Stashing money away in your 401(k) for years on end, sadly, does not guarantee a fruitful retirement. Just look at the numbers. Fidelity reports that the average 401(k) balance in 2018 was $102,900 . That’s just a fraction of what you’d need to live comfortably for decades without a paycheck. To put things in perspective, the AARP calculates that a retiree needs $1.18 million on hand to provide annual income of $40,000 for 30 years.
So why aren’t savers building up seven-figure balances in their 401(k) plans? Because 401(k) saving is complicated, for one. Using your employer-sponsored plan effectively goes well beyond contributing regularly and watching the balance grow. You also have to manage tricky topics like company match, vesting, and investment performance. Here are four major 401(k) mistakes that might be pushing back the timeline of your retirement.
1. Not taking advantage of company match
One of the most compelling benefits of participating in a 401(k) plan is the opportunity to receive free retirement contributions from your employer, also known as company-match contributions. Typically, your employer matches your contributions, up to a specific percentage of your annual salary.
Exact rules for matching vary by plan. If you don’t know the maximum company match for your plan, contact your plan administrator and find out. Then, adjust your contribution accordingly. In other words, if your company matches contributions up to 6% of your salary, then you need to contribute at least 6% to get your full match.
Company-match contributions can double your 401(k) savings for free, but there is a catch. It’s called vesting, which delays your ownership in those company-funded contributions. Vesting rules may, for example, state that you own 0% of the company contributions in your first year of employment, 50% after two years, 75% after three years, and 100% after five years. That means if you leave the company in year one, you can’t take your company-match contributions with you.
If you are considering another career opportunity before you are fully vested, make sure you consider any money you’re leaving on the table in your 401(k). You may decide to stick around and hang on to those company-match contributions.
2. Cashing out when you change jobs
If you do have to change jobs, do not, under any circumstances, cash out your 401(k). Some plans may allow you to leave the money with your former employer, and some may not. If you have to move the funds, do a direct rollover into an IRA or, if possible, into your new employer’s plan. In a direct rollover, the funds are moved electronically — leaving no chance for you to spend the money.
3. Not increasing contributions over time
Your 401(k) contributions are generally stated as a percentage of your salary. So if you elect to contribute 6%, the actual dollar amount of your contribution will increase as your income goes up. But if you want to be a true 401(k) rock star, that’s not enough. Let’s look at the numbers to see why.
Say you make $75,000 a year and contribute 6%, or $4,500, to your retirement plan. If you get a 5% raise, your salary goes up to $78,750, and that increases your 6% 401(k) contribution to $4,725. You are now making $3,750 more, but your annual contribution only went up by $225.
Your cost of living doesn’t change the day you get a raise. In this scenario, you could afford to increase your annual contribution to 10%, which would be $7,500 annually.
4. Ignoring investment performance
At some point, you decided how to invest your 401(k) contributions. Probably you selected from a handful of stock and bond funds with varying levels of risk. If you haven’t paid attention to how those investments are performing for you, do it now. Because a portfolio that returns 7% over time looks strikingly different, in a good way, from one that returns 2%.
An average annual return of 7% is a nice target for the long term, but know that returns rise and fall with market conditions. To understand what level of return is realistic, look to indices or other similar funds as a benchmark. Say you’re holding a small-cap fund. You could compare its performance to the S&P Small Cap Index 600 over the same time period. Or evaluate your 2050 target-date fund against the performance of other, similar target-date funds like Vanguard Target Retirement 2050.
If your picks are underperforming in a big way, try something different. The more years you have between now and retirement, the more aggressive you can be.
You might end up deciding that your 401(k) just doesn’t have great investment options. In that case, you can divert some of your cash into an IRA or even a traditional brokerage account to improve your savings performance.
Manage your 401(k) to secure your retirement
Make the most of your 401(k)’s potential by saving early and often, resisting the urge to cash out, and managing how your money is invested. These tweaks can dramatically increase your savings over time — which puts you that much closer to turning in your retirement notice.
