Top 401k Mistakes That Hurt Your Retirement

Hopefully, everyone who has access to a 401k is contributing to a 401k. To not do so is a mistake you don’t want to realize when you’re old and unwilling or unable to work. This post will discuss all the top 401k mistakes that hurt your retirement.

Let us be clear. The government isn’t going to save you. With a large Social Security funding shortfall, the government is having a hard time saving itself.

Further, thanks to a global pandemic and massive stimulus, the government has a huge budget deficit. Therefore, the government will probably adversely affect your retirement life by either raising the eligibility age to receive Social Security and Medicare, raise taxes or both!

Having contributed to a 401k and a Solo 401k since 1999, I’ve made plenty of mistakes that have likely cost me over $150,000 in lost appreciation over the years. My goal for this post is to help you not make the same 401k mistakes I made.

Top 401k Mistakes Hurting Your Retirement Portfolio

1) Not knowing your employee benefits

When you first get a job, you’re anxious to provide value and bond with your colleagues. Due to your excitement, chances are high that you won’t bother to read the employee handbook that describes all your benefits. 

It’s very easy to overlook benefits such as health care, paid time off, sick leave, retirement savings plans, paid education, and sabbaticals when you are young because what do you care? You’ve got your whole life ahead of you to save for the future. It’s hard to think about ever burning out at work because you’ve only just begun.

One of the first things you should do when you get any job is to thoroughly understand all your employee benefits. Once you’ve read your employee handbook, make an appointment with HR. Have them elaborate on every section of the handbook and answer follow-up questions.

Ask about your employer’s 401k plan, vesting period, and company match percentage. Learn how to set up your 401k contribution. Then automatically deduct a certain amount from your paycheck or after each bonus.

When I was making a $40,000 base salary in Manhattan back in 1999, I only contributed $3,000 to my 401k that year. I had just started work in July (graduated in May) and was just thrilled to have a job. If I had studied my firm’s 401k plan, I would have known I could have contributed a maximum of $10,500 in 1999.

Back then, I was so busy working 12-hour days. After the long day was done, I’d spend another several hours studying for my Series 7 exam. The last thing on my mind was contributing to my 401k plan. After a long evening, my classmates and I wanted to enjoy NYC’s nightlife!

2) Not maxing out your 401k every year

If you do nothing else for your retirement, at least max out your 401k every year. Yes, it might seem daunting to max out a 401k when you’re first starting out. However, remember before you started work you were even more broke as a student!

Maxing out your 401k is a habit you should accomplish every year. I promise you will be able to adjust your spending habits after you set up your automatic pre-tax 401k contributions.

Over time, as you earn more money, maxing out your 401k will get easier. Once you turn 50, you can contribute an extra $6,500 a year in pre-tax income into your 401k as catch-up contributions. In 10 years, you will be amazed by how much you’ve accumulated in your 401k.

Below is my 401k savings chart by age. I’m confident everyone who maxes out their 401k for the next 20 years will be millionaires. If you’re not, you can blame the government.

401k Savings Targets By Age Guide - 401k mistakes

3) Not paying any attention to your investments

The world and your needs are changing all the time. As a result, it’s important to stay on top of your 401k investments. It’s worth rebalancing at least twice a year, even if only minor tweaks are made.

The goal is to review your 401k portfolio at least twice a year to make sure your asset allocation is congruent with your financial goals and risk tolerance. Your risk tolerance may be very different as a 25-year-old versus a 50-year-old who is burning out at work.

Back in 1999, everything was going great with tech and internet stocks on fire. Nobody could lose until the NASDAQ imploded one fateful day back in the spring of 2000.

After reading all about my firm’s retirement benefits, I had been diligently maxing out all I could in a hyper-growth Janus Tech fund that could do no wrong. Then it blew up. I hadn’t bothered with diversification, cash management, or buying bonds.

I paid the price, but luckily I didn’t have that much money invested in my 401(k) at the time. It’s good to learn from your mistakes when you’re still young and poor!

4) Trading way too often

The flip side of not paying attention to your 401k is paying too much attention to you 401k.

It’s been shown time and time again that trading in and out of securities is a bad idea. You will likely underperform your respective indices.

The time you spent trading your 401k is time you could have spent becoming a better employee. Getting promoted and paid is where the real money is for the first 15-20 years of your career.

Trading my 401k too much was my biggest problem. I worked in the Equities department of a couple of Wall Street firms. Stocks were all I thought about and talked about every day.

I couldn’t help but trade my portfolio, like a bartender who can’t help but sip on his concoctions until he gets a little too tipsy for his own good.

On some trades, I made a killing. On other trades, I underperformed miserably. At the end of each year I’d compare my gains to my losses, and most of the time the difference was negligible (i.e., under $20,000). For many years in a row, I’d reach Fidelity’s rebalancing limit and get a warning. Thankfully, there was a trade limit; otherwise, I would have kept on going.

If you have trading tendencies, try and keep your rebalancing to once a quarter, max. The more you trade, the worse your performance in the long run. Don’t let trading distract you from work.

5) Borrowing or withdrawing from your 401k

There is a reason why the government withholds taxes from us throughout the year. Humans cannot be trusted to do the right thing with money!

Can you imagine the chaos that would ensue if the government allowed its taxpayers to pay everything they owed at the end of the year? Half of us wouldn’t come up with anything because we’d have spent all our money. 40% of us would probably fudge our taxes to the point where we’d argue to pay much less. Maybe only about 10% of us would actually be good boys and girls and pay 100% of what the government told us we owed.

Borrowing from your 401k puts a huge drag on performance. The only positive is that you are paying a high borrowing rate back to yourself. Yo also use after-tax dollars to pay back your 401K loan.

As the saying goes, “time in the market is better than timing the market.” If you permanently withdraw from your 401k, not only will you pay normal income taxes, you’ll also pay a 10% penalty on your money.

Of course, if the choice is between death and borrowing from your 401k, then pillaging your 401k is a better course of action. But hopefully, no Financial Samurai reader will ever be that short of money, because, in addition to contributing to a 401k, everyone should also be saving in a taxable investment account as well.

As soon as you let yourself borrow from your 401k, the floodgates may open. You’ll want to borrow every time there is an emergency.

Related: Only Petulant Fools Borrow From Their 401k

6) Not contributing once you’ve left your job

A job change is generally a stressful time. You could have lost your job due to a layoff or you could have found a new exciting job opportunity. Whether you are self-employed or a new employee, it’s important to continue contributing to your 401k or other pre-tax retirement accounts.

When I left my job in 2012, I was feeling very content to finally get out of the rat race. I wanted to spend all my free time writing and traveling, so that’s what I did. I didn’t bother researching things such as the SEP IRA or Keogh 401k (solo 401k) until the very end of the year because I had already rolled over my 401k into an IRA. The last thing on my mind was contributing to my retirement because I was already retired. I wanted to spend my money, not save!

In retrospect, I made two 401k mistakes in 2012. The first mistake was not contributing the maximum $17,000 to my employer 401k.

I had left work in April 2012 and had gotten the last of my base salary in June 2012. If I had planned better, I would have upped my 401k percentage contribution from my base salary to get to the maximum $17,000 amount before I left. But I didn’t because there were too many things going on. As a result, the most I contributed was about $8,500 to my 401k.

My second mistake was not opening a Solo 401k in 2012 and also contributing the 401k maximum of $17,000 from my online income. All told, I missed out on contributing $25,500 to my 401ks. At an 8% compound return, these 401k mistakes cost me $22,000 in lost profit over these past eight years.

7) Joining a firm with no 401k benefits

Only after you retire or become unemployed do you really start to appreciate company benefits. When I left work in 2012, I also left behind between $20,000 – $25,000 a year in company profit sharing. This company profit sharing was deposited directly into my 401k each year. Then, of course, I eventually had to start paying for full health care insurance premiums once my wife retired as well.

The type of companies that tend not to have any 401k or retirement benefits is startups. Joining a startup has become more popular over time. However, most startups fail or fail to exit big. Therefore, if you join a startup, not only are you likely getting paid a lower salary than you could get at an established firm, you’re also likely foregoing any 401k benefits.

When you make your employment decision, definitely take into consideration the 401k profit sharing and other benefits. The company you join that doesn’t have a 401k better have massive equity upside.

Below are the historical 401k contribution limits. Please also pay attention to how much the employer can contribute as well as the catch-up contributions once you turn 50.

Historical 401(k) Contribution Limits Up To 2020

8) Converting your 401k into a Roth IRA

This 401k mistake might not seem like a mistake to some. But I think it’s a mistake for high income earners.

It’s one thing to contribute to a Roth IRA if your marginal income tax rate is on the lower side or if you’ve already maxed out your 401(k). It’s another thing to convert your 401k into a Roth IRA if you reside in one of the higher taxed states in the country and are in a top income tax bracket.

If you live in California, Wisconsin, New York, New Jersey, Connecticut, Pennsylvania, or Maryland, please consider delaying your Roth IRA conversion until after you move to a lower income tax state such as Florida, Wyoming, Washington, Oregon, Tennessee, or Louisiana. If not, you will be paying 3% up to 10% more in taxes than you would otherwise.

The greater your 401k’s value and the higher your taxes, the more you should consider never doing a Roth IRA conversion. Simply rollover your 401k into a traditional IRA without paying taxes up front.

If you’re a young buck in a low-income tax bracket who anticipates great earnings potential ahead, then converting your 401k into a Roth IRA makes more sense. Just know that as soon as you give up your free will, you might as well give up your freedom as a US citizen.

Relative to the private sector, the government is extremely wasteful. The more you pay in taxes, the more you will realize this truth.

See: Disadvantages Of A ROTH IRA: Not All Is What It Seems

9) Only relying on your 401k for retirement

If you want to retire comfortably, relying only on your 401k is a mistake. In the past, most company and government workers got pensions for life. Today, less than 15% of Americans get pensions.

The mistake some people with pensions make is not contributing to a 401k or taxable investment account because they think a pension is all they need. If their companies go belly up or if the government decides to reduce their pensions, these retirees will end up in a difficult situation.

Everyone must not only max out their 401k every year, but also build up a taxable investment portfolio equal to or greater than your 401k. On top of these two investment vehicles, everyone should also devise a way to make supplemental retirement income as well.

This is the new three-legged retirement stool: you, you, and you. You must count only on yourself to survive. If Social Security, a pension, and a rich aunt give you a financial boost, then wonderful! If not, then you’ll still be just fine.

10) Paying high 401k fees

Do you know who are the richest fund managers in the world? They are those who not only gather the most assets but also charge the most in fees. Given that The Vanguard Group manages trillions of dollars, you might think the late founder, Jack Bogle, would have died a billionaire. Wrong. Before Jack died he revealed to the public that his net worth was in “the low double-digit millions.”

In contrast, hedge fund managers and all-star active fund managers are worth much more due to fees. For example, Steve A. Cohen of SAC Capital – who had one of his fund managers convicted of insider trading – got paid over $2 billion just in 2013.

The money management business is one of the best businesses in the world to get rich because it is so scalable. It doesn’t take a person any more brainpower to manage a $100 million portfolio than it does to manage a $10 billion portfolio. 

For 11 years, I never once looked at the fees I was paying in my 401k until I discovered Personal Capital in 2012. When I ran my 401(k) through Personal Capital’s 401(k) Fee Analyzer tool, I was absolutely shocked to discover I was paying $1,700 a year in fees.

Due to the 401k fee analysis, I sold my Fidelity Blue Chip Growth Fund and bought a Vanguard Blue Chip Growth fund with much lower fees. Below is a snapshot of what my 401k portfolio looked like before I made the change.

Why don't more people contribute more to their 401(k)

11) Not taking your required minimum distributions

You must start taking mandatory minimum distributions from your 401(k) in the year you turn 72 or the year you retire. The age is up from 70.5 due to the passage of the SECURE Act.

The minimum amount you must withdraw each year is calculated by dividing your 401(k) account balance by your longevity, as defined by an IRS longevity table. The required minimum will vary each subsequent year to reflect earnings and the fact that calculated life expectancy is reduced by 9 months. You can have your 401(k) administrator calculate your minimum each year.

If you fail to take your required minimum distribution, the IRS will impose a penalty tax equal to 50 percent of the required minimum distribution that wasn’t withdrawn. Further, if your required minimum distribution is too large, it may bump up your income tax or capital gains tax rate.

When you reach the age where you are able to withdraw from your 401k penalty-free, please do another round of financial planning for your golden years.

401k Mistakes Can Be Fixed

Live long enough and you’ll make a lot of mistakes. The good thing is, you now know the most common 401k mistakes people make and how to avoid them.

Please don’t waste your opportunity to contribute the maximum amount every single year. Stay the course and know that every 401k contribution makes your future retirement a little bit better. X-ray your 401k for excessive fees and keep track of your finances.

Build a retirement portfolio that generates a healthy amount of passive income. If you do, you will eventually start viewing your 401k as bonus money. At this point, you probably won’t have a retirement worry in the world because you’re also treating Social Security as bonus money too.

Readers, what are some other 401k mistakes you are aware of? Have you ever made any of these 401k mistakes?


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