In most cases, you are the one managing your 401(k) plan, unless your advisor is the administrator for the entire company plan. This can be a great opportunity for you to understand what you own, but there are a few pitfalls to avoid.
When you start a new job, you have enough on your plate without adding the future of your life in retirement to the mix. There are so many funds to choose from and so much research to do that people become overwhelmed and take the path of least resistance: doing nothing.
If you’ve fallen victim to 401(k) inertia, there are a few main issues you need to make sure you address:
- Are you contributing to the plan, and if so, are you contributing to the full extent of your employer match (if offered)? Not participating in an employer match is leaving guaranteed money on the table!
- Are you invested in the right funds for your individual situation? This does require some initial research, but the long-term benefit is absolutely worthwhile. The sooner you are fully invested, the more time your money has to benefit from compounding.
- Are your beneficiaries up to date? If you have had a big life change like getting married, divorced, or remarried—or if a minor has now reached the age where he or she could be a beneficiary—you may need to update this. You definitely want to avoid a situation in which someone you do not want as an heir is inheriting your life savings! Making sure your beneficiary instructions are as clear as possible can save your heirs the expense and complexity of funds going through the estate. Most of the time this is a very easy change to make, and it is well worth the small effort.
- Do you have old 401(k) plans from past jobs that you have not rolled over? Don’t let your savings linger in a forgotten account! You can roll over your prior plan to your IRA for greater diversification.
- Constant Changes
On the flip side, some investors make frequent changes to their retirement plans. Remember though, that the whole idea of a 401(k) is long-term savings. In most cases, you won’t be able to take money out of your 401(k) account until age 59.5 (unless you want to pay a 10% early withdrawal penalty, plus any taxes). Jumping in and out of funds based on short-term factors just doesn’t make sense. While rebalancing once or twice a year is important (if your plan does not have an auto-rebalance feature), you should not change your strategy for years ahead based on day-to-day emotions or news.
- Becoming emotionally attached to a holding.
It might be that you have loaded up on your company’s stock as a sign of loyalty and a literal investment in your workplace. Or you might just plain like a particular company’s products.
Keeping a particular holding for emotional reasons could be benign if it’s a small portion of your portfolio, but there is an opportunity cost if it’s not a good fit for your needs.
- Not understanding what you own.
Mutual funds often have confusing names that don’t accurately reflect what’s in them. An example is PIMCO Real Return, which is one of the most common 401(k) plan funds. You might assume from the name that it would be focused on earning returns—but in fact, it’s a bond fund with very conservative holdings that aims to preserve capital with rising inflation. In other words, the purpose of the fund is to have a very stable price with almost no return!
To better understand your mutual funds, you can go to Morningstar.com, search the ticker or name of the fund, and you will find a category and description that will explain the fund’s strategy in plain English.
- Borrowing from the plan.
It is possible to borrow from your 401(k) in certain circumstances, but that doesn’t make it a good idea. Though it may seem like you have the money to use, a 401(k) loan is literally borrowing from your future well-being in retirement, and in most cases, stems from not understanding when to invest (long-term goals) versus when to save (short-term goals of five years and under). To add insult to injury, you are taxed twice on 401(k) loans since you pay taxes to withdraw the money and you pay back the loan with money you have already paid taxes on.
You can use this tool to estimate the opportunity cost of taking a 401(k) loan.
- Not contributing enough.
If your employer offers a 401(k) match and you are not taking advantage of it, you are leaving free money on the table. If there is not an employer match, ideally you should start by saving 10% of your income and increasing it as income increases. If you find that 10% is hard to save initially, back into this goal by saving a lesser percentage, and then increasing the amount every three to six months until you reach your goal. Eventually, you may be able to reach the maximum annual 401(k) contribution ($18,000 if under age 50, or $24,000 if over age 50 according to the IRS limits for 2016).
We repeat this often, but it’s true—if you start early and treat retirement saving like a monthly bill, the power of compounding will be hugely beneficial to your future retirement.
- Not knowing how to liquidate.
After a lifetime of saving, there is one last hurdle to benefiting from your 401(k): actually taking out the money. You can begin taking distributions from your account starting at age 59.5, but you are not required to do so until age 70.5 (unless you are an active employee and not classified as an owner). At that point you must take what is called a Required Minimum Distribution, which varies for each individual based on an IRS worksheet.
At Halpern Financial, we provide 401(k) guidance to our clients based on their needs and the options available in their workplace 401(k) plans. Don’t hesitate to ask us if you need help deciding which options to choose!
IMPORTANT DISCLOSURE INFORMATION
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Halpern Financial, Inc.), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Halpern Financial, Inc.. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Halpern Financial, Inc. is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the Halpern Financial, Inc.’s current written disclosure statement discussing our advisory services and fees is available for review upon request.
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