A 401(k) plan is a tax-advantaged retirement savings plan provided by employers. It involves setting aside a portion of the employee’s monthly salary, which can be withdrawn during retirement. Introduced in the 1980s, 401(k) has been instrumental in helping people save money for their future. However, certain mistakes can prevent one from getting the most out of their 401(k) plan. Lapses here could also result in penalties.
1. Not contributing enough
Some of the biggest mistakes people make with a 401(k) are not contributing enough or consistently and not increasing their contributions over time (to match their salary). As a result, they end up losing out on the compounding interests, settling for very little money. To steer clear of this mistake, one can set up the account to automatically draw contributions from the salary account. Today, one can also opt for automatic annual increases on a date of their choice or on the effective date of their salary raise to allocate more money for their retirement.
2. Missing out on employer match
Many employers match the employee’s contribution. To build a bigger retirement fund, one should avoid missing out on these contributions. One can learn more about the employer’s 401(k) policy. Generally, employers match employees’ contributions if they are between 3–6% of the monthly income. If one does not contribute enough money to be eligible for an employer match, they will miss out on free 401(k) money.
3. Early withdrawal
As a 401(k) is a savings tool, many people may want to tap into it when times get tough. This can be done in two ways—a loan or a withdrawal. With a loan, the borrowed money needs to be repaid within 5 years, whereas a withdrawal results in a 10% incurred penalty. As both things can impact the power of compounding, breaking these funds is generally inadvisable. In case of an emergency, however, a 401(k) account holder may take a hardship distribution without incurring the fee. Additionally, now there is a new option that allows one to withdraw $1,000 a year from their account for a personal or family emergency.
4. Ignoring fees
One may forget that 401(k) plans aren’t free. They charge between 0.5% to 2% as fees. While the plan fees cannot be changed by the saver, it is possible to opt for a fund within the plan that has a lower fund ratio, such as exchange-traded funds or ETFs.
