There’s good news and bad news when it comes to statistics about retirement and American’s use of 401(k) accounts, as reported in Kiplinger’s article, “The 7 Most Common 401(k) Mistakes to Avoid.” The good news starts with a report from the Investment Company Institute: the entire 401(k) system had $4.8 trillion in assets as of March 2016, representing 52 million active plan participants, former employees and retirees. There’s also good news from Vanguard also, which reports that the average 401(k) balance reached $101,650— which is a record high.
However, there is bad news. Nearly half (45%) of the 38 million working-age households don’t own any retirement account assets, including IRA accounts or an employer-sponsored 401(k) plans.
The employer-sponsored 401(k) plan started in 1978. Therefore, it’s been available to millions of workers who are now 65-years-old and who could’ve been using it to save for retirement and save on their taxes. However, only half of Baby Boomers have more than $100,000 in a 401(k) or other retirement plan.
The good news is that younger workers have much of their working lifetime to accumulate a retirement fund. They also have the advantage of participating in 401(k) plans that have become far more sophisticated. This means that it’s a little bit more complicated for participants to understand all of the plan choices. As a result, some will make mistakes. A good goal is to save $1 million over your career to allow you to withdraw $5,000/month for 30 years with a 6% annual investment return.
Here are some common mistakes that retirement plan participants make and what they should be doing to avoid them.
Not Saving Enough. Simple math, right? To accumulate $1 million in monthly increments, you need to defer about $1,000 per month, every month, for 30 years with a 6% annual return.
Starting Too Late. Time and the power of compound interest must be worked to your advantage. The more time you have to accumulate savings, the more time the returns will have to work in your favor. Start to save right out of college, even if it’s a small amount, to make saving easier on you down the road.
Not Maxing Out. You need to “max out” your employer match. For example, if you make $75,000 per year and put away 3% ($2,250), and the employer matches, your total annual contribution is $4,500. That won’t even get you halfway to that $1 million. But on that same salary, if you defer 13% into the retirement plan ($9,750 or $812.50 per month), and your employer matches the first 3% of your contribution, that’s an additional $2,250, for a total of $12,000. The employer match is like getting a 23% return on your contribution!
Priorities. Many people don’t pay themselves first. Most 401(k) plans have an option to set an increase in your contribution rate annually, until you’re making maximum contributions. If you’re a single taxpayer, a $9,750 contribution will save you at least $2,437 in federal income tax.
Taxes. There are tax savings that are possible. How about $200 per month? Your paycheck won’t go down quite as much as the entire contribution to the plan, because there are fewer withholding taxes. In our example, we assume a conservative 6% annual return. Two factors affect returns in a retirement plan. They are fund selection and asset allocation.
Doing Nothing. This means not taking advantage of the plan’s available tools to develop an allocation plan. Spread your contributions over a variety of funds that represent a broad selection of asset classes. A large percentage of plan participants don’t even take the time to change their fund selections from the default fund the plan offers.
Monitoring and Rebalancing. Things change over the course of time, and your portfolio should also. That means rebalancing, which is sometimes offered as a feature of the account. Another is keeping track of account balances. It’s your retirement, so you should be aware of how your money is growing.
Today’s 401(k) plans are loaded with features to help you understand your investments and how to make saving for retirement easier than in the past. If you haven’t reviewed your 401(k) in a while, now would be a good time to do so!
It’s just as important that you understand the rules of your retirement plan and your spouse’s retirement plan. You don’t want either one of you to find out what the rules are when it’s too late to make a change.
That’s why at Family Estate Planning Law Group, we emphasize the need to align your assets with your estate plan, get verification from financial institutions of the correct alignment and then work with you to track changes in your assets over time. Without taking these measures, it’s easy to overlook a 401(k) rule that might throw off your whole estate plan.
For more information on the importance of aligning, verifying and tracking assets, explore our website and contact us to schedule your consultation today!
Reference: Kiplinger (July 2017) “The 7 Most Common 401(k) Mistakes to Avoid”