How’s your 401(k)’s health these days? Hopefully you treat it like your own health, getting regular checkups to make sure everything is working well. Because if you wait until you have a concern, whether it’s your own health or your 401(k)’s, you might get an unexpected surprise that could be tough to fix.
In fact, some 401(k) mistakes cannot be fixed at all. You get a once-in-a-lifetime chance to get it right. Be sure to avoid these 401(k) blunders:
1. Not Setting Aside Enough Money in your 401(k)
How do you decide how much cash to contribute to your 401(k)? The easy answer for most: you cannot save too much. We encourage clients to max out their contributions if they can. At the minimum, you want to set aside enough to get the company’s match.
Depending on your tax rates, you may also want to investigate the Roth 401(k) option. The Roth 401(k) forgoes the tax deduction today, but all growth and future distributions (after age 59A1/2) are tax free. For people who expect to be in higher tax brackets even in retirement, a Roth 401(k) may afford more advantages than an ordinary Roth IRA because of the much higher contribution limits for a 401(k).
The Roth IRA limits 2016 contributions to $5,500 ($6,500 for those over age 50), and you’re ineligible once income is more than $132,000 for a single person or $194,000 for a couple.
The Roth 401(k), however, allows you to contribute up to $18,000 ($24,000 if over age 50), and there is no income limitation.
2. Failing to Track Pre-Tax vs. After-Tax Contributions
You get one chance at retirement to separate your after-tax contributions (money you’ve already paid taxes on) in a 401(k) from your pre-tax contributions (money out of your paycheck before paying taxes on it). If you miss that opportunity to separate, then you have to track the after-tax amount on every distribution for the rest of your life.
That can be an accounting nightmare.
And if you fail to keep track, the IRS may have you pay tax on the money again. Imagine the confusion this would cause for your family after you’re gone. How would they know a portion of that money is supposed to be tax-free? The real opportunity is that the IRS now allows those after-tax dollars to go directly into a Roth IRA upon rollover, but you only get one shot to do this right.
3. Missing Big Tax Savings on Company Stock
This is another one-time opportunity at retirement that can reward you with significant tax savings: Net unrealized appreciation (NUA) allows special treatment for company stock in a 401(k). NUA lets you pull company stock out of the 401(k) and pay tax only on the original purchase price versus its current value.
For example, if you had $300,000 of company stock, but paid only $50,000 for it, at retirement you could move that $300,000 to an after-tax brokerage account (not an IRA), and only pay ordinary income tax on the basis of $50,000.
Eventually when you sold the stock, you’d pay capital gains taxes on the gain from $50,000 to $300,000. Capital gains rates may be anywhere between 0% and 20% compared with 39.6% for ordinary income. Resulting in a potential tax savings of 15% or more on $250,000, or a minimum of $37,500.
4. Not Investigating the “Brokerage Window” Option
Many employer plans offer a little publicized option called the “brokerage window”. This option offers more investment choices than your standard 401(k) plans. Brokerage accounts usually include an annual cost (in the $50 range), and trading fees are higher (I’ve seen charges of $20 to $75 per trade), but it can offer you many more investment options and greater diversification compared with your standard choices. So for a nominal fee, you can access wider and potentially more attractive options with the brokerage window.
5. Skipping In-Service Distributions
In-service distributions go a step farther. They open the door to investments not available in a 401(k) or even the brokerage window. After age 59A1/2, many companies allow you to roll over either a portion or the entire balance of your 401(k) into an IRA. One of the main reasons people do this as they approach retirement is to access investments with potentially less risk, such as certificates of deposit, individual bonds, fixed annuities or real estate. People approaching retirement should not have all of their money in the stock market, and the choices in 401(k) plans (even the brokerage window) are generally all tied directly to the markets.
6. Making the Wrong Rollover Moves
After leaving a company, you may want to consider rolling your ex-employer’s 401(k) into an IRA (for better control, access to more and different types of investments and benefits for future beneficiaries).
However, if you’re still working at age 70A1/2 and older, your current 401(k) is exempt from required mandatory distributions. Past IRAs and 401(k)s are not. While not rolling over your current 401(k) can be a mistake, in some circumstances, rolling it over while you are still working can also be a mistake. If you’re 70A1/2 or older, still working, and don’t need or want the extra income, you may actually consider rolling IRAs into your current employer’s 401(k) to avoid having to take RMDs. An investment adviser can help you weigh all factors to determine if this option makes sense.
7. Not Being Proactive
This is an area where silence is not golden. If your financial adviser is not talking to you about these ideas and formulating a proactive plan for your retirement, that’s a red flag. It could be a sign that he or she doesn’t focus on working with retirees or people planning for retirement.
These seven mistakes can have a dramatic impact on your retirement. Treat it like your own health. Go get that checkup with an adviser who understands taxes, preservation of capital and retirement income and distribution strategies.
Remember, it’s not your job to be the financial professional and know the details of all available options. It’s theirs. So, be sure to work with a financial adviser who focuses on retirement strategies.