Five Mistakes You Must Avoid In Your 401(k)


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While nearly a third of workers participate in 401(k) plans, some common mistakes and oversights limit the rewards they ultimately reap.

Many participants choose the wrong funds, fail to monitor investments or simply forget about a plan when they change jobs frequently, says Lisa Van Fleet, a partner at St. Louis-based Bryan Cave LLP who specializes in employee benefits and compensation. She suggests that employees contribute as much as they can for as long as they can and stay informed about their investments' performance and how legislation and tax rules apply.

"Arrive early, push your contributions to the limits, pay attention to the game, and, if possible, play into overtime," says Van Fleet.
Whether participants are pressed for time, confused by financial mumbo-jumbo or plain lazy, there are some simple guidelines to maximize returns.

Participants who don't contribute enough to receive matching funds from their employer are "leaving money on the table," says Van Fleet. Still others don't take advantage of special "catch-up" contributions that allow those who are 50 years old or over to contribute more on a tax-free basis than their younger counterparts.

The maximum annual 401(k) deferral allowed in 2008 is $15,500 for those under 50. It's $20,500 for those age 50 or older. If an employer provides 3% in matching funds, a $10,000 contribution by the participant will result in a $20,150 overall contribution.

Formulate an investment plan based on your age, risk-appetite and market outlook. Van Fleet suggests using life-cycle funds, which shuffle the investment mix to reduce risk (and, usually, returns) as the participant ages. Many participants have been automatically enrolled into this type of 401(k) because an increasing number of employers are using it as the default option.

Participants with multiple plans from various jobs should make sure each is a part of a comprehensive investment strategy. Otherwise, it might make sense to combine the individual funds into one account to minimize paperwork, fees and the hassle of overseeing several plans.

It's also important to check returns and fees on a regular basis, not just once a year when the Fidelity statement comes in the mail. If the 401(k) is performing poorly, it might be wise to alter strategies. But keep in mind that retirement funds are long-term investments and that churning investments frequently can diminish returns just as easily as neglect.

Participants who don't inform former employers about their relocation could lose out if the company is unable to locate them when it comes time to distribute benefits. Van Fleet says this happens to a "surprising" number of people, when a simple change-of-address card could have kept thousands in their retirement coffers.

Some participants opt to take out loans and hardship distributions or cash out of small accounts when they're in a bind. But doing so too often or without a good reason can deplete resources that will be needed even more down the road. This is particularly true for younger investors, because they are robbing themselves of even more compounded interest than older participants would eventually receive.

"This is most likely to be a temptation early in your career when you have more frequent job changes, smaller account balances and a longer retirement horizon," says Van Fleet. "However, these small benefits, if left in a plan and allowed to compound over your working career, can significantly enhance your ultimate retirement resources."

Not many participants deposit cash above the maximum deferral amount, but there are other ways to get taxed on retirement savings as well. For instance, transferring benefits directly, rather than allowing them to roll over to a successor plan, eliminates the need to satisfy withholding tax obligations and timing rules.

Another factor to consider is a Roth IRA -- which gets taxed before the contribution -- versus a 401(k), which is taxed upon withdrawal. The right choice depends on whether one believes tax rates will rise or fall.

All participants should know the tax rules and how they apply to each individual situation before choosing a plan, figuring out contributions and making any withdrawals or changes. While no one has a crystal ball, it's always best to make an informed choice.

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