401(k) Mistakes That Wreck A Comfortable Retirement

Are you saving for a comfortable retirement? You can help ensure your quality of life in retirement doesn’t drop, as long as you don’t make a bunch of avoidable 401(k) mistakes.

To be fair, not everyone has access to a 401(k). Some folks have other plans, like 403(b)s, and they can pretty much follow this advice too. Others are still lucky enough to have a guaranteed pension, and may not need it. And some folks work for themselves or for employers who have no plan at all. Fortunately, there are retirement plans even if you don’t have one through an employer.

But for those who have employer-sponsored retirement plans, there’s no easier way to put a nest egg aside for retirement. And you need one. While Social Security will likely still be around for most of us in some form, it’s likely to be reduced in the future. Even now, it rarely provides enough for a comfortable retirement.

So most of us need to save for retirement if we want to be able to live in something like the manner to which we’ve become accustomed, only with more free time and less stress. And 401(k)s are a great way to bulk up retirement savings. They’re automatic, making savings easy. They’re usually tax-deferred (meaning you don’t pay tax on the money now, only when they’re withdrawn).

Now just don’t screw up your golden opportunity.

Not Contributing

The first 401(k) mistake that screws up your comfortable retirement is the biggest one.

15% of eligible employees choose not to participate in their company’s plan. That means 15% walk away from their opportunity to save for their future, even when an employer plan is offered. Some are even walking away from the employer match that is essentially FREE MONEY (more about that later.)

These non-contributors may have pretty good reasons. Maybe they think they don’t make enough to free up anything for retirment. Okay, are you going to make enough when you retire? Probably not. Much easier to save now while you are actually earning.

Maybe they think they think the enrollment paperwork is too much trouble.The enrollment paperwork rarely takes more than an hour or so to fill out, and you can probably get someone to help you do it if you need it.

Maybe they don’t like or understand the investment options. Okay, just pick the one you dislike the least or understand the most. Just pick something. Investment options change, and you can always educate yourself more and change your investments later.

The most important 401(k) decision to make to ensure a comfortable retirement is to sign up for your company’s plan as soon as you can and get started. 

Not Getting the Full Match

If someone said, “Here’s some Free Money!,” would you take it?

Sure, and yet, every year, people turn down free money from their employers when they don’t take advantage of their employer match.

While not every company offers a 401(k) match, plenty offer one. Usualy, the match says something like “For every dollar you put into the plan, the company will add 50 cents, until the total match equals 3% of your gross pay.” Some companies will even offer dollar-to-dollar matches, and some offer higher or lower percentages.

And yes, some companies put conditions on their part of the contribution, commonly saying you have to work for the company for a certain length of time in order to keep the match. But even if you don’t plan to stay at a company all that long, it’s still worth getting the match. Who knows? You could stick around a lot longer than you think.

If your employer offers a match, make sure you take full advantage. It’s the best way of leveraging your own money to get better returns. There aren’t too many investments that guaranty 50 cents on the dollar annually.

Only Getting the Full Match

Okay, now you’re participating, and you’re getting the full employer match. But is 5% of your salary (or 7 1/2% after the match) going to get you the retirement of your dreams?

Probably not, particularly as you get older.

Look, if you have a bunch of debt to pay down and you limit yourself to the match while you aggressively pay down your debt, then you have a good argument for only contributing enough to get the match. But most folks are going to need to contribute more than that. Maybe not the full $18,500 annually that the government allows, but probably more than 7 1/2%.

The easiest way to ramp up your contributions is to put part of every raise toward your 401(k). Even assuming a 2% raise, adding 1% each year can really add up over time without making you feel like you’re being deprived.

That said, the comments below prompt me to admit that you can ramp up your retirement savings outside your 401(k) instead, especially if your employer plan options don’t seem attractive. IRAs, whether Roth or traditional, offer more investment options and may be a better second savings option after maxing the employer match. Just remember that unlike your 401(k) contributions, you may not be able to deduct your IRA contributions at higher income levels.

Keeping Your 401(k) in Cash

There are a lot of risk-averse folks out there, and some of them really don’t like the stock market. So they contribute to their 401(k) to save for the future and get that free money from their employer, but then they don’t invest it. They keep it all in nice, safe cash.

And that’s a big 401(k) mistake.

Cash REALLY isn’t all that safe, because the piddly interest rate you get paid on your cash is way lower than the rate of inflation.

Yes, the stock market can go down, and returns on the investments in a 401(K) aren’t guaranteed. Companies go bust, and their stock becomes worthless.

Fortunately, mutual funds make up most 401(k) plans. They are much broader than a single stock.Over time, the stock market bounces back. As long as you keep your money in the market and don’t sell when the markets crash, so does your account balance. If you keep investing during the crash, you’ll have bought stocks when they’re cheaper and be better off long term BECAUSE of the crash.

Just don’t sell.

If your low risk tolerance keeps you wary, or if you feel too close to retirement to play the market, you can at least move your money out of cash and into bonds for safety’s sake.

Not Paying Attention to Fees

Not all 401(k) plans are created equal, and not all investments in them are good. Sometimes, there can be some real stinkers.

Paying big fees to the mutual funds in your retirement holdings means your retirement savings don’t work as hard as they should. If you invest $100 a month for 10 years (assuming a 4% return), the difference between a 1% and a .2% fee is over $575. Over 30 years, it’s over $8000.

Maybe your 401(k) doesn’t offer Vanguard Index funds, but you should still be able to find a fund that won’t cost too much.

Not Understanding All of the Plan

When employers set up their retirement plans, they don’t necessarily set up the same rules. 

Don’t assume you understand all the rules. Read the plan documents.

Some plans will let you take out loans, some won’t (and I’ll explain in a minute why you shouldn’t take one.) Some plans let you keep your money in their plan indefinitely, Others will force you to cash out upon leaving your job, especially if your balance is low.

Your employer may set up a plan with automatic enrollments, or not. The plan may have Roth options. It may have different rules for rollovers or for beneficiaries.

Know your plan. Make sure it does what you think it does, or you may end up with some inconvenient surprises later.

Getting a Loan

A 401(k) loan sounds like a great idea, right? You borrow from your 401(k) for a new home or some other really noble reason, then pay yourself interest as you pay it back.

In theory, it can be, if you pay the loan back on time. But it comes with some caveats.

The first is that even if you pay back the loan, you lose the investment potential of the money you’ve pulled out. Maybe you’ve used the money well enough to mitigate that, or maybe not.

The second, more serious problem, is that if you leave your job, you have to pay the loan back in full immediately, or the loan becomes a distribution.  Even if you go on unpaid leave, you may have to keep making payments while you’re on leave, depending on the terms of the loan.

If the loan becomes a distribution, it becomes income. You have to pay income tax on it. And unless you’re older, you probably have to pay the 10% penalty on early withdrawals. And unlike other early distributions, you haven’t done any withholdings to offset the income tax.

This can all leave you with a big tax bill and a lower retirement account balance. Ouch.

401(k) Mistakes That Wreck A Comfortable Retirement

Cashing Out When You Leave Your Job

So, you’ve left your job, and your old company’s HR department might want to know what you want to do with your 401(k). Or maybe you have some bills to pay, and you know you have money stashed in your retirement account. They can just send you a check, right?

Don’t do it.

Unless you’re over age 55, you’ll pay a 10% penalty on any distributions you take when you leave your job, and regardless of your age, you’ll pay income tax on the distribution.

If you cash out a big 401(k), it can bump you into new tax brackets. Even a small one can move you into new territory. If you really need the money because you have no other options, at least consider taking only what you need rather than the full amount.

If you don’t NEED the money, then don’t cash it out. It’s meant for retirement, and you should save it for retirement. Leave it be, move it over to your new employer’s plan, or roll it directly into an IRA. Whichever you choose, you’ll avoid paying extra taxes and still have your retirement funds waiting to see you through retirement.

Don’t Wreck Your Retirement

So if you want a comfortable retirement (and most of us do), take advantage of whatever retirement plans your employer makes available. Just avoid these common 401(k) mistakes, and dream of a future that makes you smile.

What have I missed? Any other 401(k) traps to avoid?

*Part of Financially Savvy Saturdays on brokeGIRLrich.*

26 thoughts on “401(k) Mistakes That Wreck A Comfortable Retirement

  1. I’m only getting the full company match right now because I want to explore other investments which potentially could bring in more money over the long term. I’m interested in Real Estate, and also small business.

    As my salary increases, 4% is a decent number and when combined with a 4% match and $5.5k to an IRA, it adds up.

    Thanks for sharing Emily.
    Erik @ The Mastermind Within recently posted…How To Create Passive Income Making Websites With Fiverr Service ArbitrageMy Profile

    • Yeah, it’s a good point. Combined with other investments, your retirement investment rate is not bad at all, but you aren’t just depending on your 8% 401(k) contribution + match to fund retirement. A lot of folks only do the contribution and match, and that’s where they make the mistake.

      But I should have added an asterisk that the further savings don’t necessarily need to be within the 401(k). I love the flexibility that an IRA provides since you can invest in a lot more options. But remember that the deductibility of IRAs phases out at higher incomes if your employer does provide a retirement plan (phaseouts start at $61K modified AGI for single). You may get to a point where your 401(k) is your best tax-deferred option.

  2. A 401(k) is a great place to start investing. Never a good idea to leave free money (match) on the table, consider it part of your overall compensation. Many people rationalize a 401(k) loan “it’s my money” they don’t understand the possible impacts to investments. I like the idea of investing outside of the company sponsored program if you have limited investment options. Great overview!
    Brian recently posted…Financial Literacy for MillennialsMy Profile

    • Yeah, the loans have a pretty quantifiable opportunity cost, even if you don’t get stuck with having them transfer to distribution status for one reason or another.

      I also think if you think your employer plan options aren’t so good, you probably should prioritize your retirement savings ramp-up by getting the full match first, then fully funding a Roth or traditional IRA before increasing your 401(K) more.

  3. These are all really good tips Emily. We’ve had a little trouble deciding how to handle my 401(k) as we pay down our debt. The minimum has always been what is necessary to receive my employer’s full contribution. As time goes on, and we’re no longer facing high interest rate consumer debt, we’ve upped our contribution little by little – usually with raises. We didn’t increase it this year, because we knew finances would be somewhat unpredictable with the impending arrival of the twins. But we will probably increase the deductions again, once we figure out our new normal.
    Harmony@CreatingMyKaleidoscope recently posted…How To Plan A Wonderfully Frugal Mother’s DayMy Profile

    • Your impending arrivals are a really good reason not to up your contribution this year (or even to take it down a little temporarily.) But the most important thing I see in your statement is the clear intention to ramp up again as soon as you figure out your situation. So many folks leave their 401(k) contribution level on autopilot, but as life changes, so should the contribution.

    • The effect of those fees becomes magnified over time as your investment compounds. Unfortunately, I have to confess the same. Fees have probably really hurt.

  4. I made the “not paying attention to fees” one and it cost me thousands. In the year since i have fixed this mistake (by switching to an IRA and ultimately getting my company to switch plans) my retirement had a huge boost. It kills me to think of the years – decades almost! – that my money just malingered.
    Linda at Brooklyn Bread recently posted…Upright Citizens BrigadeMy Profile

    • Yay on getting your company to switch plans to something better. It’s so easy to settle or complain rather than turn that energy into a positive for everyone. Good job, Linda!

    • Yes, doesn’t matter why you leave, you still have to pay the 401(k) loan back in a very short window. Scary!

      And wow, what a terrific match! Geez, that’s 160%. Hard to believe people weren’t moving heaven and earth to take advantage of that benefit.

  5. Thanks for the great investing advice! You’ve done a great job laying out the key things to know when it comes to growing your retirement nest egg! And I know it’s nothing new, but I can never believe how people don’t take advantage of contribution matching from their employers. It’s like leaving free money on the table!

    As you mentioned (and as you’ve done yourself) lowering fees can also have a massive impact over time. Thanks for sharing and have a great weekend!
    Jay recently posted…Trend Following Trade Ideas for April 2017 (Part 4)My Profile

    • Thanks, Jay. I used to handle my company’s 401(k) enrollments, and the number of people who passed on the plan and the number of people who cashed out their plans when they left frankly scared the hell out of me. (So did the number of people who went without health insurance.) We had a very young workforce, but most of them didn’t think more than a week or two ahead.

  6. Love this post! It is amazing to me how frequently people skip out on the company match. I work for a company with a very generous match and I still have a hard time getting people to sign up for our 401K plan. I will literally walk them through the entire process and bend over backward to accommodate them. People just don’t understand the importance of compounding interest.

  7. Awesome tips! I’ve never had a 401k. All my retirement” options” through work have been pensions, but I wouldn’t count myself lucky for that. PA’s gets 4% interest. Four. Percent. That’s far below even conservative estimations of market performance, and contributions are mandatory. Couple that with my age—I’m pretty sure it won’t be there when I retire. Even my principal.
    Femme Frugality recently posted…Children, Medicaid & Autism: State-by-State GuideMy Profile

  8. I’ve really got to take a look at the fees in my 403b. But what do I do once I discover them? I have everything in a Target Date fund, so there’s not much more I can do, I think. I’ve cashed out a lot of 401ks over the years, which was dumb. I would be in a much more comfortable spot now if I hadn’t done that. But, I thought I’d use it to pay off credit card debt. It never worked. Cashing them out never works. I’m glad to see it on here because I feel like it was my biggest 401k mistake.

    • Amanda, it’s worth checking the fees in your Target Date fund to make sure they aren’t too high. The advantage of the Target Date Fund is risk management (adjusting your stock/bond mix as you age) rather than necessarily low fees. Some of them do have pretty high fees. If the fees on your target date fund are high, consider investing in a total market fund/bond mix yourself if the fees would be lower.

  9. I would also advise setting up your 401k contributions immediately when you get a new job, especially if you can make sure they are in effect before your first paycheck. That way you won’t “miss” the extra coming out of your paycheck and it won’t “hurt” to see the lower amount.
    Jax recently posted…Weekly Accountability: The Happiness (and Money) EditionMy Profile

    • I agree, although it’s not always possible to get your employer to take retirement contributions out of the first check. Some employers make you wait months (or even a year) before they’ll let you join their retirement plan. I guess if that’s the case, you can just direct some of your paychecks directly to an IRA for a similar effect.

  10. I made a 401(k) mistake when I left the last job that had one. Since it had less than $1,000 in it, I never noticed the fine print that if I did nothing when I left, in 90 days it would be cashed out and the check would be sent to me. I would’ve rolled over what was in there to another old 401(k) if I had know that was going to happen.
    Mel @ brokeGIRLrich recently posted…Accountability: April 2017My Profile

    • Ouch. I’ve seen this before, and knew it was a danger with low balance 401(k)s. Knowing the terms of the 401(k) can be pretty important, as can taking care of your investment in a timely fashion after you leave. I probably should add a quick section to the article. Thanks for the idea, Mel.

  11. It’s interesting to read about some of the worst and most common mistakes people make with 401ks, particularly about keeping it in cash. I didn’t know that it’s actually safer to have the 401k through other means due to inflation, etc. I’ll have to keep this in mind for when I start planning for mine because I want to ensure I have a safe retirement for when the times comes.

    • Yes, right now the interest rate you get is low enough that you’re not keeping up even with the current low rate of inflation, much less getting ahead of a future higher rate. If you’re young, the safest long-term play is probably to go heavily into stocks and plan on continuing to invest regularly whether the market rises or falls. So far, the market over time has always rebounded higher and kept ahead of inflation. You just have to wait it out and not pull money out during the down times.

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