If you haven’t read my posts Retirement 101 and Retirement 102, I highly recommend starting there first. It will give you a decent foundation on retirement accounts and all of the different options available. Now, I want to focus on the potential pitfalls you could encounter if you are not actively involved in managing your accounts.
- Not Getting Your Full Company Match - As an HR professional, I saw first-hand how many people do not take full advantage of the company's match. If the company matches up to 6%, you put in at least 6%. If they match up to 3%, you put in at least 3%. If not, you are leaving free money on the table. That money every pay check adds up! Some may say, "but Tiffany, I have debts to pay before I can even think about retirement". Honestly, everyone's situation is a bit different BUT my late grandpa always told me to pay myself first then the bills and other responsibilities after. It doesn't matter how much I think I need the money for bills, I have always made it with paying myself first (even at $10 an hour). My philosophy is to make it work especially if you are fully vested from day one.
- Not Actively Managing Your Portfolio - When you are investing in a retirement account, that account is not like a savings or checking account. You have to put that money into at least one (preferably more) investments. One mistake I see quite often is people take that step and start contributing but have no idea where the money is going. Allocations should be based on your risk tolerance. Stocks are high risk with potentially high returns. Bonds are low risk with low returns. If you have more of a risk tolerance and capacity, then you would have a higher percentage of stocks in your portfolio. Check your allocations at least every 6-12 months to make sure you are still in your target percentages.
- Getting Hit with Extensive Fees - Every investment has a corresponding expense ratio. The expense ratio is how much fees are attached to that particular investment. Make sure your fees are not killing your returns. For example, if you have a 1% expense ratio and you return is averaging 7% a year, you are only experiencing a 6% return. That is also not taking into consideration inflation which averages 2% a year so then you are down to 4%. So although 0.50% expense ratio may sound small it can add up quite a bit over time. Keep an eye on it!
- Forgetting to Designate Beneficiaries - Once you open a retirement account, it is important to name beneficiaries who will be entitled to your proceeds if you were to pass away. If you don’t name a beneficiary, the funds usually default to your estate. You may be thinking, “well what’s the problem with that?” If it goes to your estate and it is a pre-tax account, your age would be used to calculate what year the RMDs start (read Retirement 102 for definition). Let’s say you die at 70. Once you would have turned 70 1/2, your estate would have to start taking distributions. This could be an issue if your family needed the money for a future time. Make sure you have beneficiaries named on all of your accounts.
- Ignoring your 401K When You Switch Jobs - I highly recommend rolling a company's retirement plan to an IRA when you leave the company. This is important because when you are in a company-sponsored plan, your investment choices are limited. With an IRA, you have access to the whole market! Just make sure you are following the correct procedures when rolling or you could face hefty taxes or fees. If you do choose to leave your funds with the company's plan, make sure your are still actively managing your investments.
These are some common pitfalls people make with their retirement accounts. Don't let them happen to you! Knowledge is power!
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