Tax-advantaged retirement plans provide many workers with a chance to save for the future and reduce their tax bill at the same time. Employer-sponsored retirement plans are easy to use, and many contributions are deducted from paychecks, so the investing becomes automatic. However, retirement accounts also require workers to make important decisions, and many investors make mistakes that can reduce their ability to build wealth. Here are some serious retirement plan errors to avoid:
1. Not taking the full match when available. One of the biggest mistakes we make when planning for retirement is failing to set aside enough money. If you have an employer-sponsored plan with a match, one of the biggest errors you can make is not taking full advantage of it. That match is free money for your future. Don't leave it sitting on the table.
Contributing as much as you can to your tax-advantaged retirement plan will allow you to grow your wealth as efficiently as possible. But even if you can't max out your 401(k), at least take advantage of the full match.
2. Failure to research plan options. Many retirement plans allow you to choose your investments. But don't just pick something without doing any research. Compare the costs of each asset. In many cases, it's possible to invest in a low-cost and diversified fund. This can provide you with instant diversification that will help protect your savings and minimize the fees that sap your real returns. While you don't need to be an investment expert, you should check out your options and look for something with low costs.
If your retirement plan doesn't offer low-cost options, you might be able to get better returns by investing in a low-cost IRA. While you still want to take advantage of a match where it is available, you can put additional savings into an IRA that costs less and offers you a better real return on your investment over the long term.
3. Taking money from your retirement plan. Your retirement plan can be a tempting set of assets to tap into. Many consumers make the mistake of thinking of a retirement plan as another emergency fund. But when you take an early distribution from your retirement plan, it will cost you. Not only will you have to pay taxes on money withdrawn from a tax-deferred plan like a traditional 401(k) or IRA, but you will also pay a 10 percent penalty to the IRS if you are under age 59 1/2.
In addition to those immediate consequences, taking money out of your retirement account also causes you to miss out on future growth. The capital that you spend is no longer earning returns for you. The years of compound interest you are missing out on could mean the difference between a comfortable retirement and a difficult retirement.
There's also an opportunity cost when you borrow from your retirement plan. Even though you are paying yourself back, the interest that you pay on the loan probably won't make up for the earnings you missed out on while the capital was gone from your account. And don't forget that many loans from a retirement account come with fees as well.
4. Not getting started soon enough. The biggest error to avoid is not getting started right now. You can start saving for retirement no matter how little you have. There are retirement plans that allow you to invest with as little as $5 from each paycheck and IRAs you can open for just $100 per month. No matter what your financial situation, you can start investing for retirement with a tax-advantaged plan.
While saving a small amount probably won't enable you to retire in comfort, beginning to save will start putting compound interest to work on your behalf for as long as possible. As your financial situation improves, you should increase your contributions. Over time, as long as you keep increasing your contributions when you can, an early start will benefit you.
Jeff Rose is a certified financial planner, U.S. combat veteran and the founder of GoodFinancialCents.com.
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