14 Common 401(k) Mistakes You May Be Making

Your 401(k) delivers a powerful set of wealth-building features, including automated contributions and investments. Still, the 401(k) is not infallible. It's easy -- and fairly common -- to make mistakes that can slow your wealth progress.

Here's a look at 14 mistakes that other 401(k) savers are making. Review each and correct any you find in your own savings process. Doing so could unlock six figures in retirement funding over time.

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According to Vanguard's report How America Saves 2021, about 78% of employees with access to a Vanguard 401(k) are actively participating. That's good news, but it's the flip side of that number that's concerning.

If 78% of workers are participating in an available 401(k), then 22% are not.

Not making use of your 401(k) means you're giving up on tax deductions for saving plus tax deferrals on all the income earned in that account. You may also be forgoing employer matching contributions -- which is free money for you to invest.

All in, the cost of not participating in a 401(k) could stretch into six figures. That's if you include the tax perks, employer matching contributions, and what you could earn on those matching contributions over time.

According to research from health benefits administrator Alight Solutions, 19% of 401(k) savers did not contribute enough to earn their full employer matching contributions in 2019. Shorting yourself on employer match for an extended time frame could be an extreme financial blunder.

As an example, let's say your employer matches up to 6% of your salary on a dollar-for-dollar basis. If you contribute 3%, you'll earn half your match. At a $50,000 salary, that equates to $1,500 in employer match plus $1,500 in contributions from your paycheck. In 20 years, assuming average annual growth of 7%, those contributions grow to about $124,000.

If you increase your contributions to earn your full match, you'd have nearly $250,000 after 20 years under the same assumptions. That's an extra $124,000 -- and it only cost you $1,500 per year out of pocket.

ALSO READ: How Much Is Your 401(k) Match Really Worth?

Vanguard's retirement trends report also states that the average default contribution rate is 3%. For most savers, a 3% contribution is not enough to fund a comfortable retirement.

Run the numbers through a compound interest calculator and you'll see the outcomes. If you assume 40 years of savings at 7% average annual growth, a 3% contribution rate grows to about six times your annual salary -- or 12 times if you're also earning 3% employer match. But most people need savings equal to 20 or 25 times their annual salary to avoid a lifestyle downgrade in retirement.

The takeaway? If you were auto enrolled in your 401(k), check your contribution rate. If you're on the default rate, it's probably too low to support your savings goals. A contribution rate of 10% or higher is where you want to be.

Most 401(k)s that pick investments automatically will put your contributions into a target date fund, or TDF. They can be good picks for retirement savings, but they're not right for everyone. Because they're designed to be low maintenance, TDFs don't allow for customization of your risk or exposures.

If you don't remember selecting investments for your 401(k), log in to your account and see what your portfolio looks like today. While you're there, evaluate and compare your fund options. Review fund portfolios, investment approaches, and expense ratios. You may choose to keep the TDF anyway, but make it an informed decision -- rather than a default you accepted.

ALSO READ: 4 Steps to Choosing Your 401(k) Investments When You're Clueless

You want your retirement contributions to grow as much as possible over time. But there is a danger in investing too aggressively. Funds with the highest growth potential also have the highest risk of loss.

If you start investing for retirement early in your career, you don't need to rely on high-risk, high-reward funds. The long-term average annual growth of the stock market is 7% after inflation -- that's enough to amass a sizable nest egg.

Broad market index funds, tempered with fixed income funds, are an appropriate combination for most retirement savers. If you have three or four decades before retirement to contribute and invest, that pairing can deliver the growth you need.

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Fear of losing in the stock market can push you into another 401(k) problem -- investing too conservatively. This issue can take the shape of not investing at all or investing only in ultra-safe Treasury debt funds. Either way, your average annual returns will be, at best, less than 2%.

The return you earn in your 401(k) can make or break your retirement savings efforts. Sock away $600 monthly earning 2% annually for 35 years and you'll have about $360,000. Raise that average growth rate up to 7% and the same contribution will grow to $1,000,000 after 35 years.

If retirement is more than two decades away, consider investing at least half of your contributions in equity funds. That will improve your growth potential -- and make it easier for you to reach your savings goals.

Alight Solutions reports that 45% of target date fund investors hold other securities in their portfolios.

TDFs are intended to be the only fund in your retirement portfolio. This is because each vintage of a TDF has a mix of stocks and bonds that's tailored to one age and investment timeline. A 2030 TDF, for example, is structured for savers who plan to retire in 2030. The portfolio will be more conservative than a 2060 TDF, because 2060 retirees have a much longer investment timeline.

If you hold a 2030 TDF alongside any other security, you will likely disrupt your balanced, age-appropriate portfolio. Say your 2030 TDF is composed of 40% bonds and 60% stocks. Pair that TDF with an S&P 500 index fund and the equity exposure will rise above 40%. That increases your risk, which is not what you want if you plan to retire in 2030.

If you want to invest in a TDF, hold it as the sole position in your retirement portfolio.

ALSO READ: 4 Target Date Fund Pitfalls to Avoid in Your Retirement Account

Rebalancing is the process of adjusting your mix of investments to fit your target composition. Let's say you've allocated 70% of your contribution to an S&P 500 index fund and 30% to a bond fund.

In time, your S&P 500 fund will outgrow the bond fund. A year later, the S&P 500 fund might account for 75% of your portfolio's value, for example. If you let that trend go unchecked, the risk level of your portfolio gradually rises over time.

Rebalancing resets your composition so you aren't holding more risk than you want. To do this, you'd sell off some of your S&P 500 shares and use the proceeds to buy more of your bond fund.

According to a Fidelity report on retirement trends, the average 401(k) hardship distribution in the third quarter of 2021 was $3,600. That may not seem like enough to ruin your retirement. But you should know this: The long-term cost of an early 401(k) withdrawal is much higher than the amount pulled from the account.

Straight away, you'll pay taxes on the withdrawn amount. You'll also probably pay a 10% penalty unless you qualify for an exception. You will forgo earnings on those funds, too. And your 401(k) may charge an administrative fee for allowing the withdrawal.

The lost earnings can be hard to recoup. Even if you repay the funds within a year, you've missed out on several months of earnings -- which adds up if you consider the potential for future compounding.

Of course, you might not care about future consequences if you're in a financial bind today. Just make sure you've considered all other options before you pull money from your 401(k).

ALSO READ: The Basics of 401(k) Hardship Withdrawals

Vesting is the process by which you take ownership of your matching contributions. If you're not fully vested and you leave your job, you would forfeit a portion of your matching contributions. That could slash your retirement savings balance by 25% or 50%.

Many employers have phased vesting schedules, where you gradually assume ownership of those matching contributions. For example, your employer might award you 20% ownership for each year of your tenure as an employee. Under that system, you'd fully own the match on the fifth anniversary of your hire date.

Verify your vesting schedule with your benefits administrator. If you are not 100% vested, evaluate the cost of lost matching contributions before you accept another job opportunity.

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The market moves up and down. One year, your 401(k) balance might grow by 15% or 20%. The next year, you might lose ground. It's natural to think about how to keep the gains and avoid the losses. All it takes is the ability to predict when the market's going sideways -- a strategy called timing the market.

Unfortunately, it's nearly impossible to predict market cycles consistently. Investors who try often end up with larger losses than those who don't.

Here's what can happen. You sell your shares after the market shows weakness -- and share prices are down. You keep your funds in cash until share prices recover. You then buy your shares back, at higher prices. Now your cost basis is higher (and your cumulative growth is lower) than before you sold.

Timing the market is a compelling idea, but it's more likely to go wrong than right. Don't react to temporary market cycles. Instead, focus on owning quality funds in your 401(k) and trust that those cycles will average out to growth over time.

When choosing funds for your 401(k), it can be tempting to compare options based solely on past performance. The thinking is, why invest in Fund A if Fund B grew twice as much last year? That seems reasonable at first glance -- except that there are several reasons why Fund A might be the better choice.

The first point to remember is that performance can be temporary. Emerging markets funds, international funds, and small-cap funds, for example, can show inconsistent results from year to year -- way up one year and down the next. Secondly, a fund's growth rate often isn't the best measure of performance. You might look at how the fund performed relative to its benchmark index instead, for example. And finally, a fund might provide something of value outside of performance -- like exposure to a specific type of asset.

If you're maxing out your 401(k) contributions before year-end, you could be accidentally missing out on employer matching contributions.

Here's a look at the numbers. In 2022, the 401(k) contribution cap is $20,500 if you are younger than 50. Say your employer matches 6% on a dollar-for-dollar basis and you make $150,000 annually. You could hit the contribution cap in 10 months by contributing $2,050 monthly. In that time, your employer would fund $7,500 in matching contributions -- equal to 6% of your salary for the 10 months you contributed. You won't earn any match in the two months you don't contribute.

Alternatively, you could contribute $1,708 monthly for 12 months. Your total contribution is the same, but you'll earn an additional $1,500 in matching contributions. Specifically, your total match for the year would be $9,000, or 6% of your full, 12-month salary.

If you want to max out your 401(k), go for it. But get your full match in the process by spreading your contributions out over the full year.

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If you're already saving and investing in your 401(k), congratulations. You're moving forward with your retirement savings plan. Now you're ready to get more from your contributions with a few small tweaks.

Start by learning your matching and vesting rules. Earning and keeping those matching contributions could be your most effective step toward funding the retirement you want. From there, pay attention to your investments and the risk you're taking on. Choose funds you can hold for decades, look past short-term volatility, and monitor your portfolio's composition.

Those steps alone should help you steer clear of several common 401(k) mistakes. That sets you up to be an elite 401(k) saver, in full command of your financial future.

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