A 401k can be a magical thing. It’s a tax shelter available to most every American that can offer great returns—particularly if you have a matching program to take advantage of. But you may not know all there is to know about this personal financial tool.
Read up on a few ways in which you might be messing with the goose that wants to lay your golden eggs, and make sure you’re not doing any of these things:
1. Not Being Matched
It seems obvious: don’t turn down free money. And you get free money if you contribute enough to trigger your company’s matching plan. Usually, this is about 3-5% of your gross. Figure out what corners you need to cut to make this possible, and then smile your way to the bank.
2. Not Maxing Out
Contributing 5% is great, but if you can configure things to do better, you definitely should. Depending on your tax bracket and age, you can defer between $18k and $24k of your salary. Put in as much as you possibly can—and more if you and your spouse are both working.
3. Borrowing From Yourself
It’s so tempting, but unless you’re in an absolute emergency situation, act as though your 401k is totally off-limits until retirement. You’ll be penalized and taxed for withdrawals and loans come with a high tax rate. And remember: if a big emergency expense does come up, you could consider using your credit instead. Worst case scenario, most 401ks remain safe in bankruptcy proceedings.
4. Transferring/Cashing Out
If you’re switching jobs, don’t cash out your 401k or you’ll have to pay a 10% tax penalty. But don’t just roll it over into your new employer’s plan either. Consider opening a traditional IRA; there won’t be a penalty if you follow the appropriate procedures, and then you have much more investment freedom.
5. Not Upping Your Contribution
Every time your pay rises, automatically increase the size of your 401k contribution. Try living on your old salary and putting the whole difference away for retirement. This helps you avoid lifestyle creep and means you can retire earlier and better.
6. Not Managing Your Portfolio
Keep and eye on your allocations. Are you investing too much or too little in stocks? Are you risking too much or too little? How close are you to the golden retirement age? Are you being the right amount of careful for where you are in your career? Don’t just fall asleep at the wheel and let good money get drained away by unanticipated market crashes.
7. Not Diversifying
Don’t just put all of your 401k in one fund, particularly if your 401k is your primary investment source. Try to cover four categories: index, growth, international, and bonds. This will spread out your risk and keep your portfolio diverse. And make sure to choose funds with low fees (i.e. expense ratios of less than 1%).