For most people, saving in a 401(k) retirement plan is vital for their future financial health. Trying to save for retirement in a taxable account is not only challenging, but it’s nearly impossible to duplicate the same tax deferred compounding you get from a tax deferred (and often tax deductible) retirement account. Therefore, employers and their employees will want to avoid these 3 mistakes:
- The first mistake is not following an appropriate investment plan. Being equipped with an appropriate plan is essential to protecting yourself from acting irrationally in volatile markets. Instead of panicking and selling your portfolio when markets are down, stick to your plan and view such times as a buying opportunity. Don’t turn paper losses into real losses and consider this: if a security is down 50% it must rise 100% just to break even! Think about it in dollar terms: a stock that drops 50% from $10 to $5 ($5/$10 = 50%) must rise by $5, or 100% ($5/$5 = 100%), just to return to the original $10 purchase price.Of course, your plan needs to factor in your age and risk tolerance and be well diversified. For example: taking too much risk in volatile stocks when you have only 3 years until retirement is just as harmful to your financial health as taking too little risk when you’re invested exclusively in less risky, but lower return securities.
- The second mistake is not taking full advantage of a 401(k) plan. When you choose not to participate in your 401(k) plan, you’re essentially giving up tax-free money from your employer. This decision will likely put you further behind with your retirement goals. Still, one-third of employees who do participate in a company 401(k) program do not contribute the maximum amount allowed.* The least you should contribute is the amount that will be matched by your employer’s contribution. For example, an employee with a 401(k) plan that has a basic safe harbor match should defer at least 5% of their year-end salary to obtain the full safe harbor match. Again, it’s senseless to turn down free money.
- The third mistake is committed by employers who underestimate the importance of offering a 401(k) plan to their employees. Budget conscious small business employers may decide to terminate their plan, not sponsor a plan at all, or make serious cutbacks to employer contributions. But there can be serious, negative consequences to stopping employer contributions. A safe harbor 401(k) requires employers to provide sufficient notice to their employees if they are stopping contributions, and the safe harbor match may not be stopped mid-year regardless of the employer’s financial situation.Also, a 401(k) plan can be one of the most effective ways to attract and retain high quality employees. Studies show that employers who end their employer contributions often suffer a decline in employee morale and higher personnel turnover rates. Moreover, employers who remove the safe harbor match from their 401(k) plans may jeopardize their ability to maximize their deferral contributions, pay more in third party administration fees (for the additional required IRS testing), and have a logistical headache on their hands.Keep in mind that employer contributions, including fees to pay third party administrators (and record keepers) are tax deductible. The company’s retirement plan should be a major factor when discussing an employee’s compensation package.