Access to a 401(k) can be a boon for workers saving for retirement, but it’s important to remember that this account is just a tool. If you want to get the most out of it, you have to learn how it works in order to use it correctly. Not understanding your 401(k), or any retirement account for that matter, can lead to costly mistakes, like the three described below.
1. Skipping a 401(k) match
Whenever possible, claim your 401(k) match your top priority. Try to contribute at least enough to the account to get its full match each year. If you don’t, you’re giving up a bonus that could be worth a few thousand dollars today and possibly tens of thousands or more by the time you’re ready to retire.
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Check with your company’s human resources department if you’re not sure if they offer a match or how their matching formula works. Most employers offer a match of $0.50 per dollar or dollar for dollar up to a certain percentage of your income. That means that for every dollar you put into your 401(k), your employer will contribute $0.50 to $1.00 on your behalf until you reach the limit. In other words, you can enjoy an instant 50% to 100% return on a portion of your 401(k) contributions.
You should also inquire about your 401(k) Award Schedule If you haven’t been with the company long. This determines when you are eligible to keep your employer matching funds if you leave the company. Ideally, you can hold out until you’re fully invested so you don’t lose any of your match.
2. Pay high investment fees
All investments charge fees, although not everyone realizes this, because the money comes directly out of your 401(k) each year. There’s no way to avoid fees entirely, but you can keep your costs down by choosing your investments carefully.
Most companies offer their employees a choice of several mutual funds, and these have expense ratios, or annual fees expressed as a percentage of your assets. If you’re paying a 1% expense ratio, that means you’re paying the mutual fund company 1% of all the money you’ve invested in the fund each year. That’s just $1 if you have $100 invested in the fund. But if you have $100,000, you’re paying $1,000 per year.
You should try not to exceed a 1% expense ratio whenever possible, but you may not always have a choice. You are limited to the investment options provided by your employer, and they may not always be the most affordable.
If your employer doesn’t offer an investment option that’s right for you, you can talk to them and see if they’ll add some more low-cost options, like index fundsbut they are not required to do so.
Your other option is to skip your 401(k) altogether and invest in a GO TO, which gives you greater freedom to invest in what you want. But if you go this route, remember to max out 401(k) matching contributions first. You can then switch to your IRA and even return to your 401(k) if you reach your IRA maximum for the year.
3. Take a 401(k) loan
Loan from your 401(k) It may not be as bad as making an early withdrawal, but it’s still something to avoid when possible. Doing this will slow the growth of his savings, forcing him to save even more each month in the future to retire when he originally planned.
Explore other alternatives before taking money out of your 401(k). If you’re thinking of buying a home or car, consider a mortgage or car loan. You could also search a personal loan to finance other types of purchases or to help you pay off high-interest debt. Another option is to just wait and save what you need.
If you have to borrow from your 401(k), try to withdraw as little as possible. Check with your plan administrator for your loan repayment due date, and make sure you pay it all off by that date. If you don’t, the government will treat the outstanding balance as a distribution and you’ll pay taxes on it, plus an early withdrawal penalty if you’re under age 59½.
When thinking about your 401(k), it’s crucial to take a long-term view. A decision like skipping a 401(k) match or taking out a loan may not seem like a big deal right now, but you’ll feel the consequences of these moves more in a few decades than you do now. Learning about your 401(k) and making decisions with your long-term goals in mind can make your 401(k) one of the best tools in your retirement arsenal.
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