Ask young job seekers what they want from prospective employers and you’ll find a retirement plan tops the list. According to a survey from Fisher Investments 401(k) Solutions, 80 percent of millennials prefer to work for a company that offers a 401(k).
That doesn’t mean they fully understand how to make the most of these plans. For example, the survey found that only 25 percent of millennials working at companies with 200 or fewer employees are enrolled in their 401(k). That’s a problem, says Jason Parker, founder and president of Parker Financial in Silverdale, Washington.
“It’s very important to start saving right away because you want your money working for you as long as possible,” Parker says. “The more time you spend saving, the more compounding interest you can enjoy.”
[See: The Top 10 Investment Portfolio for Millennials.]
Delaying enrollment in a 401(k) — or avoiding it altogether — can mean missing out on a sizable amount of savings. That’s not the only mistake you can make with your plan. If you’re navigating the 401(k) ropes for the first time, watch out for these missteps.
Saving by default. Many companies encourage 401(k) participation with auto-enrollment, but it’s not a perfect solution. When enrollment is automatic, your contributions may be set at a default rate. According to a T. Rowe Price report, 29 percent of plans that auto-enroll participants do so at a 6 percent salary deferral rate.
That’s a good start, but it may not be enough, says Eric Hutchinson, a certified financial planner and managing director at United Capital in Little Rock, Arkansas. He says younger workers should aim to save 10 to 20 percent of their salary if possible, with maxing out the annual contribution limit as the goal.
If necessary, break up that goal into smaller increments to make it seem less daunting. “Start your contributions with the most you feel comfortable with,” Hutchinson says, and then try to increase contributions by 1 to 2 percent a year.
Increasing contributions beyond the default level can accelerate a nest egg’s growth over time. For instance, a 25-year-old with a $40,000 annual salary and a default contribution rate of 6 percent would have roughly $514,000 saved by age 65, given a 6 percent annual rate of return.
Now, assume that same 25-year-old gets a 2 percent raise each year and increases contributions 1 percent annually, maxing out at 15 percent of the person’s pay. At age 65, those savings would top $1.1 million with the same 6 percent return.
Hutchinson says if you’re timing a contribution increase with a raise, it’s best to bump up your savings rate before you have a chance to get used to a higher salary. If you wait until after the raise is in effect, you run the risk of lifestyle inflation eating up the difference, he says, and raising contributions after that point “would feel like tightening the belt.”
Missing the match. Settling for the default contribution rate is a mistake if the amount isn’t enough to snag the company match. A Financial Engines study estimates that Americans sacrifice $24 billion annually by not saving enough to qualify for a matching contribution. “You aren’t helping your retirement if you’re leaving free money from your employer on the table,” Parker says.
If you can’t save enough to get the match, review your expenses for anything you can pare down or eliminate altogether. Those savings could add up, perhaps enough for you to take advantage of the 401(k) match.
[See: 10 ETFs to Buy for Aggressive Growth.]
Wasting the waiting period. If you can’t contribute to a new employer’s plan right away, use the time to brush up on the plan’s rules and requirements. “Most employers have online tools for their employees to review while they’re in the waiting period,” says Mel Hooker, director of relationship management at Wells Fargo Institutional Retirement and Trust in Charlotte, North Carolina. These tools can help you determine when you’re eligible to participate in the plan, what the default contribution rate is and how much your employer offers for a match.
If you intend to start with the default rate and increase contributions over time, check whether the plan includes auto-escalation. This feature lets you choose how much to increase your deferral rate annually, and the plan adjusts your contributions automatically. Just remember to choose an amount that doesn’t compromise your budget. Your contributions should increase “up to the amounts that you can tolerate without taking away from your other short-term needs,” says Joel Russo, president of Premier Financial Group in Wall, New Jersey.
You can also explore other savings options during the waiting period. Rebecca Pavese, a financial planner and portfolio manager with Palisades Hudson Financial Group in Atlanta, says younger workers should consider using the waiting period to build a cash emergency fund.
If you already have some emergency savings, you could start investing in an individual retirement account, or if you’re in the early stages of your career, a Roth IRA may be the better choice. A Roth doesn’t allow tax-deductible contributions like a traditional IRA, but you get something that may be even better — tax-free qualified distributions.
Getting rollovers wrong. Your first job probably won’t be your last, and when you leave, your 401(k) should leave with you. Forgetting a plan at a previous employer is one of the biggest mistakes workers make, says Roman Catli, regional manager with U.S. Bancorp Investments in Seattle.
Any 401(k) money that isn’t rolled over into an IRA or the new employer’s retirement plan is considered a distribution, and if you’re younger than 59 1/2, the money may be subject to income tax and a 10 percent penalty. The rollover method also matters because doing it wrong will cost you.
When a 401(k) distribution is made directly to you, 20 percent of the money is withheld for taxes, Parker says. If you want to roll over what’s left, you’d have to make up the difference to avoid a tax penalty. You must also complete the rollover within 60 days. Otherwise, the entire amount becomes a taxable distribution.
[See: 12 Steps to a Stronger 401(k).]
Indirect rollovers are tricky, so have your employer roll the money over directly into your IRA or the new employer’s plan. That should eliminate any headaches. “There are a lot of rules regarding 401(k) rollovers,” Parker says, so ask a financial advisor if you’re unsure what to do.
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4 Mistakes to Avoid With Your First 401k originally appeared on usnews.com
