This article takes a look at the 5 biggest 401(k) mistakes to avoid. If you wish to check out our detailed analysis on unraveling the controversy surrounding 401(k) plans, you may go to 13 Biggest 401(k) Mistakes to Avoid.
5. Failing to Differentiate Between 401(k) Account Types
There are two types of accounts workers come across when saving for retirement. This is the traditional 401(k) and the Roth 401(k). In a traditional 401(k), contributions are pre-tax, thereby providing upfront tax benefits. However, withdrawals in retirement are subject to taxation. On the other hand, Roth 401(k) contributions are taxed when made, but the withdrawals in retirement are tax-free. This ensures you retain the full accumulated growth. Choosing between the two depends on aligning with your specific needs and financial objectives.
4. Leaving Before Vesting in Employer Contributions
For employees who participate in 401(k) plans, matching contributions can be a good way to boost your retirement savings. However, employees must know that the employer’s matching contribution usually doesn’t become fully yours right away. Vesting is the legal process through which your entitlement to your employer’s contributions is established. Some employers practice immediate vesting, ensuring you own your entire 401(k) balance instantly. However, most 401(k) plans gradually allow vesting employer contributions over time. Leaving a job before vesting may forfeit some or all of the employer contributions that haven’t vested.
3. Failure to Periodically Re-balance Portfolio
Another major mistake that retirees often make is failing to rebalance their portfolios over time. Neglecting portfolio balance often leads to unintended shifts in risk and potentially lower rate of return. Individuals should also look at their investments within each asset class. If one sector has a particularly good or bad year, it might need to be readjusted.
2. Failing to Update Beneficiary Designations
Another major mistake individuals make with their 401(k)s is failing to update beneficiary designations over time. This is because, in the case of your death, the remaining balance of your 401(k) will be passed on to the beneficiary whose name is on the beneficiary designation form. For instance, your 401(k) balance may end up with your former spouse if you’ve failed to update your beneficiary designation form and their name is on it.
1. Ignoring Roth 401(k) Options
If you overlook the benefits of Roth 401(k) options, it can potentially impact your tax planning and distribution strategy in retirement. As discussed previously in the article, Roth 401(k) contributions are made with after-tax dollars, meaning withdrawals in retirement are tax-free. This can be particularly advantageous for individuals expecting higher income tax rates in retirement.
If individuals don’t consider them, they may miss the opportunity to diversify their tax strategies, and potentially reduce future tax liabilities. Additionally, Roth 401(k)s have no required minimum distributions (RMDs) during the account owner’s lifetime, thereby offering them flexibility to manage their retirement income. Failing to leverage the benefits of Roth contributions could result in a less tax-efficient retirement strategy.
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