Employer-sponsored 401(k) plans are an extremely valuable savings tool. But if you don't manage yours the right way, you could end up losing out on income that could otherwise prove quite valuable in retirement. Here are four mistakes you could be making with your savings -- and how to fix them.
1. Not knowing what you're paying in investment fees
The privilege of having a 401(k) comes at a cost. Not only do these plans impose administrative fees that are passed on to savers, but the individual investments 401(k)s offer charge fees as well. The problem? Most people with a 401(k) are clueless in this regard.
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In a TD Ameritrade survey last year, 73% of Americans didn't know how much they were paying in 401(k) fees. If you're one of them, take a look at your plan and see how much your investments are costing you, because while you probably can't do much to change what you pay in administrative fees, you can choose cheaper funds to put your money into -- namely, by opting for index funds, which are passively managed, overly actively managed mutual funds.
2. Sticking with your plan's default investment option
When you first sign up for a 401(k), your money will generally be invested in your plan's default fund until you go in and choose the specific investments you're interested in. That default fund is usually a target-date fund -- a fund designed to grow increasingly conservative as you inch closer to retirement.
Target-date funds aren't always a bad idea, but they also don't necessarily provide the best returns. Your plan's default target date might also be a mismatch with regard to your personal risk tolerance. Therefore, once you open your 401(k), don't wait months or, worse yet, years, to select your investments. If you need help choosing the right funds, consult a financial advisor or ask your employer for assistance. Many companies bring in independent financial professionals to assist employees with these decisions.
3. Not contributing enough to get your employer match
Most companies that sponsor 401(k) plans also match employee contributions to varying degrees. But if you don't put in enough of your own money to snag that match, you'll essentially end up leaving free cash on the table -- and perhaps a lot of it.
As of late 2018, the average employer contribution to a 401(k) was 5.1% of employee pay, which, based on nationwide earnings, equals close to $2,400. Keep in mind that when you give up any sort of match, you don't just lose out on that principal; you also lose out on potential growth associated with it.
Imagine, for example, that you give up $2,400 this year, and that you're not retiring for another 30. Investing that $2,400 at an average annual 7% return could turn it into $18,000, and that's a large chunk of future income to give up. Therefore, cut back on living expenses, work an extra job, or do whatever it takes to eke out enough money to snag your employer match in full.
4. Not understanding your plan's vesting schedule
Some 401(k) plans come with a vesting schedule, and if yours does, it means you won't retain complete ownership of your employer match right away. For example, your company might impose a five-year vesting schedule where you gain ownership of 20% of your employer's contributions per year until you're 100% vested.
Understanding your vesting schedule could help you make better choices with regard to your job and your 401(k). For example, say your employer imposes what's known as a cliff vesting schedule, which means that you must wait a certain amount of time to get ownership of your employer's contributions, and you get nothing along the way. If that vesting schedule spans five years, leaving your job at the four-year mark would mean forfeiting the matching dollars you'd otherwise be entitled to. So, you might stay on an extra year and get that cash.
The more careful you are in managing your 401(k), the better that account will serve you in retirement. Avoid these mistakes, and with any luck, you'll be sitting on a nice chunk of cash by the time your golden years roll around.
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