Five 401(k) Mistakes to Avoid
February 1, 2012
The 401(k) plan has long supplanted the traditional pension plan as the most popular type of tax-qualified retirement plan. Thus, there is a good chance that an employee will be eligible to participate in a 401(k) where he or she works. If the employee is married and working, both spouses may be able to participate in their respective plans. However, many eligible employees are guilty of "mistakes" involving 401(k) plans. What is particularly frustrating is that these errors are relatively easy to avoid. Here are five common mistakes to watch out for: Mistake #1: The participant sits on the sidelines. Many participants bailed out of their 401(k) plans in the wake of the stock market decline of 2008-2009 or cut back or eliminated deferrals. But history has shown that, despite the inherent risks, investing through a 401(k) will generally provide long-term rewards. For 2011, the deferral limit is $16,500, plus an extra $5,500 contribution is allowed for someone age 50 or older. Furthermore, an employer may "match" a participant's contribution up to a stated percentage of salary. This matching contribution costs the employee zero. Mistake #2: The participant does not invest carefully. As with investments outside a 401(k) plan, a participant should avoid an overly heavy concentration in one particular offering. Other errors include over-diversification such as investing in every possible mutual fund or other available option. Try to find the proper balance. A logical approach is to allocate assets based on current age, expected retirement age, the annual contribution amount and tolerance for risk. Caveat: There are no absolute guarantees with any investment. Mistake #3: The participant "raids" the 401(k) early in life. A 401(k) plan is meant to be a savings vehicle for retirement. However, participants often take distributions well before retiring, especially if they are changing jobs. This reduces the funds that would be available in retirement. As a general rule, a distribution made prior to age 59½ is subject to a 10% penalty tax on the taxable portion, in addition to the regular income tax that is owed. Note: If a participant switches jobs and rolls over funds from a 401(k) to an IRA or another qualified plan in a timely fashion, the rollover is exempt from current income tax. A direct trustee-to-trustee transfer is recommended. Mistake #4: The participant borrows money from the plan: As with raiding, a participant should be discouraged from taking a loan from the 401(k). Even though the participant is effectively being paid back, it will be more difficult to meet retirement goals. The participant will not have access to the funds that could have been earned if the principal had remained intact. Borrowing may be necessary in an emergency, but it should generally be viewed as a last resort. Mistake #5: The participant does not seek assistance. Recent law changes encourage 401(k) participants to obtain advice within certain parameters. There is no need to go it alone. With professional guidance, 401(k) participants can sidestep the common pitfalls outlined above.