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The 401(k) Mistake You Can't Afford to Make

Rebecca Lake

Saving in a 401(k) can get you closer to your retirement goals, but many Americans may be squandering their plan's full potential. Research from Alight Solutions shows that one in five workers isn't saving enough in a 401(k) to get the employer's full matching contribution. Millennials are the worst offenders, with 29 percent of 20- to 29-year-olds saving below the matching contribution threshold.

[See: The Top 10 Investment Portfolio for Millennials.]

Losing the match deprives you of easy money. Wells Fargo puts the average lost value of the match at $750 annually. A study from Financial Engines found that number is even higher, at $1,336. Those amounts may seem small, but passing up free money can hurt your retirement more than you think. Steven Forrester, senior vice president and head of financial planning at EMM Wealth in New York, says missing the full match by even 1 percent can mean missing out on tens of thousands of dollars over time.

He offers the following example based on a dollar-for-dollar match of up to 6 percent of compensation. "An employee making $65,000 annually could receive an employer match of up to $3,900," Forrester says. Assuming a 30-year-career and a 7 percent rate of return, the total match including returns would come to $370,339. Even if the employee contributed 5 percent to the plan instead of the 6 percent needed to get the full match, that individual would have $61,723 less as a result, he says.

That's not small potatoes, which begs the question why so many savers fall short of the match. "Competing demands for paycheck dollars is a big reason many workers miss out on the match," says Rob Austin, director of research for Alight Solutions in Charlotte, North Carolina. "Most workers say that they contribute the most they feel they can afford."

That isn't always enough, and many employees seem to know it. Only 18 percent of savers say they're very confident about their ability to save for a comfortable retirement, according to the Employee Benefit Research Institute's 2017 Retirement Confidence Survey.

Making the most of your 401(k) could help bolster your confidence about retirement. So if you're not getting the full match, that's a mistake you can't ignore.

Know the details of your 401(k). It's easy to fall short of the employer match if you don't know how an employer's 401(k) matching formula works. "A typical employer match may be one where the employer matches 50 percent of your contributions, up to 6 percent of your pay," says Michelle Herd, a certified financial planner and senior client advisor at TFC Financial in Boston. "This means you'll need to contribute at least 6 percent of your pay into the plan to receive the full match." If you only contribute 3 percent, the employer contributes just half of that, or 1.5 percent of your salary.

If you were automatically enrolled in a plan, find out what percentage you're contributing. Based on Alight research, about half of plans with automatic enrollment set the initial default contribution level below the full match threshold, Austin says. Check your current contribution rate to see if you're falling short of that amount and if so by how much.

You also should understand how the vesting schedule works. The employer match is often not 100 percent the employee's the day that it's contributed, says Mimi Schanzlin, a certified financial planner and managing director at United Capital in Buffalo, New York. Instead, "it can take several years for the employee to fully vest and earn these contributions." That's good to know if you want to stay long enough to be fully vested before changing jobs.

[See: 10 Long-Term Investing Strategies That Work.]

If you don't know how your plan works, "contact your human resources or benefits department and ask what the match requirements are, and if you're taking full advantage of the match," says Terry Dunne, senior vice president and managing director for retirement services at Millennium Trust Co. in Oak Brook, Illinois.

Put savings on autopilot. Auto-escalation is a powerful way to supercharge your 401(k) savings and hit your matching target. Jon Graff, director of participant services for Wells Fargo Institutional Retirement and Trust in Charlotte, North Carolina, says auto-escalation takes the pressure off so that you don't have to remember to increase contributions. It's also a way to gradually save more, "which can be easier to manage from a budget perspective if affordability is the issue," he says.

Automatically escalating your 401(k) contributions works for two reasons, says Lou Cannataro, a partner at Cannataro Park Avenue Financial in New York. First, he says, human nature and a tendency to inertia often keeps savers from increasing their contributions on their own. Auto-escalation removes that decision from your hands. Second, you may be less inclined to reduce your contributions when they're on autopilot.

If auto-escalation is an option, set those increases strategically. Consider your current contribution level, where the match tops out, how much your salary is likely to increase year to year, and the maximum contribution limit. Cannataro suggests correlating auto-escalations to annual raises so you don't miss the extra money coming from your paycheck.

Compensate for a small or stingy employer. Sometimes, there's no match to get. "Not all 401(k) plans have a match, especially at small companies," says Nahum Daniels, certified financial planner and representative of Brokers International Financial in Stamford, Connecticut.

If your plan doesn't offer a match, you'll have to find ways to make up the difference. Saving more in a 401(k) is one option and contributing to an individual retirement account is another. A traditional IRA affords the benefit of tax-deductible contributions while a Roth IRA allows for tax-free withdrawals in retirement.

Though not a retirement account, a health savings account also is a way to add to your savings. These accounts, which are associated with high-deductible health insurance plans, permit tax-free withdrawals for medical expenses. At age 65, the money in an HSA can be used for any purpose without penalty, but you will owe taxes on the amount withdrawn.

[See: 10 Out-of-the-Box Ways to Save Money.]

Even if you have to consider other savings options, don't give up on your 401(k) altogether. Saving early and consistently in an employer's plan should still be a priority, even when there isn't a match. "A 401(k) is a good thing and a match from the company is just the icing," Dunne says.

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