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5 'No's' for Your 401(k)

Scott Holsopple

Do you have questions about your 401(k) plan? Most people do. And in many cases, the right answers are as varied as the people asking. However, there are a few questions that are easy to answer. For these, the answer should almost always be "no." And remembering "no" could help you avoid costly mistakes.

1. Should I take out a loan from my 401(k)? No! Here's why:

The rules governing 401(k) loans are fairly strict. Your plan will require you repay the loan - plus interest - through automatic payroll deductions. During the repayment period, which is generally a few years, your obligation to repay your loan with interest can really hurt your ability to afford the regular contributions you'll need to make to help rebuild and grow your nest egg.

Plus, you'll likely take a tax hit. If you make pre-tax 401(k) contributions and take a loan from your account, you have to repay the loan with after-tax dollars - remember that taxes come out of your paycheck before loan repayments do. Then since the original contributions were pre-tax, you'll have to pay income taxes on that money again in retirement, so in essence you will have paid taxes twice.

2. Should I cash out my 401(k) when I change jobs? No! Here's why:

When you cash out your 401(k), your account is subject to a mandatory 20 percent withholding on top of ordinary income taxes, so you'll immediately see a sizeable reduction in your retirement nest egg. And if you're under age 59 1/2, you'll pay an additional 10 percent penalty, so it'll shrink even further. You worked hard to save that money for your retirement, so cashing out is akin to stealing money from the future you. Your 401(k) savings need to remain invested so the money can continue to work hard to help you move toward retirement readiness.

There are three really good options when you change jobs: roll the money to your new employer's 401(k) plan, roll the money to an individual retirement account or leave the money in your former employer's plan (if you like it and the plan allows you to do so). Cashing out instead? No.

3. Should I invest heavily in company stock? No! Here's why:

Diversification means spreading your money around different investment options to reduce risk, and your company stock is one of the least diverse investment choices you could make. It's not a mutual fund, which inherently provides diversification by combining many stocks or bonds. It's a single security on its own.

Just think about what would happen if your company failed or suffered significant loss. Your paycheck is already dependent upon your company's success, and if your 401(k) account is heavily invested in your company stock so is a large portion of your nest egg.

Diversification is especially important for retirement savings. Why? At retirement age, many people become less employable with less earning potential, yet there aren't any retirement loans, grants, or scholarships. Your expenses could be lower than they are now - but not necessarily that much lower. Medical costs will almost certainly see to that, so you'd better not risk your retirement funds unnecessarily by putting too many eggs in one basket.

4. Should I stop my contribution rate at the company match? No! Here's why:

Your company match likely maxes out at 6 percent, if it even goes that high, but you should be contributing - or working toward contributing - at least 10 to 15 percent of your salary to your 401(k). Most people won't begin to afford the kind of retirement they want if they only contributed enough to receive the company match.

On the other hand, if 10 to 15 percent is more than your budget will currently allow, it's important to contribute at least enough to receive the match (and then set up automatic contribution increases so your rate goes up every time you get a raise). Otherwise, you're saying no to free money your company wants to give you, and that's something to which no is never the right answer.

5. Should I try to make money by timing the market with my retirement dollars? No! Here's why:

Refer back to question three - your retirement investments shouldn't be overly risky, and timing the market is definitely a high-risk endeavor. Even people with advanced degrees in economics and finance who've studied the market for years have difficulty timing the market. If you buy too high or sell too low, the impact on your retirement savings could be huge. Failure to accurately time the market can mean a huge drop in your nest egg value in very short period of time. And if you need another reason to say no, market timing requires frequent trading, which could come with fees in a 401(k) account.

Scott Holsopple is the president of Smart401k, offering easy-to-use, cost-effective 401(k) advice and solutions for the everyday investor. His advice has been featured on various news outlets, including FOX Business, USA Today and The Wall Street Journal.

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