The 401(k) is an important retirement savings tool because its annual contribution limits are far more generous than those of an IRA. Currently, workers under 50 can sock away up to $19,000 a year in a 401(k), while those 50 and over get a $6,000 catch-up that raises this limit to $25,000. IRAs, by contrast, max out at $6,000 and $7,000, respectively.
But just because you have access to a 401(k) doesn't mean you're making the most of it. And if you fall victim to these mistakes, you could end up hurting your savings on a long-term basis.
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1. Not snagging your full employer match
Most companies that sponsor 401(k)s also match worker contributions to varying degrees. There's no standard for employer matches -- it's at your company's discretion. But it pays to familiarize yourself with what you need to do to snag that match, and then contribute enough money to capitalize on it in full. If you don't, you'll effectively be leaving free money on the table.
Imagine your employer is willing to match contributions equal to up to 3% of your salary. If you earn $60,000 a year, all you need to do is contribute $1,800 to get another $1,800 from your employer. If you don't, you'll be giving up an opportunity not only to get extra money in that account, but also to invest those matching dollars for added growth.
2. Choosing the wrong investments
If you're the conservative type, you may be inclined to play it safe with your 401(k) by mostly investing in bonds. Big mistake. If you don't go reasonably heavy on stocks during your investment window, you'll lose out on higher returns, thereby limiting growth in your account.
Imagine you manage to sock away $400 a month for retirement over a 30-year period. With a stock-heavy investment strategy, you might easily score an average annual 7% return over those three decades (which is a bit below the stock market's average), leaving you with $453,000 in savings at the end of the day. But if you stick to bonds, your average annual return may be closer to 3%, leaving you with just $228,000 after 30 years.
3. Not paying attention to fees
In addition to the administrative fees associated with maintaining your 401(k), you'll also be liable for fees on your investments, and the higher they are, the more they'll eat away at your returns. That's why sticking with actively managed mutual funds in your 401(k) could be a mistake. Though these funds offer the benefit of being run by experts who are actively involved in overseeing fund activities, their fees, known as expense ratios, can easily be four times higher or more than those of index funds.
Index funds are passively managed funds that track existing market indexes, like the S&P 500. Often, they do just as well as actively managed funds, only at a fraction of the cost, so it's worth seeing what low-fee options are available in your 401(k).
4. Borrowing against your savings
Most 401(k)s allow you to take out a loan against your savings balance. But doing so is a dangerous move for a couple of reasons. First, by removing a lump sum of money from your 401(k), you'll lose out on the opportunity to invest it and grow it into a larger sum, especially if it takes years for you to pay yourself back. Secondly, if you don't manage to repay your 401(k) loan on time, it will be treated as an early withdrawal, and that means you'll be subject to a 10% penalty on the amount you remove, assuming you're not yet 59 1/2.
If you're in need of money, it pays to explore options outside of borrowing from your 401(k). Borrowing against your home, for example, could be a better bet.
A healthy 401(k) could be your ticket to a comfortable retirement. Avoid these mistakes to ensure that your savings grow at a solid pace so you're left with a significant balance by the time your career comes to a close.
