When Woody Allen suggested that 80 percent of success is just showing up, he obviously wasn’t thinking about retirement planning. Sure, participating in an employer’s retirement plan puts you on a path toward possible success, but actually achieving your goal requires taking an active role in sweating the details.
And that’s just as true if your employer automatically enrolled you in the plan. “Automated services have been a great benefit, but the downside is that you may not be as engaged in your 401(k),” says Judith Ward, a senior financial planner at T. Rowe Price. “You need to take the time to make sure you are making the most of it.”
Here’s how to steer clear of costly mistakes:
Mistake: Turning Down Free Money
About one in four participants don’t pocket the maximum match from their employer. Often it’s an employer’s odd policy choices that contribute to the missed opportunity. Among plans that offer a matching contribution, the employee typically needs to contribute at least 6 percent of his salary to qualify for the maximum match. The problem is that many employers that provide automatic enrollment in a plan typically set the employee’s initial contribution rate at just 3 percent—or just half of what is needed to earn the maximum match.
The Fix: “If you were auto-enrolled it’s up to you to make sure you are in fact contributing enough to get the maximum match,” says Ward.
Mistake: A Contribution Rate in the Single Digits
The Center for Retirement Research at Boston College crunched the numbers and concluded that households should save around 15 percent of their earnings to have a shot at generating the income they will need in retirement to supplement Social Security. Yet the median participant is contributing just 5.9 percent, according to Vanguard. Even if you assume a company matching contribution adds another 3 percent—a common level—the total contribution is still below 10 percent.
The Fix: Get to 15 percent ASAP. Increasing your contribution rate by 1 percentage point a year is a common tactic, but Ward suggests doubling down. She says that among plans that automatically increase contribution rates by 2 percentage points a year, very few employees threw a fit and asked for their contribution rate to be lowered. And when you get a raise, consider earmarking a portion for your retirement. For example, if you get a 4 percent raise, you might think about using half of it—in this case 2 percent—to boost your contribution rate.
Mistake: Passing on the Roth 401(k)
About half of employers now offer a Roth 401(k), yet less than 10 percent of folks with this option use it. “That’s a big missed opportunity,” says Josiah Grauso, an adviser at ASC Financial Group in Bartonsville, Pa.
The Fix: Let go of the upfront tax break on a traditional 401(k) and focus on the eventual payoff of a Roth 401(k), even though your contributions are made with after-tax dollars. While all money withdrawn from a Traditional 401(k) will be treated as taxable income, withdrawals from a Roth 401(k) will be 100 percent tax-free. “Your CPA is going to hate this, because his job is to lower your taxes right now. My focus is on making sure you have the income and flexibility you need in retirement,” says Grauso. “If you can get the government out of your pocket upfront by choosing the Roth 401(k), that’s the way to go.”
Mistake: No Purposeful Allocation Strategy
When Hans Scheil, president of Cardinal Retirement Planning in Cary, N.C., sits down with new clients, “it’s rare to catch them with a properly allocated portfolio,” he says. Either they “are way too conservative given that they may live 20, 30 years or more in retirement, or they are a gambler not paying attention to the downside.”
The Fix: Aim for an age-appropriate mix of stocks and bonds. Plenty of retirement plans now offer free online tools to help sort through allocation decisions. Or try this easy hack: Many plans now offer Target Date Funds that make the allocation decisions for you, based on your expected retirement date. Even if you don’t want to invest in the TDF, you can use the allocation mix for the TDF that corresponds to your expected retirement date as a benchmark to compare your mix with.
Mistake: Not High-Tailing It out of an Expensive Plan
While you are an active employee you must keep your money in the plan. But the minute you leave you have the option of moving your money out. And with the average worker expected to job-hop seven times in her career, that can mean plenty of old 401(k)s eligible for a move.
One key litmus test is whether a 401(k) plan’s investment options charge above-average annual expense ratios. (This should be easily found online, or by calling customer service.) According to research firm Morningstar, the average asset-weighted expense ratio for index portfolios is 0.20 percent—some charge 0.10 percent or less—and 0.79 percent for actively managed portfolios. Fees are definitely worth sweating. Assuming a gross (pre-expense) return of 5 percent, $100,000 today will grow to more than $255,000 in 20 years if your expense ratio is 0.20 percent, and just $228,000 if you're paying 0.80 percent.
The Fix: If the fees on your 401(k) are high, it's time to make a move. If your new employer allows you to transfer money in an old 401(k) into your new plan, check if the fund options are indeed low cost. Or you can do what is called an IRA Rollover, where you move your money out of the 401(k) and directly into an IRA account at a discount brokerage or fund company that offers a lineup of investment options with razor-thin expenses.
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