401(k) plans are one of the most popular investment vehicles used to save for retirement; according to the Investment Company Institute, approximately 60 million Americans participated in a 401(k) plan in 2021. While participating is important, merely doing so isn’t enough—you should also be aware of and avoid common mistakes that can potentially jeopardize your future goals. Let’s dive in and discuss some widespread blunders to help you avoid the same.

Not participating when you can

A common mistake is failing to participate in a 401(k) plan when your employer offers one. Seems obvious, right? Perhaps not so much when you consider that only 41% of workers with access to a 401(k) at work actually participate in that plan, according to the U.S. Census Bureau.

Saving too little

How much should you save? If you do a little research online, you’ll discover various rules of thumb that say you should save anywhere from 10-20% of your gross income after you’ve paid off any high-interest non-mortgage debt. You can also attempt to predict how much money you’ll need in retirement, though that isn’t the easiest exercise—especially if your golden years are a long way away (by the way, perhaps it’s helpful to know the average retiree spent $52,141 in 2021). Even if you home in on a number you’re comfortable with, you’ll then need to decide how much to allocate to your 401(k); according to a recent study by Fidelity Investments, the average annual 401(k) savings rate was 9.3% of worker earnings.

The truth is that there is no right or wrong number. How much you should save (and how to save it!) ultimately depends on your own personal financial situation and goals. That said, we do encourage you to sock away as much as possible because retirement certainly isn’t cheap and is only getting more expensive as the years march on.

At a minimum, you should contribute the entire amount eligible for employer matching—assuming that’s offered within your 401(k) plan. Ignoring this benefit would mean losing out on free money and the easiest way to boost your savings rate.

Not rebalancing

Before you invest, you should know your risk tolerance so that you (or your financial advisor) will know how to properly allocate your investments between stocks, bonds, and other vehicles (a process known as “asset allocation”). Once you select your investments, it’s important to engage in periodic reviews and rebalance if necessary.

Rebalancing is simply the process of adjusting (buying and selling) your investments to restore portfolio weights to your desired asset allocation. For example, assume your initial investment was $50,000 and you allocated $30,000 (60%) of it to stocks and $20,000 (40%) to bonds. Subsequently, assume your stocks perform well over the year and the overall value of your portfolio increases to $55,000 but also shifts your allocation to 70% stocks (worth $38,500) and 30% bonds (worth $16,500). In this case, you (or your financial advisor) would simply sell stocks and buy additional bonds to return to your portfolio's original 60/40 allocation.

The objective of rebalancing is twofold. First, you can optimize the value of your portfolio by selling investments when their value is high and buying other investments that have decreased in value but still have merit. Second, rebalancing helps keep you disciplined in that your investments won’t sway too far away from your tolerance for risk.

The best approach you can take is to review your 401(k) investments at least once a year and then determine—with the guidance of a financial advisor—whether rebalancing is necessary.

Taking out a 401(k) loan amidst alternatives

If your 401(k) plan offers the option to take out a loan, the maximum amount you’re generally allowed to borrow is 50% of your vested account balance or $50,000: whichever is less. Thus, if your vested balance is $50,000, you can borrow up to $25,000.

While a 401(k) loan may make sense in some cases, the risks generally outweigh the benefits—as you’ll miss out on potential investment growth, may end up contributing less or nothing at all (some employers may not allow contributions when a loan is outstanding), and may be required to pay your loan back sooner than expected if you leave your job (voluntarily or not). As for better alternatives? These often include a home equity loan, personal loan, or zero-rate promotional credit card (assuming you can pay off the balance within the promotional period).

Leaving your job prior to vesting

It usually doesn’t make sense to leave any money on the table; therefore, you should check your plan’s vesting rules before changing jobs whenever possible. If you leave before you’re vested, you won’t be able to keep contributions made by your employer—which is essentially free money.

Over-investing in company stock

Many employers offer their employees the option to invest in company stock within their 401(k) plans. While these opportunities are sometimes appealing, you’ll need to ensure you don’t overexpose yourself to excessive risk if you decide to engage in this practice—meaning that you should generally not have more than 10 to 15% of your total retirement portfolio in one stock, as this could increase the volatility of your assets.

Ignoring old 401(k) plans

If you have a 401(k) with a previous employer, you may want to reconsider keeping it there. One option is to roll the funds over into your current employer’s plan (if allowed), especially if you're satisfied with corresponding investment options, costs, and features. Plus, the decision to consolidate means one less account for you to manage!

You may also want to consider rolling over your savings into an IRA, in turn enjoying more investment choices than 401(k) plans typically offer. Plus, if you plan on changing jobs at least a few times over the remainder of your career, an IRA can serve as a single destination for the entire breadth of your retirement savings plans.

Not taking advantage of catch-up contributions

If you’re age 50 or older, the IRS allows you to make contributions above standard limits to your 401(k) and IRAs: known as “catch-up contributions.”

For 2023, these limits are an additional $7,500 per year for your 401(k) and $1,000 for your IRA: or a total of $8,500 if you have both accounts.

If it makes sense for your overall plan, you should take advantage of these benefits—because even if you save an extra $3,000 annually ($250 a month) for 15 years and average a 4% return, you’d accumulate more than $61,000 in additional savings for retirement.

In sum: avoiding 401(k) mistakes

You’re probably already off to a good start if you’re currently participating in your employer’s 401(k) plan. However, you’ll be off to an even better start if you avoid the common 401(k) mistakes discussed in this article. Be sure to reevaluate your approach and make any necessary changes, accordingly!

Want to make sure you’re getting the most out of your 401(k)? Schedule a FREE Discovery call with one of our CFP® professionals.

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Vision Retirement is an independent registered advisor (RIA) firm headquartered in Ridgewood, New Jersey. Launched in 2006 to better help people prepare for retirement and feel more confident in their decision-making, our firm’s mission is to provide clients with clarity and guidance so they can enjoy a comfortable and stress-free retirement. To schedule a no-obligation consultation with one of our financial advisors, please click here.

Disclosures:
This document is a summary only and is not intended to provide specific advice or recommendations for any individual or business.