Top 5 mistakes employees make with 401(k)s

The results are in, and our advisors have agreed that these are the five most common mistakes employees make with their 401(k) plans:

1.       Not participating: The biggest mistake you can make is not contributing to a 401(k) if you are eligible, especially if your employer matches your contributions.  Start out with small contributions and increase them gradually, otherwise you are missing out on an effective pretax and tax-deferred investment.  The only reason not to start contributing is if you have an outstanding debt, as paying off your debt should be a priority.

2.       Not contributing enough:  Contribute enough to receive your employer’s match. Many employers will match your contribution up to a certain percentage. Otherwise, you are basically walking away from free money. For 2013, you can contribute as much as 17,500 in addition to a catch up of $5500 for those 50 or older. For example, if your employer matches you dollar-for-dollar up to 5%, and you make $100,000 annually, then you should aim for a minimum contribution of $5,000 so that you will receive a match of $5,000 from your employer.

3.       Forgetting to rollover or cashing out your 401(k) when switching jobs: In the hassle of switching jobs, many put off rolling over their 401(k), eventually forgetting about it all together. Almost half of employees choose to cash out their 401(k) balances when they switch jobs. Cashing out the balance before retirement causes the money to be subject to both an income tax and a 10% penalty. Instead, you can easily roll over your 401(k) into your new employer’s plan or an individual retirement account (IRA). Don’t put it off and don’t cash out.

4.       Taking a loan from your 401(k): Although you can borrow up to half of your 401(k) balance (a maximum of $50,000), it’s best to leave your money untouched.  You may be tempted to take out a loan from your 401(k) when in need of cash, since after all, you’re paying yourself back with interest. But the money withdrawn from your 401(k) will no longer compound and this could set you back from your retirement goals. Moreover, if you are terminated or switch jobs, you have to repay the amount within 30 to 60 days; otherwise, you will have to pay taxes and penalties on it.

5.       Poor diversification:  Many employees select only a couple of stocks or mutual funds, leaving their portfolio undiversified, which is riskier by definition. Decide on an asset allocation that fits your risk tolerance. Additionally, most employees hold too much of their company’s stock.  Even if you feel confident in the future prospect of your company, it’s still not ideal to have a large percentage of your investments in your company’s stock. Having a balanced portfolio can help to protect you from market volatility.

Don’t be a statistic. Avoid these errors and get started on the path to a happier retirement.

Azzad Asset Management

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