When it comes to potential 401(k) mistakes, it pays to listen to the investing gurus. Warren Buffet once said, “Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.” Wise advice, especially when planning for your retirement, where there may not be time for do-overs. As most Americans can no longer rely on pensions for retirement, and as Social Security risks running out of money in the next decade, the humble 401(k) plan is the workhorse of most people's retirements.
Two studies — from Vanguard and GoBankingRates — show how Americans mismanage their 401(k) accounts. One of these mistakes could cost you $300,000 over your working lifetime. We've unpacked these blunders and five other slip-ups to help you safeguard your 401(k). Fortunately, it only takes a little planning to avoid the worst 401(k) mistakes.
401(k) mistakes that can cost you
Experts agree that a 401(k) is one of the best ways to save for retirement. With a 401(k), you get both tax advantages and employer matching (if available), which can add substantially to your contributions. Plus, if you automate your savings, your contribution limits can be significantly higher.
An astonishing 33% of middle-class Americans are cashing in their retirement investments before they retire. That one seemingly unimportant move can leave them at risk of poverty as they age, according to recent data from the Transamerica Institute. A podcast about navigating the messy line between work and life, called The Lonely Office recently covered the pros and cons (mostly cons) of pulling from your 401(k) fund. Some people may not realize that when you withdraw money from your 401(k) before the age of 59-1⁄2, you are subject to a 10% early withdrawal penalty, in addition to any other income taxes you might owe.
After interviewing several people, the podcast drew two conclusions: taking money out of your 401(k) early and paying a penalty must mean you are either running out of money or you're unaware of the downsides.
Here are eight 401(k) mistakes to avoid as you plan for or enter retirement.
1. Not knowing the difference between 401(k) plans
Employees may have two 401(k) plan options — a traditional 401(k) and the Roth 401(k) — but many don't know the differences between the two plans. Let's start with the similarities: Contributions to both traditional and Roth 401(k)s, and any gains you earn, grow tax-free. Contribution limits for both types of plans are the same and both types of 401(k)s are eligible for employer matching contributions, if offered.
How they are not the same: Traditional 401(k)s, are funded with pre-tax contributions, meaning you won’t pay tax on the money going into your account. That's an upfront tax benefit. When you withdraw the money in retirement, you will be taxed. Depending on your tax bracket, the tax savings for pre-tax 401(k) contributions could be quite a lot. On the other hand, contributions to a Roth 401(k) are made with taxed income. However, you can withdraw those funds in retirement tax-free, meaning you keep all of the accumulated growth.
Not sure which is best for you? Check out our article: Roth 401(k) vs. 401(k): Which Is Right for You?
2. Switching jobs
A 2024 Vanguard study showed that 55% of job switchers reduced their 401(k) nest egg by $300,000 over their working lives by failing to adjust their savings rate to their new, higher salary. Most employees (64%) experienced a 10% boost to their income when they switched jobs, but less than half did the smart thing: increasing or, at least, maintaining their savings rate from their prior job. In fact, most people effectively decreased their savings rate in their new job.
The study also revealed that the outcome was far worse when an employer offered voluntary enrollment in a 401(k) plan versus automatic enrollment. All the same, even those who were automatically enrolled in a plan had losses, too. That's because 60% of enrollees stuck to the default savings rate, often 3%.
It's easy to forget to increase your 401(k) contributions in line with your income. However, the result is that as you become accustomed to a higher salary, you underfund the same standard of living in your retirement.
3. Forgotten 401(k)s
News flash: 401(k) accounts don’t automatically transfer when employees change jobs. That may be one reason why, in May 2023, there were 29 million forgotten 401(k) accounts, accounting for over $1.6 trillion in lost money floating around, according to updated data from Capitalize.
Forgetting a 401(k), especially if you change jobs often, can mean landing a job and starting a 401(k), then moving on to another company and forgetting to transition the 401(k) or roll it over. The good news is that there are ways to find a lost 401(k). The SECURE 2.0 Act of 2022 tasked the Department of Labor (DOL) with creating the new Retirement Savings Lost and Found Database. It is managed by the Employee Benefits Security Administration (EBSA), and continues to be a work in progress. Even so, it's a good place to start if you've misplaced your 401(k).
4. Not knowing your 401(k) investments
It’s not uncommon for employees, especially if automatically enrolled, to overlook how their 401(k) funds are invested. That's a mistake, as many agree you should adjust your risk level as you age, from more growth in your early years to more stable, fixed-income investments as you age. Many people use target date funds in their 401(k)s to meet this need, automatically adjusting their risk level as they age.
Another downside of ignoring your 401(k) holdings is failing to get a handle on what fees you may be paying. High fees leave less in your account to compound over time. At the very least, you should review your 401(k) plan's annual fee disclosure statement. Better yet, take the time to log into your account periodically to check your fees and investments. If you feel the fees stated are high, consider investing only enough in your 401(k) to qualify for your employer match and save the rest in an IRA instead, which also offers tax advantages.
5. Not taking advantage of employer match
Many employers offer employee matching, which means any contributions you make to your 401(k) are matched by your employer, usually up to a set percentage of your salary. If you don’t contribute enough to qualify for employer matching, you are essentially leaving free money on the table.
6. Not being vested
If your employer offers 401(k) matching, you may not be able to keep that money until you're fully vested. Vesting requires employees to fulfill a specified term of employment to gain access to benefits. Although a common vesting schedule is three to five years, employee contributions to an employer-sponsored retirement plan are always considered 100% vested.
Just be sure you understand your employer's vesting rules, which may allow you to keep the matched portion of your 401(k) after a set number of years or may be incrementally phased in. Though you keep your own 401(k) contributions if you leave your job before the vesting period ends, you might lose the matched portion.
7. Taking an early withdrawal
Cashing out your 401(k), taking a 401(k) loan, or hardship withdrawal are some of the worst mistakes you can make if you're counting on the money from your 401(k) to help support your lifestyle when you retire. Understandably, if you’re in a tight spot and need an influx of money to pay for basic necessities or a medical emergency, raiding your 401(k) may not be an option you should walk away from. 401(k) loans often have lower interest rates than traditional loans, and you can repay yourself with payroll deductions. Besides, these loans don't impact your credit score.
However, cashing out your 401(k) before age 59-½ means that the money you withdraw will likely be subject to a 10% penalty on top of any income tax owed. And although many 401(k) plans allow for loans or hardship withdrawals, these withdrawals usually incur fees. Cashing out retirement money early can be a major negative and contributes to why many people have so little saved for retirement.
8. Not rolling over an old 401(k)
You can typically opt to leave your 401(k) where it is (with your old employer), roll it into an IRA, or move it into your new employer’s 401(k) plan. But sometimes, parking your money indefinitely in an old employer's plan is the wrong move.
If your account has under $7,000 invested under a previous employer's plan, they may decide to distribute the amount to you or roll it into an IRA under the "forced plan distribution" rule. Not only is this a bureaucratic headache, you will also have to pay taxes on any distributions. If your 401(k) balance is between $1,000 and $7,000, your former employer may be able to help you roll the funds into your new employer's 401(k) plan. Finally, if you change jobs often, you may mistakenly leave 401(k) plans floating around that can be easy to forget or lose track of.
Just as the Vanguard study showed, 55% of job switchers reduced their 401(k) nest egg by, on average, $300,000 when they switched jobs. Not rolling over an old 401(k) when you move to another company might be an expensive mistake.
On the other hand, there are some advantages to keeping a 401(k) in your former employer's plan. First, if the plan has superior investments or lower fees than your new employer's plan, you might want to keep your old plan as-is. Second, if you plan to retire early, you might want to take advantage of the "rule of 55." This IRS rule allows individuals who leave their job during or after the year they turn 55 to withdraw funds from their 401(k) without the 10% early withdrawal penalty. By rolling over an old 401(k) into an IRA, you lose the ability to take advantage of the rule of 55.
Reasons why people withdraw from their 401(k) early
A study by GoBankingRates, “5 Reasons the Middle Class Is Withdrawing From Their Retirement Accounts Early," cites several reasons why people extract money from their 401(k) before retirement. Those reasons include:
- Financial emergencies. Major car or home repairs, family emergencies, and other unexpected costs can add up quickly. Before you turn to your 401(k) savings, read Kiplinger's advice on preparing for a financial emergency.
- Paying down debt or for everyday expenses. You might tap into your 401(k) early because of a job loss or the inability to find a new job, credit card and/or student loan debt. Instead of tapping your 401(k), check out our solutions for paying off credit card debt.
- Paying for unexpected medical bills. The report from Transamerica reveals that 20% of those who dip into their retirement accounts say medical bills are the main reason.
Bottom line
Many experts advise replacing 80% of pre-retirement income for a comfortable lifestyle post-retirement. Although that may sound like a lot to some people or be nearly impossible to achieve for others, according to Northwestern Mutual’s 2024 Planning & Progress Study, most retirees surveyed believe they will need $1.46 million in the bank to retire comfortably. That’s a 15% increase over last year — far outpacing the 3% to 5% inflation rate — and is up 53% from 2020.
That’s also a sharp contrast to the average amount that most adults have saved for retirement — a meager $87,000 in 2024 compared to $89,300 in 2023. Given that 11,000 Americans will turn 65 every day through 2027, only half of boomers and Gen Xers believe they’ll be financially ready for retirement when the time comes. Avoiding these eight 401(k) mistakes now that could imperil your retirement later on can save you many sleepless nights. That much you owe to yourself.
