Having a 401k plan account may be one of the best and most popular ways to save for retirement. And while focusing on the performance of your investments is crucial to maximizing the funds you will have at retirement, it is not the only critical factor.
It is easy to overlook some of these other factors when times are good, such as during the market’s current bull run. But even in the “boom” times, there are things other than performance to which you need to pay attention so your 401k operates at peak performance.
It is important that you pay attention to the details, to the fine print if you will, and to have regular and periodic “maintenance checks” of your account. Failure to do so can result in an account performing well below its potential, even if the particular investments chosen are good ones.
The first “oops” is not taking full taking advantage of the match contribution your employer offers. It is free money, so take it! With most plans, though, it does not just happen; you have to make the first move to get it.
Plans differ, but bottom line; you should take what is offered. If, for example, your employer offers a 100 percent match on the first 3 percent of pay you contribute, be sure you defer at least that 3 percent. Regardless of the specifics, do not throw away free money by not taking full advantage. Think of it as giving yourself a raise!
A second leak to your 401k comes in the form of "expense ratios" of your mutual fund investments. Assuming you even bothered to read your portfolio documents (which you should) you might have seen these and just thought, “Eh, what’s the big deal?”
The thing is, even small fees add up fast, and those fees get shaved off your 401k account each year.
As an example, assume you invest $4,000 per year in your 401k and achieve a 5.5 percent annual return on your investment. In 30 years, you will have a nice retirement account of about $306,000. But if you have to give up just half a percentage point so that you average only 5 percent on your annual return, in 30 years the account will only be about $279,000. Big difference, right? That is why it is important to pay attention to those expense ratios, and look for investment options that minimize them.
Not so easy to spot are certain administrative expenses of the plan itself. By law, most companies have to report fees and expenses of their plans. This commonly can be found on your 401k statement in the transaction history. If you see something withdrawn or partial shares taken out, that is likely an administrative fee that is being charged to you.
Many employers will foot the bill for fees like this, so you may not have any. However, sometimes they are unavoidable, such as when an employer makes just a single 401k provider available to its employees. If your fund investment options are limited or the fees seem too high, it could be time to consider alternatives to a 401k for at least some of your retirement savings.
Another common pitfall is that of failing to have at least an annual portfolio checkup, where you consider if you need to rebalance your investments to meet your goals and objectives.
Rebalancing involves looking at how your portfolio has changed over time and then moving funds around to best fulfill your retirement goals. Because of the way different mutual funds perform, your 401k can become unbalanced without you even noticing.
For example, you decided at some point a portfolio allocation between a domestic stock fund and an international stock fund of 50-50 was right for you. You initially invested $15,000 in each.
Due to differences in market performance the international stock fund goes up to $20,000 in value, while the domestic stock fund to only $17,500. You know longer have your 50-50 balance.
How do you correct this? You take $1,250 out of your international fund and transfer it to your domestic fund, and, presto, you are back to 50-50.
This is a critical part of managing risk in your portfolio. Over time your risk tolerance can and will change, whereas your portfolio might not reflect that. Periodically (at least annually) reviewing and taking any needed rebalancing action will help you stay within your acceptable tolerance zone.
Finally, taking money out of your 401k plan too early is another way to keep it from living up to its full potential.
For one thing, making withdrawals before age 59½ not only costs you income tax, but you also have to pay a 10 percent early-withdrawal penalty, unless you meet one of a very limited number of exceptions. So the cost is steep! Do you really want to do that after working so hard to save?
Also, remember the positive effect that compounding can have on your account. Withdrawing from your account now reduces what you could have saved up down the line far more than the mere amount you take out.
Even taking out a loan against your account can hurt you, since often the interest rate at which you will have to pay it back is less than you could earn in other plan investments.
The moral of the story is to avoid taking a loan from your 401k plan or cashing out early if at all possible. You might be better off in some situations using a credit card or taking out a home equity loan (the interest on which may be deductible) than to dip into your retirement nest egg.
Lane Keeter, CPA is Office Managing Partner of the Heber Springs Office of EGP, PLLC, CPAs & Consultants