As financial planners and investment advisors, we see mistakes that employees make when handling their 401(k)s. Four such mistakes standout as having the greatest impact on a comfortable versus not-so comfortable retirement. The good news is that everyone eligible to participate in a 401(k) has the power to avoid these mistakes.
Though we specifically mention 401(k), our observations are the same for 403(b), SEP and any other contributory retirement plans.
Mistake #1: Not Starting Early Enough
This mistake may be the most costly of all. An employee that begins contributing early to his/her 401(k) has an enormous advantage over someone who waits until retirement is looming. Consider this: a 25 year old who saves approximately $381 per month to a 401(k) ends up with $1,000,000 by the age of 65. By waiting until age 45, that same person would need to save over five times that amount, $1920 per month, to end up with $1,000,000 at age 65. Why? That’s the power of compounding! As a 25 year old, coming up with $381 per month to stash away in a 401(k) may be difficult. The important point is to start early with whatever amount possible. Just setting aside $100 per month in a 401(k) would provide over $262,000 by age 65. These assumptions use an average annual return of 7%, which is not a high hurdle for a 40 year investment period.
Mistake #2: Not Saving Enough
As mentioned above, the earlier you start to contribute, the better. Also true, the more you save, the better. In considering the amount to contribute, what many forget is that the dollars contributed to a 401(k), go in “pre-tax”. This means that directing $381 from your paycheck to your 401(k) will not reduce your take home pay by $381, because less income tax is withheld. If our 25 year old is making $40,000 a year and contributing $381 a month to the 401(k), his/her take home pay would see a reduction of only $316. This assumes a 12% federal and 5% state/local tax rate.
