7 401(k) Mistakes You’re Probably Making

Many savers make 401(k) choices that may not get them to a secure retirement

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The typical 401(k) balance rebounded in 2009. Above average market returns and continued worker and employer contributions caused the average 401(k) balance to climb from $57,150 in 2008 to $70,970 in 2009, according to a recent Hewitt Associates analysis of 3 million employees at 120 large companies. But balances are still below the 2007 high of $79,570. And many employees continue to make 401(k) choices that may not get them to a secure retirement. Here are a few 401(k) mistakes some workers continue to make.

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Missing the match. A 401(k) match is part of your compensation that you give up when you fail to fully participate in your retirement account. Some 28 percent of 401(k) participants do not contribute enough to their 401(k) to receive their full employer match, Hewitt found.

Too much company stock. Among workers offered stock options, the average allocation to company stock was 19 percent in 2009, up nearly 4 percentage points from 2008. About 13 percent of these workers had half or more of their 401(k) balance in their employer’s stock. It’s generally best to diversify your nest egg beyond the company you work for.

Early withdrawals. Over a quarter (26 percent) of employees had an outstanding 401(k) loan in 2009, up from 23 percent in 2008. And 7 percent of participants took an early withdrawal. 401(k) distributions before age 55 for retirees or age 59 ½ for current employees carry a 10 percent penalty on the amount withdrawn in addition to regular income tax due. Both early withdrawals and loans interfere with the compounding process and will leave you with less money in retirement.

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Ignoring the Roth option. While traditional 401(k)s give you a tax break in the year you make the contribution, income tax is due in retirement. A Roth 401(k) allows you to pay the tax up front and take retirement withdrawals tax free. Just 7 percent of 401(k) participants elected the Roth option when it was available in 2009.

Blindly accepting the default investment. Over half (58 percent) of the large employers surveyed automatically enroll workers in retirement accounts unless they specifically opt out. The majority (69 percent) use target-date funds as the default investment. While target-date funds can be a good investment for employees who don’t wish to design their own portfolio, individual funds vary significantly in the percentage of the fund allocated to equities at various stages of a person’s lifetime and the fees changed to investors. Participants should make sure that any investment they are defaulted into fits their individual risk tolerance and will put them on a path to meeting their retirement savings goals.

Forgetting to rebalance. Market appreciation boosted the amount of equity employees held in their 401(k) plans from 59 percent in 2008 to 67 percent in 2009. Investors wishing to maintain a specific proportion of their portfolio in the stock market need to shift some of their money back into more conservative investments in years when stocks do well and transfer money into equities in years when the market falls. Most workers fail to make these annual adjustments. Some 16 percent of employees made any sort of fund transfer in 2009, down over 3 percentage points from 2008. “While it’s encouraging that most workers stayed the course throughout the market’s roller coaster fluctuations, most did so simply because they were disengaged with the retirement saving process or too paralyzed with fear and confusion to touch their 401(k) plans,” says Pamela Hess, Hewitt’s director of retirement research. “If employees continue to ignore their 401(k) plans, they’re hurting themselves by letting the market dictate their retirement strategy.”

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Failing to participate. Workers were able to recover some of their 2008 losses simply by continuing to save more in their 401(k) plan. But just over a quarter of workers who have access to a 401(k) don’t participate. “Employees have to make retirement planning a priority and take more proactive steps to manage their plans, including rebalancing their portfolios, gradually increasing their contribution rates, and paying attention to fees,” says Hess. Among those who are saving for retirement, the typical contribution rate is 7 percent of pay.