Saving for retirement is something we all know we should be doing. The ease and convenience of having contributions automatically deducted from your paycheck can be a major enhancement to your retirement possibilities. When you add on the tax savings from Uncle Sam it is no surprise why 401(k)s are a popular way to prepare for retirement. Despite a widespread understanding that most of us need to save for retirement, not all employees with access are actually participating in an employer-sponsored retirement plan.
If you are currently saving for retirement in a 401(k), you already have taken a step in the right direction. While you may rest at ease thinking you are one of the fortunate ones able to save for retirement, it is important to realize that just participating may not be enough. If you aren't paying attention, you may be making some major mistakes in your 401(k) plan that you are not aware of. Learn how to overcome those mistakes.
Not Knowing Retirement Needs
Predicting exactly how much money you will need to live comfortably isn't easy. Still, many retirement savers make the mistake of not having some basic retirement saving goals in place that they can strive to achieve. Lack of awareness regarding how much you need to be setting aside to achieve a sense of financial freedom likely will result in some bad consequences.
The good news is that running a basic retirement calculator at least once per year can improve your chances for success. Running a few ballpark estimates is helpful even if you have decades to go until retirement and your vision of life after work is a little fuzzy. The sooner you start running a retirement estimator the more time you’ll have on your side to make any necessary adjustments.
The Solution: Start by creating a simple definition of what financial freedom means to you. This will help you begin thinking about the lifestyle you would like during retirement. There isn’t a magic number that works for everyone. Conventional wisdom suggests the average person will need to replace around 70% to 90% of pre-retirement income to maintain a comfortable lifestyle. The most important thing you can do is to start thinking about how much you likely will need based on your lifestyle goals. If you aren’t sure what your acceptable income range is, run some retirement calculators to see if you are on the right track toward a secure retirement.
Saving Too Little
Many employers have shifted to auto-enrolling new employees in 401(k) plans. This can help increase retirement plan participation rates, but if the automatic enrollment amount isn’t enough to help you reach your personal goals, you may have an income shortfall. A typical amount saved in a 401(k) plan is around 6%. Even when you add an additional 3% matching contribution, you may find yourself behind on your savings plan. While not saving anything for retirement is a big problem, not saving enough is another major mistake.
So exactly how much is enough? While the amount you need to save will vary based on your personal goals, many experts suggest saving a target goal of between 10% and 20% of your income. This can be frustrating to hear if you are trying to make ends meet and pay for current financial obligations. If you are paying off high-interest debt or still trying to build up your emergency savings, then it usually makes sense to contribute enough to at least get the company match.
The Solution: The obvious answer if you aren’t saving enough is to save more. But that may seem a bit daunting if you are already trying to balance competing priorities. Review your spending plan and see if you can make any adjustments to increase your 401(k) contribution rate. Then, avoid falling victim to those good intentions to save more tomorrow by making a commitment to automate future increases. Contribution rate escalator features in 401(k) plans allow you to automatically bump up your savings over time. A calculator will help you see how much these small changes can impact your retirement outlook.
Fees should always be on your radar. While your 401(k) account balance at the time you retire will determine how much income you ultimately will receive, the fees and expenses in your plan will gradually work to reduce your potential growth.
For 401(k)s, fees and expenses generally fall into three categories as defined by the U.S. Department of Labor: plan administration fees, investment fees, and individual service fees.
The financial services industry has gotten better at disclosing fees, but it still can seem overwhelming for the average investor to figure out how much they are really paying in fees and expenses within 401(k) plans.
The Solution: Review your plan documents to see if you can determine how much you are paying in your 401(k) plan. Larger plans tend to have lower expenses. Other tools include the Fund Analyzer tool provided through FINRA. If you have an old 401(k plan from a previous employer, be sure to compare the fees to your current plan to help you decide if a 401(k) or IRA rollover makes sense.
Overemphasizing Company Stock
One of the biggest disadvantages of having employer stock in your retirement plan is that large company stock holdings may increase the volatility of your retirement portfolio. Fewer 401k plans are using company stock for matching contributions, but there still are many employers that give employees the option to invest in corporate stock within the 401(k).
The Solution: Assess how much risk you are exposed to if your 401(k) plan includes company stock. Try to keep your overall exposure to any individual stock to no more than 10% to 15% of your total retirement portfolio.
Failing to Rebalance Investments
It’s no secret that investments rise and fall over time. The general premise behind asset allocation is that certain asset classes do not always rise and fall together. As such, your original game plan to diversify across different asset classes may drift over time.
The Solution: You may choose to participate in an automatic rebalancing program if one is offered in your 401(k) plan. As an alternative, investing in target-date retirement funds or asset allocation mutual funds will help you take a more hands-off approach to rebalancing your investments on a consistent basis.
Wasting Opportunities for Matching Funds
Matching contributions represent additional income from your employer. If your employer matches any percentage of your 401(k) contributions, it often makes sense to at least contribute enough to take full advantage of the match.
The 401k contribution limit as of 2019 is $19,000 ($25,000 if you are 50 or older).
The Solution: Review your benefits package to see exactly how much, if anything, your employer will match in your 401(k). If you are already contributing enough to receive the full matching contribution, consider increasing your contributions above the match.
Ignoring Roth Options
When you begin taking money out of your pre-tax 401(k) accounts during retirement, the withdrawals are treated as taxable income. In contrast, Roth 401(k)s allow your earnings to grow tax-free. This typically benefits those who do not need to lower their taxable income today or anticipate being in the same or higher income tax bracket during retirement.
The Solution: Compare the differences between traditional pre-tax contributions and the Roth 401(k). Decide whether it makes more sense for you to receive the known tax benefits of using pre-tax savings today versus the uncertainty of future tax savings in the Roth 401(k).