Common retirement plan mistakes
- By Milt x_Zall
- Apr 04, 2002
The collapse of Enron, Global Crossing Ltd., K-Mart Corp. and other high-profile
companies has dramatically highlighted the risk of investing too heavily
in company stock in 401(k) or other employee-funded retirement plans, such
as the Thrift Savings Plan (TSP).
But workers often make other mistakes in such plans. Following are other
common mistakes cited by Dennis Filangeri, a certified financial planner
based in San Diego.
Failing to participate
According to the Profit Sharing/401(k) Council of America (www.psca.org), 20 percent to 25 percent of eligible workers don't participate
in available 401(k) plans. This means they are missing out on one of the
most tax-effective ways to save for retirement, and they could end up depending
mostly on Social Security benefits when they retire.
Failure to participate is especially costly because more than 70 percent
of employers match part of each employee's contribution, according to the
council. Consequently, failure to join essentially means passing up free
Failing to save while waiting
Most 401(k) plans don't allow you to join the plan until you've worked
for the employer for a year and many require you to be at least age 21.
If that's your situation, set aside money each month in a savings account.
When you do join the plan, you can use the extra savings to supplement your
cash flow so that you can maximize your regular 401(k) contribution over
the next year.
Failing to contribute the maximum
Not every employee can afford to contribute the maximum allowed by the
plan, but many employees don't contribute the most they can afford to contribute.
The average 401(k) participant contributes less than 7 percent of pre-tax
salary, according to the Employee Benefit Research Institute (www.ebri.org), although plans usually allow higher limits (TSP allows 10
percent) as long as the amount does not exceed $11,000 in 2002. At the very
least, contribute enough to maximize the employer's matching contributions
5 percent for TSP but put in more if you can.
Not adjusting automatic enrollment
An increasing number of 401(k) plans automatically enroll workers, unless
they opt out. This increases the participation rate, which is good. However,
participants often fail to adjust the enrollment's initial default choices.
Consequently, they probably aren't contributing as much as they can afford
to, and the investment defaults are likely too conservative. Take the time
to make adjustments.
The average 401(k) plan offers about 10 investment choices too few,
critics say. However, nearly half of all 401(k) participants invest in only
one or two of the mutual funds offered anyway, according to Hewitt Associates.
Filangeri says that's poor diversification, particularly if those funds
are similar in style, such as two large-cap stock funds. And remember, if
you hold company stock, it's important to diversify away from your company
as well as the industry it represents.
Failing to balance with outside investments
For most workers, a 401(k) or similar employer-sponsored retirement
account is their main investment aside from their house. However, you may
have other significant investments, such as your spouse's retirement account,
individual retirement accounts, real estate, college savings and so on.
So when choosing retirement plan investments, make investment choices that
take into account the outside investments as well. Your overall portfolio
needs to be properly balanced for risk and return.
Heavy on company stock
After all the publicity about Enron and Global Crossing, this seems
like obvious advice. Yet many workers have been quoted as saying they will
continue to load up heavily with their particular employer's stock because
they're confident their employer's stock will continue to do well. Certified
financial planners generally recommend that workers keep no more than 20
percent of company stock in their retirement account.
Borrowing from the plan
It may be financially attractive to borrow from your 401(k), but avoid
it unless absolutely necessary. You're taking money out of the account that
otherwise would grow tax-deferred. And if you fail to pay back the money,
you could face income taxes and penalties. Instead, build an outside emergency
fund you can draw on.
Cashing out plan account
Most workers under age 35 cash out their 401(k) account's accumulated
value when they switch jobs, according to the 401(k) Association (www.401kassociation.com). That money no longer grows tax-deferred, but the
withdrawal faces taxes and usually a 10 percent early withdrawal penalty.
Zall, Bureaucratus columnist and a retired federal employee, is a freelance
writer based in Silver Spring, Md. He specializes in taxes, investing, business
and government workplace issues. He is a certified internal auditor and
a registered investment adviser. He can be reached at firstname.lastname@example.org.