off their personal financial situation they should be contributing more. Having a company match is a fantastic benefit you should certainly use if you have the cash flow to do so. Like I said before, you are essentially banking free money from your employer.
However, as little 13% participants contributed the max to their 401(k) in 2018 according to a Vanguard study1. So what are the maximum contribution limits for 2019? The maximum contribution limits are $19,000 and if you are over 50 then you can add a catch-up contribution of $6,000. Let’s say your salary is $100,000 and the company match is 5% so you decided to contribute up the match. This means you are only contributing $5,000 from your earnings where you can be contributing all the way up to $19,000!
Depending on your financial scenario it may be wiser to invest more money into your retirement than what your employer will match in your 401(k). This is why you can’t skip point number1. You need to determine how much money you will need to retire and then determine the savings rate it will take you to accumulate that nest egg.
3. There Is No Match, So You Don’t Participate at All
Employers are not required to match your 401(k) contributions. If your employer isn’t matching your contributions, should you just skip investing into your 401(k)?
Usually not…
Remember, the 401(k) is a great way to automatically make contributions toward retirement. Also, the amount you contribute will reduce your taxable income and grow tax deferred for the years to come! Who doesn’t like to save taxes?
4. Not Getting Professional Help Choosing Your 401(k) Investments
I have asked many executives in the past how they choose the investments inside their 401(k). Many say back that they just randomly choose funds that they thought looked good or that a co-worker told them to buy.
As mentioned before, this could be one of your largest assets in retirement and it needs to be handled with care. It’s best to hire a professional that can guide you through which funds make the most sense in your overall financial plan.
A good financial advisor will first determine your asset allocation and diversification, then choose investments within your 401(k) that will help you achieve your overall financial goals.
Don’t go in alone. Seek quality advice and you’ll potentially earn more money while reducing the overall risk of your portfolio.
5. Failing to Pay Attention to Fees
I can’t tell you how many people have told me they are not paying fees inside their 401(k) plan. Many people are so focused on picking an over performing fund that they forget to pay attention to the fees of the fund that can reduce your overall return in the long run. The fees and expenses in your plan will gradually work to reduce your potential growth. Keep in mind that 401(k) plan fees and expenses generally fall into three categories: plan administration fees, investment fees, and service fees.
The financial services industry has gotten better at disclosing fees, but it still can seem overwhelming for the average investor to figure out how much you are really paying in fees and expenses within 401(k) plans.
You can call your benefit service center to determine the exact administration fees, investment fees and service fees you are paying in your account or review the plan documents first given to you at participation.
6. Borrowing from Your 401(k)
Although it is a nice option to be able to borrow from your 401(k) at any point, it is not something I would suggest making a routine of. By taking money out of your 401(k) defeats the purpose of why you contributed this money in the first place. I suggest looking at the money you add to your 401(k) as money you are not going to touch again until you are over 59 ½ (money for the long term).
You also could find yourself in a situation where you could be paying extra penalties and taxes if you don’t have enough money to pay back your 401k loan in time. When this happens, your unpaid balance is now considered a distribution which means you will also be looking at a 10% penalty if you are under 59 ½!
There are usually better sources to obtain liquid cash such as an emergency fund or home equity line. Your 401(k) plan should be used as a last resort!
7. Trying to Time the Market with Your 401(k) Investments
Your 401(k) is a great long-term investment vehicle. I say long term because if you try to take money out of it before 59 ½ you will not only have to pay the taxes on that money but you will also have to pay a 10% penalty on the distribution.
Unfortunately, I have seen many executives who did not have much knowledge of financial markets and when they become fearful as markets declined, they sold their equity position to cash and jeopardized their retirement. Since you ideally will not see any of this money again until after age 59 ½, investing for growth over the long term can leave you in a better situation than if you kept all the money in cash.
A professional can help you find the right funds, but better yet keep you invest at a time of market volatility which can ultimately help you reach financial freedom in the future. Whatever you do, don’t let your emotions dictate your investment decisions.
8. Making Terrible 401(k) Decisions When You Leave Your Job
When you leave your job, DO NOT cash out your 401(k). Remember those penalties and tax implications if you take a 401(k) loan and don’t pay it back? Well, the same applies here and depending how large your 401(k) is at the time, these penalties and taxes could add up to a significant amount of dollars.
As soon as you leave your employer, it is important to understand that you do have options when it comes to deciding what to do with your 401(k). One common option is to leave it invested at the old company. The other option is to rollover your 401(k) into a self-directed IRA after you leave your job. Usually, in an IRA there will be more investment options than your old employer gave you, but be sure to understand the fees associated with the rollover to see if it makes sense.
The 3rd option available to you is to rollover your old employer’s 401(k) into your new 401(k) plan so that you can consolidate your accounts and keep track of them in a more efficient manner.
9. Not Reviewing Your 401(k) Plan Often
While the 401(k) plan is a great way to ensure contributions are made by having them come directly out of your paycheck, that doesn’t mean you can sit back, relax, and forget about your 401(k) altogether.
Instead, you need to review the investments in your plan to see if they still fit your asset allocation and diversification goals. Often, you will need re-balance the funds inside your account to reach your desired asset allocation. As you get closer to retirement, many people may look to reduce the risk within their investments as their accumulation time horizon has now shortened. You’ll also want to review the fees to see if anything has changed.
And if new funds become available within your 401(k), you’ll want to know about them and consider them as potentially better options for your investments.
-Marissa Greco
Financial Planner
[email protected]
908-534-4828 ext. 104
PS: Do you have specific questions about your 401k plan? You can schedule a phone call here on my online appointment book.
Marissa Greco is a registered representative of Lincoln Financial Advisors. Securities offered through Lincoln Financial Advisors Corp., a broker/dealer (Member SIPC). Investment advisory services offered through Sagemark Consulting, a division of Lincoln Financial Advisors, a registered investment advisor. Insurance offered through Lincoln affiliates and other fine companies. Greco Nader and Associates is not an affiliate of Lincoln Financial Advisors. Lincoln Financial Advisors and its representatives do not provide legal or tax advice. CRN-2538233-051319
1 https://pressroom.vanguard.com/nonindexed/HAS18_062018.pdf