3/21/2012 5:45 PM ET|
Subtle 401k mistakes that many make
Regularly stashing away cash is essential, but knowing which pot to put it in -- and when to start taking it out -- can make a big difference in your income in retirement.
Missing out on an employer 401k match is the most obvious retirement savings mistake many workers make. But there are plenty of more subtle ways investors reduce their chances of having a comfortable retirement. Following are a few common retirement savings mistakes to avoid:
Putting too much in your 401k. Some people pour as much money as they can into their 401k plans. But that's not always the best option. Many 401k's are filled with expensive funds that will eat into returns every single year. And even the tax break may not be in your best interest in the long run. Because tax rates are at historic lows, they are likely to go up in the future. So you could be taxed at a higher rate in retirement than you would be if you paid the income tax now.
To mitigate both of these problems, contribute enough to your 401k to take advantage of the employer match, and then switch to traditional and Roth individual retirement account contributions. Once you max out an IRA, then decide whether it's best to contribute more to your 401k or a taxable account.
Diversifying each account instead of your overall portfolio. It's important to figure out an appropriate asset allocation for your investments. But you might not be taking advantage of how our complicated tax code works if you try to have the ideal mix of stocks and bonds in every single account.
Instead, think of all your financial assets as one giant portfolio and divide them up accordingly, putting tax-advantaged investments like stocks in taxable accounts while leaving the bonds, which are generally taxed at ordinary income tax rates, in your retirement accounts.
Not taking retirement account withdrawals until they become required. Withdrawals from traditional retirement accounts don't become required until after age 70½. But sometimes it's best to withdraw some money from your tax-deferred accounts before that age, even if you don't yet need it.
For some people who have large 401k balances, the required minimum distribution plus Social Security benefits might push them into a higher tax bracket. You might be able to avoid this problem by withdrawing some money from your IRAs, penalty-free, before age 70½ so you can pay the lower tax rate. Taking withdrawals early could allow you to reduce your lifetime tax rate, giving you more money to spend on yourself or to pass on to heirs.
Maintaining too many 401k accounts. Not everyone moves a 401k account to an IRA or the new company's 401k plan when changing jobs. Multiply this scenario by several job changes and you might need an assistant just to keep track of everything. Consolidating your retirement accounts doesn't necessarily mean you will have more money upon retirement, but a simplified financial picture could help you manage your finances and make better decisions.
Failing to follow through on savings decisions. Remember the advice about not putting too much money in a 401k? This strategy makes sense only if you will be disciplined about contributing to your IRAs and taxable accounts. You will need to deposit money into these accounts from each paycheck and increase your contribution amount every time you get a bonus or pay raise.
If you are the sort of person who will spend every dollar that isn't automatically withheld from your paychecks, the company 401k is a much better savings vehicle for you, because 401k contributions are taken out of each paycheck without fail.
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