If your employer offers a 401k plan, you are fortunate because you have a very power financial tool that can help you prepare for retirement.  When people ask me questions about their 401k accounts, I often hear a lot of the same things.  A lot of times many people make mistakes with their 401k plans that are keeping them from maximizing this useful retirement account.  I’m going to outline those mistakes and hopefully keep you from making these same mistakes.

  1. Not Getting the Maximum Match

A 401k plan allows you to contribute from your paycheck each pay period to go towards your balance in your 401k. Most employers offer a match up to a certain percentage of what you put in your 401k.  For instance, an employer may match up to 100% of what the employee contributes up to 4%.  If you put in 4% of your paycheck your employer will give you 4%.  Right out of the gate, you are getting a 100% return on your money.  If you only put 2% of your money in, you are not getting that extra 2% match from your employer.  You are technically losing out on free money.  This is the biggest mistake I think most people make.  That extra money your employer is putting in is free money that grows tax deferred for your retirement.  The compounding of just the match money can significantly impact your retirement balance years down the road.  Make sure you are getting the maximum match on your 401k or any kind of retirement plan you are offered.

2. Not Investing Properly

Within your 401k plan, you are given several options to choose from for you money to be invested that you are contributing.  These investment options typically consist of a variety of mutual funds or exchange traded funds.  When you sign up for your 401k plan, if you do not choose an investment option, your company plan will have a default investment option.  Sometimes that default is a target date fund which is perfectly fine.  Sometimes it’s a fixed account that pays a fixed interest rate or maybe it’s a conservative fund.   Make sure when you sign up for your company’s 401k plan you choose an option that best suits you and not just let it go to the default option.  If you’re a in your 20’s and the default option is a conservative account, you could be missing out on substantial potential gains in the market if you were invested according to your risk tolerance and time horizon.  Another mistake people make in regard to their investment selection is choosing too many funds.  Some people think they should choose some of every fund available in the plan.  That could cause more harm than good.  Your plan should have an advisor you can contact or an 800 number to call to get assistance.  If not, or if you just aren’t sure what to choose, almost every plan now has target date funds.  Those funds will be invested according to when you turn 65 or whatever year you choose is closest to your planned retirement age.  As you get closer to the retirement year, the funds will automatically adjust the allocation to be more conservative.  These are great options to choose from, especially if you don’t want to worry about if you’re invested properly.

3. Trading your funds

Some people like to think they are day traders and like to move in and out of their funds in their 401k plan.  If this is you, please stop doing this.  You are causing yourself more harm than good in the long run.  I’m sure some people have been lucky and done well with this, but it’s not sustainable.  You will end up costing yourself money by either selling when the market is down or missing out on the upside when the market is moving up.  I tell everyone if it was that easy, more people would be doing it and they wouldn’t be working where they are now.  They would be sitting at home doing this all the time.  If you want to do this with some extra money you have set aside, feel free to do so.  Just don’t use your employer retirement account to do it.

4. Not using the Roth Option (if available)

This may not pertain to everyone since a lot of plans may not offer this option.  If your company plan offers a Roth option for your 401k, I would consider utilizing this option.  You don’t have to put all your money in the Roth option, but you should consider at least a portion.  The Roth option goes into the plan after taxes, grows tax deferred and when you take it out later in retirement, you don’t pay any taxes on it.  This can be a very powerful tool for your retirement needs.  Something else to keep in mind, if you choose the Roth option, your company match still goes in before taxes, so you still must pay taxes on the company portion in the future.  If your company matched 100% up to 4% of what you contribute, your 4% could be the Roth portion and the company match of 4% would be pre-tax.  Another thing to consider, if you and/or your household make over a certain AGI limit, you do not qualify for a ROTH IRA, but if your company plan offers the ROTH option, there is no AGI limit.  Plus, you can contribute up to the maximum of $22,500 or $30,000 if you are over 50 years old.

5. Taking a Loan on your 401k

Most 401k plans offer the ability for their employees to take a loan on their 401k plan up to a certain percentage and/or amount based on the balance in the plan.  The way these loans work in a nutshell, you are charging a certain interest rate based on current rates, you pay that loan back on a term up to 60 months, and the payment comes out of your paycheck.  The interest you are charged with actually goes back to yourself.  A lot of people think they’re paying themselves back and think that sounds like a good deal.  Here are the problems with the loans.  Whatever amount you take a loan on, that amount will come out of the market, so it’s not growing at potential market returns.  That 6% interest rate you’re paying yourself back could cost you 10% by those funds not being in the market.  That is just a hypothetical number.  I just want to illustrate the scenario.  Some people may say, but it could save me from losing money.  That may be true for a year or so, but not in the long run.  Another issue with 401k loans is that when you make the payment back to your loan, the payment amount is after tax.  You are using after tax money to go back into your pretax retirement account that will be taxed when you take it out in the future.  The money you are paying back to your loan is getting double taxed.  401k loans are not always bad.  It just depends on your situation.  I would consider the 401k loan before cashing anything in that has a penalty that you have to pay taxes on in addition to the penalty.  Sometimes it may be necessary, but it should be a last resort in my opinion.

6. Not Putting in Extra when the Market is down.

One way you can supercharge your 401k plan, when the markets are going through a downturn or correction, use that opportunity to put extra in your plan.  Most companies will allow you to make a one-time increased contribution amount for a pay period.  You are putting more money to work when the market is on sale.  In the long run, this can significantly improve your returns.

7. Putting all your money in company stock

Some companies allow their employees to use their 401k or retirement funds to purchase stock in their own company.  This is okay for a small portion of your retirement funds, but where people often mess up is when they put a large portion of their funds or all their funds in their own company stock.  This can be one of the worst mistakes you make.  Not that your company is going to go under, most probably will not, but if it does think about what happens to you.  You would lose your job and your retirement, a double whammy that you may never be able to financially recover from.  Maybe your company doesn’t go under, but they significantly underperform the overall markets.  You are robbing yourself of valuable years of compounding.   A rule of thumb, if you choose to put your retirement funds in your company stock, try to keep it under 10% of your total retirement portfolio.

I hope these mistakes we’ve discussed will help you utilize your company sponsored retirement plan to its fullest potential.  Remember you should always consult with your financial advisor and/or tax advisor when making major money decisions.  If you don’t have one, you can contact me to schedule a call to see how I can assist.  www.appafinancial.com/contact/