From poor investment decisions to not rolling over your plans, these five 401k mistakes can crush your retirement dreams
Work in financial planning and investing for as long as I have and you start seeing mistakes that are nearly universal among clients. Most of these are fairly easy to correct and don’t lead to too much financial hardship. The most heart-breaking are the 401k mistakes that people make, causing them to lose money and crushing their retirement dreams at the last minute.
All of these mistakes can be avoided with a little planning and a calm head. Read through the post and avoid making these most common 401k mistakes.
Panicking and Withdrawing your 401k Money
The S&P 500 didn’t budge in 2015, its worst performance since the crash of 2008. The Federal Reserve has started hiking interest rates, which will drag on the economy towards the latter half of 2016, and growth around the globe isn’t fast enough to prop up the global economy.
A tumble in the stock market may not be far off. Stock prices are trading for more than 22 times the earnings companies made over the last year, well above the average price-to-earnings multiple of 16 times. Any weakness in the economy and investors may decide that the investments aren’t worth their high prices, sending the market crashing as people try to exit all at once.
The result will be a repeat of what we saw in 2000 and 2008. Investors will panic and sell their 401k investments, taking the 401k withdrawal penalties and hit on taxes rather than hold steady for the long-term.
The buy-high, sell-low investor behavior is part of the reason that the average investor earned just 2.6% a year over the decade to 2013 even while stocks averaged a return of 7.6% annually and bonds managed over 4% over the period.
Understand that the market will do as it pleases, crashing every once in a while to clear out the irrational behavior of investors. If you’ve got more than a decade left to retirement, don’t sell out of your 401k investments when market volatility returns.
A better option would be to start positioning in assets that will hold their value or even gain on market volatility. Hard assets like gold and silver are the typical safety investments to which investors scramble during a crash.
Taking a lot of 401k Risk Just before Retirement
This is one of the worst 401k mistakes you could make but nearly everyone makes it. Fidelity reports the average 401k balance is just over $150,000 for those 55 and older. This isn’t enough to retire on and people start getting a little anxious in the years approaching retirement.
What happens is that investors reach for that last big win, putting all their 401k in risky stocks and other investments. Ask anyone that was planning on retiring in 2009 and they’ll tell you it’s not a 401k mistake you want to commit.
Instead of taking more risk leading up to retirement, you should be taking less risk with your investments. You might not have saved up as much as you would have liked but you definitely can’t afford to lose it. Within five to ten years of retirement, you need to be positioning in safer investments that hold their value in good times and bad. If the income from your investments is going to fall short of your goals, reassess the goals instead of putting your entire retirement at risk.
Not taking advantage of a Roth transfer option
One of the best advantages of retirement saving is the immediate benefit to reducing your income taxes. Deposits into a 401k or IRA are tax-deferred until you take the money out in retirement.
The other retirement savings plan, the Roth account, is not as popular because it doesn’t enjoy this immediate benefit. You pay current income taxes on deposits into a Roth retirement account but can then take the money and earnings out tax-free in retirement.
Most people plan on earning less income and having a lower tax obligation during retirement, so it makes sense to pay your taxes later rather than now. But let’s face it, nobody knows what taxes will be like in the future. Besides not being able to know what your income will be like, the government has continuously broken promises and raised rates to cover its runaway spending.
The smart way to avoid this 401k mistake is to hold both traditional IRA and Roth IRA accounts. You’ll pay taxes on withdrawals from the traditional plan while enjoying tax-free withdrawals from your Roth account. Diversify your tax obligation just as you do your investments.
Not transferring old 401k plans
Few people work their entire lives for one company anymore. There’s nothing wrong with that but what you get is a jumble of 401k retirement plans left over at old employers. Besides the risk that any one of these inactive 401k plans could fail due to corporate malfeasance, it makes it impossible to know your asset allocation.
Make sure you convert your old plans with a 401k rollover, combining them into an IRA plan that you control. You’ll know what is happening to your money and will be able to better see the exact percentage you have in different assets like stocks, bonds and precious metals.
Taking out a 401k loan without knowing the risks
Some employers will allow investors to take a 401k loan out on their investments, repaying the amount within five years. IRS rules allow for loans of up to $50,000 or 50% of the account value.
It sounds like a sweet deal since interest rates are fairly low but it ends up being a huge 401k mistake for many borrowers. You’re paying interest on money that was yours anyway and there you’ll have to pay the 10% withdrawal penalty if you can’t pay back the loan. You also lose the ability to make max contributions to your 401k plan, losing the free money match from your employer.
These five 401k mistakes can crush your retirement plans and leave you wondering if you’ll ever be able to retire at all. You’ve worked hard to secure your financial future, don’t make these common mistakes and see it all that hard work disappear.