Avoid These 7 Mistakes With your 401(k)
You've worked hard to grow your 401(k). You've consistently set aside a portion of your salary, watched your investments grow, and felt confident in your progress. But as retirement looms, a new challenge emerges: managing this account so it lasts the rest of your life.
For many, pivoting from growing a 401(k) to drawing it down can feel overwhelming. Without careful planning, you could be subject to higher taxes, penalties, and even the risk of depleting your savings too quickly. That's why it's essential to understand the most common pitfalls and how to avoid them.
Make sure you avoid these common 401(k) mistakes during your retirement.
1. Withdrawing funds without a plan
Taking money from your 401(k) without having a plan can lead to incredibly costly mistakes. Inconsistent and sporadic withdrawals can lead to avoidable taxes and penalties. They can even cause you to draw down on your retirement funds too quickly, causing significant financial strain during your retirement.
Create a withdrawal strategy as part of your comprehensive financial plan. Consider your living expenses and cash flow needs while managing your income tax rates. Factor in your other income streams like social security, pension, rental, and other investment income. And make sure you avoid overly simplistic rules of thumb, like the "4% rule." Your drawdown strategy should be unique to your situation.
2. Overpaying Fees
Many retirees unknowingly pay excessive fees on their 401(k) accounts, which can significantly erode their savings over time. The two primary types of fees are:
Plan Administration Fees: These cover the costs of recordkeeping, investment selection, and other administrative tasks.
Investment Management Fees: Each investment fund charges a management fee, which varies by fund.
To avoid overpaying, review your plan's fee structure. Compare these costs to alternatives, such as rolling your 401(k) into an IRA, which often offers a broader range of low-cost investment options and may eliminate administrative fees. By managing these costs, you could save thousands—or even tens of thousands—of dollars throughout your retirement.
3. Making Early Withdrawals and Ignoring Penalties
Early retirement can be exciting, but withdrawing money from your 401(k) before age 59½ can be costly. Early withdrawals typically incur a 10% penalty in addition to regular income taxes.
If you need funds before 59½, explore penalty-free options like the Rule of 55 or hardship withdrawals. However, both of these should be considered a last resort. The key to avoiding penalties is understanding withdrawal rules and planning.
4. Not Naming or Updating Beneficiaries
Failing to name or update beneficiaries on your 401(k) can create unnecessary complications for your loved ones. Without a designated beneficiary, your account may go through probate, a court-supervised process that can cost 3-7% of your assets in fees.
To ensure your money goes to the right person, review your beneficiary designations regularly and update them after significant life events such as marriage, divorce, or the birth of a child.
5. Not Adjusting Your Asset Allocation
During your working years, a growth-focused investment strategy is essential. But as you approach retirement, adjusting your asset allocation to reflect your new priorities is vital. Holding too many high-risk investments could lead to significant losses that jeopardize your financial security.
Develop your asset allocation to align with your risk tolerance, time horizon, and withdrawal strategy. Periodically review the asset allocation to ensure it aligns with your goals and risk tolerance, and rebalance it as necessary. If you're unsure how to proceed, consult a fee-only fiduciary financial advisor for guidance.
6. Not Taking Advantage of Roth Conversions
If your 401(k) was funded with predominantly pre-tax amounts, you might miss out on a valuable tax-saving opportunity by not making strategic Roth conversions.
A Roth conversion involves transferring funds from a pre-tax account to a Roth account and paying taxes on the converted amount in the year of the conversion. While this creates a tax liability upfront, the long-term benefits can be significant: tax-free growth, tax-free withdrawals (if certain conditions are met), and no RMDs for the account holder.
Building a large Roth balance can provide greater financial flexibility and tax efficiency in retirement. Consult a tax advisor or financial planner to determine whether Roth conversions make sense for your situation.
7. Forgetting to Take RMDs
You are required to take RMDs from pre-tax retirement accounts beginning at age 73 (or 75, depending on your birth year). These withdrawals are calculated annually based on the account balance and life expectancy.
Failing to take your RMDs can result in an excise tax of up to 25% on the amount not withdrawn. To avoid this penalty, understand the rules and plan your withdrawals accordingly.
Conclusion
A 401(k) account is one of the most powerful tools to plan for a secure retirement. But once you retire, you must manage it carefully to ensure it meets your financial needs. Avoid these seven common mistakes to protect your hard-earned savings, minimize taxes, and ensure your money lasts as long as possible.
If you need help planning for retirement with your 401(k), please schedule your free 30-Minute retirement planning consultation today.
Presented by Irvine based Financial Advisor JP Geisbauer,CPA, CFP®, of Centerpoint Financial Management.
About Our Presenter:
JP Geisbauer is a Certified Public Accountant, a Certified Financial Planner ®, and the founder of Centerpoint Financial Management, LLC, a financial planning, investment management, and income tax planning firm located in Irvine, CA. JP Geisbauer is dedicated to helping California-based business owners and executives transition into retirement. He has been quoted in many news outlets including Forbes, Newsweek, US News & World Report, MarketWatch, YahooFinance, CNN and NerdWallet.
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Disclaimer:
This article is for general information and educational purposes only. Nothing contained in this article constitutes individual financial, investment, tax, or legal advice. Before taking any action on any topic discussed in this article, consult with your own financial planner, investment advisor, tax professional, and/or attorney for advice on your specific situation.