No doubt everyone who has a company sponsored retirement account (401K, 403b) and/or self managed plans (IRA, Roth IRA) has read about all the right things to do like regular investing, diversification and choosing low-cost funds. However, it is just as important to consider what NOT to do with your retirement accounts so that you avoid the various pitfalls and traps ahead of you, and to ensure you have enough in retirement.
1. Do NOT Borrow from your plan. A plan loan may be a convenient way to pay for a big expense—but it is not free money. You have to pay back the principal plus interest to your plan account—usually within 5 years. Loans also reduce the amount of money that’s available to compound and grow. Worse, if you leave your employer before you have repaid the loan, you may be forced to repay it quickly. If you cannot, the outstanding balance is considered a taxable distribution. If you are under age 59½, you have to pay a 10% early withdrawal penalty as well.
Consider the following example: Jack, who had $50,000 in his 401(k) plan account, took a $25,000 loan for a new sports car. A month later, he left his job and had to cash out of the plan. After the required 20% withholding and automatic loan repayment, Jack, who is 45 years old, received a check for only $15,000. He had to pay income taxes on that sum plus a 10% early withdrawal penalty. He was left with less than $10,000, a new car, and no retirement savings. Make sure you explore all of your borrowing options before taking a loan from your retirement account. With interest rates so low a personal bank or credit card loan may be cheaper – especially if the need is only for the short term.
2. Do NOT Contribute only as much as your company match. If your company offers a match, it is important to take full advantage of it. But contributing just enough to get the company match may not be enough. A good goal is to contribute a minimum of 9% to 12% of your income to your retirement plan, which would include any employer contributions. Ideally, higher-income workers should consider contributing 12% to 15%, including employer contributions, to maintain their current standard of living in retirement.
3. Do NOT Chase hot-performing funds. It is a mistake to chase hot performance. Just because gold, cryptocurrency or any other investment is performing well now does not mean that it will in the future. Instead, select a diversified mix of stocks, bonds, and short-term reserves that’s right for you—then stick with it for the long term.
4. Do NOT Avoid risk. There’s a risk to devoting a large portion of your retirement savings to short-term reserves—the risk of inflation. Inflation eats away at your investment return, giving your bucks less “bang” over time. How you invest should always be based on how long you can keep the money invested and your tolerance for taking risk. While a short-term reserve fund does offer stability, these investments do not offer much opportunity for growth. Stocks and bonds, in comparison, have historically had higher average annual returns over long periods of time, with stocks offering the greatest long-term return potential. If all, or most, of your assets are invested in a short-term reserve fund, such as a money market, you may want to consider reinvesting some of this money in stocks and bonds. No matter how conservative a long-term investor you are, consider allocating a portion of your savings to stocks to help defend your portfolio from inflation’s ravages.
5. Do NOT Cash out of your plan if you leave your employer. You may be able to cash out, but you’d take on a potentially large tax liability. You would owe ordinary income tax on the distribution plus a 10% premature distribution penalty if you were under age 59½. Instead, Consider a direct rollover into a low cost IRA account or into your new employers 401K plan.
6. Do NOT Try to “time” the market. It’s impossible to predict with any consistency the market’s ups and downs and how they’ll affect your account. By frequently transferring money in and out of the market, you’ll likely miss out on some growth potential and increase the fund’s expenses. Leave market timing to the portfolio managers. They get paid to make informed decisions about buying and selling the securities within the fund.