American employers are increasingly dropping pension plans, and that means workers are increasingly counting on 401(k) retirement accounts to provide financial security in their golden years. To get the most out of your account, be sure to avoid these three mistakes our Motley Fool contributors think could derail your 401(k).
One of the worst things you can do with your 401(k) account is to cash it out when you change jobs. Yet many people do just that. Recent data from Fidelity Investments, which administers many companies' 401(k) plans, shows that 35% of those plans' participants cashed out their accounts last year when leaving their jobs. Jeepers!
A 401(k) is supposed to be a retirement savings account, not just a handy place to accumulate money temporarily. Considering that fewer and fewer Americans have the luxury of guaranteed pension income in retirement, and the average Social Security benefit is about $1,328 per month as of January 2015 (that's only about $15,900 annually), most of us need to be socking away lots of money on our own for retirement.
Fidelity also noted that among its plan participants in their 20s through 40s, the average cashed-out account balance was $14,300. To get an idea of just how destructive cashing out can be, let's see what would happen to such a sum if it had been kept in the 401(k). Imagine a worker in the middle of that age range, aged 35, with about 30 years until retirement. If that $14,300 stayed in the 401(k) account (or a similar retirement account) for 30 more years, and it grew at the stock market's average long-term annual growth rate of about 10%, it would rise to $250,000! And that's without any further contributions. If $5,000 were contributed each year along the way, the end result would top $1.1 million.
Sure, after cashing out, you might start contributing to a new 401(k) account, but you will have lost a meaningful sum, significantly shortchanging your future.
Another huge 401(k) mistake you can make is paying more than you have to in fees.
Last year I helped a friend navigate the fund choices in his 401(k). There were probably 40 different funds -- but several were basically duplicates. The sheet listed two S&P 500 index funds, for example. They held the same stocks, in the same weighting, and generated the same pre-expense performance.
The only difference was that one fund's expense ratio -- the percentage of your invested funds that it charges you each year -- was 10 times higher than the other's: 0.50% versus 0.05%.
Picking the more expensive fund would have been a simple mistake. After all, it was featured higher on the list of choices, and at 0.50%, it was still less expensive than most mutual funds. However, over time, the difference between 0.50% and 0.05% in annual fees is massive. Think thousands of dollars in lost returns over the course of your career.
If I learned a lesson that day, it's that investors need to pay close attention to fund choices in their 401(k). Sometimes a better deal is right under your nose.
One of the biggest 401(k) errors is not taking full advantage of money that your employer is willing to contribute to your account. Many employers make contributions in two different ways: They add profit-sharing contributions to employee accounts that are based on a percentage of your overall salary, and they match any contributions that you make on your own behalf up to a certain amount. Both of these types of contributions amount to free money from your employer, and it's worth the minimal effort to claim it.
Most of the time, you don't need to do anything to receive profit-sharing contributions. But with employer matching, it's critical to save at least enough to maximize the amount of your employer's contribution. Typical 401(k) plans will include provisions that match half of your contributions up to a maximum of 6% of your total salary, but some are much more generous, matching your contributions dollar-for-dollar or providing matching on even higher percentages of your total pay. Even though employer matching and profit-sharing are sometimes subject to vesting requirements that can make them disappear if you don't stay at the job for a minimum period of time, your contributions are always yours to keep, so there's no risk yet huge potential reward when your employer offers 401(k) matching.
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