5 common mistakes to avoid when opting for a 401(k) plan

“A penny saved is a penny earned” is an age-old but evergreen proverb. While many schemes help people save, the 401(k) plan is a popular one. Provided by one’s employer, this savings plan helps people set aside a specific sum every month, which they can use after retirement. The amount is deducted automatically from the employee’s paycheck and deposited into a special account. While the 401(k) has many benefits, users should avoid certain mistakes.

Not knowing the different types of 401(k) accounts
Under this scheme, there are two types of accounts: traditional and Roth 401(k). In the traditional plan, while the amount entering one’s savings account isn’t taxed, the amount withdrawn after retirement is taxable. In contrast, Roth 401(k) users incur taxes from their incomes but not during withdrawals. Each plan has pros and cons, which account holders should know to avoid confusion.

Withdrawing early from the 401(k)
With 401(k) accounts, being a little patient is always good. If one withdraws before turning 59.5, they face a 10% penalty over and above the income tax on the distribution. Even if a plan does not involve such a penalty (which is uncommon), one might miss out on any additional returns that can be earned from the investments. So, waiting before withdrawing from the 401(k) account is always better.

Not understanding the fee breakdown
Understanding the fees one pays when holding 401(k) accounts is important. The fees typically include the expense ratio plus any administrative charges. Usually, 401(k) plans entail a 1% fee, which means one would pay $10 for every $1,000 in their portfolio. Understanding such fees ensures one knows where one’s money is going so there is no financial crunch later.

Leaving the company before one gets vested
An employer can decide to match the employee’s contribution in a 401(k) plan every month. But one needs to stay with the organization for a certain time (vesting period) before they can keep the entire match. While this period might last for at least three years, the amount accumulated at the end is quite high, which makes it rewarding. Conversely, if one quits the company before this period ends, one loses the opportunity to earn the employer’s contribution. In these cases, employees only keep their own contributions, which will be less than what they would enjoy after completing the vesting period.

Maintaining the same contribution amount
It is important to increase one’s contribution gradually to a 401(k). Investing the same amount even as time passes limits one’s investment returns considerably. One can increase the amount they set aside in the plan every time they earn a raise at work or receive a reward. Doing so helps one enjoy a bigger sum upon retirement.