Saving for retirement can be tricky. If you're not careful, one wrong move can set you back years and thousands in potential earnings. Watch out for these common retirement investing traps.
Taking a loan against your 401(k). Most employer benefit programs describe the 401(k) loan as an added benefit to your 401(k) plan. But a 401(k) loan should rarely, if ever, be taken. When you take out a 401(k) loan, several negative things can happen. The market could see a huge jump and your borrowed funds won't benefit from those gains. Your plan might not allow you to contribute while you have a loan outstanding, causing you to miss several months or even years of retirement contributions. And, worst of all, you could lose your job, which makes the loan due within 60 days. A default on the loan would likely mean a 10 percent penalty from the IRS plus a huge income tax bill. 401(k) loans are definitely not the worst place to access cash, but they should be avoided. Those funds had one original goal: securing your retirement.
Withdrawing 401(k) funds when you change jobs. When you leave your job, there is a strong temptation to raid your old 401(k) and use those funds to pay for current expenses until your next paycheck comes. When you do this it's considered an early withdrawal. You will be required to pay taxes on that distribution plus a 10 percent penalty imposed by the IRS. Luckily, you have other options. You can leave the funds where they are or do a tax-free rollover to an IRA or your new 401(k) plan. If cash is an immediate need, consider taking a part time job to make extra money before you dip into those funds.
Ignoring investment costs. With an employer-sponsored 401(k) plan you are often given a limited choice of mostly high-cost mutual funds to choose from. Investment marketing materials often focus on past performance and brand name. Fund costs aren't always apparent in the informational materials. Make sure you consider the expenses associated with your investments. You may have to dig around in the fine print, but it will be worth it. Index funds and exchange traded funds tend to have the lowest costs.
Not diversifying your portfolio. Avoid holding too much of your money in a single investment. Many investors hold too much company stock. Company stock is a great perk if your company decides to reward you with cheap shares. But be careful not to let company stock or any other single investment grow to more than 10 percent of your portfolio. That way, if one investment goes bad you won't lose everything.
Relying too much on others. We can’t rely on the government or our employers to help us in retirement. We need to take more responsibility for our own retirement. Make sure you put a portion of your earnings in a tax-advantaged account each year. Invest in a broad mix of investments at a well-known and widely used investment firm. And don't overpay someone else to do it for you. If you need an adviser, make sure you stick to independent certified planners who charge you by the session.
Phil Taylor is the author of the popular 52 Ways to Make Extra Money. Find out how to save more money and get the latest news on the best online savings accounts and the best online stock brokers at his blog, PT Money: Personal Finance.