If you're lucky enough to have a 401(k), it really pays to the make the most of that plan. That's because the money you save today could set the stage for a financially stable future. That said, there are certain 401(k) moves that could easily derail your retirement savings efforts and hurt you financially. Here are a few things you should never do with regard to your 401(k).
1. Take an early withdrawal
Maybe you've lost your job and are having a hard time paying the bills. Or maybe you have a near-term financial goal you're looking to meet, and figure you might as well access the money you've saved in your 401(k). After all, that cash is yours, so why shouldn't you spend it?
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Well, there's a good reason why you shouldn't tap your 401(k) before reaching age 59 1/2: You'll be hit with a whopping 10% early-withdrawal penalty on whatever amount you remove. This means that if you withdraw $10,000 before age 59 1/2, you'll lose $1,000 right off the bat. On top of that, you'll be taxed on whatever amount you withdraw -- though that would be the case even if you were to wait until 59 1/2.
But penalties aside, the more money you remove from your 401(k) for non-retirement purposes, the less income you'll have access to when you're older. And that's reason enough to leave that money alone.
Furthermore, while you may have heard that it's OK to take an early withdrawal to pay for college or buy a first-time home, those allowances only apply to funds held in an IRA. If you have a 401(k), you won't qualify for the same exceptions to the early-withdrawal penalty.
2. Cash it out when you switch jobs
Job-hopping is fairly common nowadays, so when you stop working for the company that's sponsored your 401(k) to date, you may be inclined to cash out your plan and start a new 401(k) with your next employer. Big mistake. The early-withdrawal penalty we talked about above applies when you cash out a 401(k) upon leaving a job, so don't go that route. Instead, roll that money into an IRA or see about rolling it into your new employer's plan. This way, you'll avoid taxes and penalties on the money you've worked hard to save.
3. Borrow money from it
Some companies allow employees to borrow money from their 401(k) plans. If you have that option, you can borrow the lesser of $50,000 or half of your account's vested balance.
While borrowing certainly is preferable to taking an early withdrawal, it's a move that could end up backfiring in several ways. First, if you get laid off from your job, your outstanding 401(k) loan amount will be treated as a distribution -- which means that it automatically gets taxed. And if you're under 59 1/2 at the time, you'll get hit with that nasty 10% early-withdrawal penalty, as well. Furthermore, any time you remove money from your 401(k), you lose out on its associated growth by virtue of not having it invested. And that could end up hurting your savings.
4. Miss out on employer-matching dollars
An estimated 92% of companies that sponsor 401(k) plans also match employee contributions to some degree. But if you don't contribute enough of your own money to snag that match, you'll be losing out on free cash. Incidentally, about 25% of workers don't contribute enough to capitalize on employer matches, and as such, the average employee gives up $1,336 each year.
But as is the case with borrowing from a 401(k), when you fail to take advantage of employer-matching dollars, you don't just miss out on the money itself, but also on its growth potential. Passing up $1,336 a year for 20 years, therefore, doesn't just mean losing out on $26,720 -- it means losing out on $54,770 if your investments could've generated a 7% average annual return during that time (which is more than doable with a stock-focused strategy). And that's a lot of cash to give up.
5. Ignore your investments
Many people set up their 401(k) investments early on and then fail to check up on them regularly. But if you don't review your investments periodically, you'll have no way of knowing how they're performing.
What if you chose a fund initially that averaged an 11% return per year, but in the past two years, it's failed to do better than 4%? Would you really want to keep your money there? Though you don't need to check your investments on a weekly basis, schedule a quarterly or semiannual review. This way, if you see that your funds are underperforming, you'll have an opportunity to act and move your money around.
By saving in a 401(k), you're putting yourself in a great position to retire comfortably. So don't blow that chance. Avoid these mistakes and with any luck, you'll build an impressive nest egg that covers you throughout your golden years.
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