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401(k) – 5 Deadly Traps You Need To Avoid When You Love Your Money

Financial Ginger - 401(k) traps

By Guest Author: Stacy Miller

Financial experts keep talking about 401(k) and how it’s beneficial for us. But do you know what it actually is? Well, Investopedia defines a 401(k) account, “A 401(k) plan is a qualified employer-established plan to which eligible employees may make salary deferral (salary reduction) contributions on a post-tax and/or pretax basis. Employers offering a 401(k) plan may make matching or non-elective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan. Earnings in a 401(k) plan accrue on a tax-deferred basis.”

If a 401(k) account is used properly, then you can save a lot of money for the golden years of your life. However, there are a few traps or pre-retirement blunders you need to avoid when you’re participating in a 401(k) plan.

Trap #1. Using a 401(k) account as your credit card: Please understand one thing that a 401(k) account is not your credit card. It is a tool that can help you boost your retirement savings. But if you take out a loan from your 401(k) account, then it will be a terrible mistake. Here are a few reasons:
a) The outstanding balance will be due within 2 months of separating from your employer.
b) You have to pay origination fees and maintenance fees. These are extra costs.
c) You have to pay penalties in the event of loan default. Plus, the loan will be considered as a taxable income. (You’re going to be paying taxes, on your own money twice)

Trap #2. Assuming that 401(k) and Roth 401(k) are same: Both are distinctly different from each other.

According to Bankrate, a Roth 401(k) account is, “An employer-sponsored retirement plan that lets employees have the option of setting aside money from their paychecks that’s taxed upfront and saving it in a retirement account where it can grow tax-free forever. Money can be withdrawn tax- and penalty-free as long as the participant is age 59½ and has held the account for at least five years.”.
The key differences are:

401(k) – Contributions aren’t taxable for the year you’re making contributions (dont pay taxes now, pay them when you withdraw at retirement)

Roth 401(k) – Contributions are taxable for the year you’re making contributions (pay taxes now and not later when you withdraw during retirement)

401(k) – This is subjected to RMD by the day you turn 70.5 years old.

Roth 401(k) – This isn’t subjected to RMD by the day you turn 70.5 years old.

Let me define RMD for those who don’t have any idea about what a Required Minimum Distribution is: “A required minimum distribution (RMD) is the amount that traditional, SEP
or SIMPLE IRA owners and qualified plan participants must begin distributing from their retirement accounts by April 1 following the year they reach age 70.5.”

It is important to know the rules and do all the calculations correctly. Otherwise, you’ll be in a mess.

Problem #3. Not reviewing/updating your contribution percentage annually: You have to select a percentage that will be taken away from your wage and put into your 401(k) retirement savings plan. It has been observed that plan holders often forget about this contribution percentage, which is a big mistake.

Your financial health changes when your life scenario changes. For instance, you get married, you have your first baby or you get a big salary hike. If you analyze carefully, you may find that your contribution amount is either too big or too small. Though it isn’t investment advice and FinancialGinger cannot be responsible for the actions of readers based on its opinion, FinancialGinger generally recommends to at a minimum contribute the maximum match offered through your companies 401(k) program.

Problem #4. Not taking advantage of maximum employer match: You’ll lose a hefty amount if you miss out on maximum employer match. In a survey of 360 employers, it has been observed that 42% of them matched employee contribution. 56% of these employees only required workers to contribute 6% from their wage to qualify for the maximum employer match. It is said that the average missed employer contribution amount is $1336 every year.

Huge Issue #5. Not adjusting your portfolio at regular intervals: You need to rebalance your portfolio at the time of choosing index funds. It might be the case that you’re holding 90% in a low-cost index fund and 10% in government bonds. However, as the market condition changes, you need to adjust your portfolio allocation (What % of your money is in each asset class) as well.

If the S&P 500 has a huge rally (quick jump upward), it will be risky to hold 95% of your 401(k) in the index fund.

Action Items

1. Never take out a loan from your 401(k) account unless you have no other option. Analyze all your loan options and compare them with your 401(k) account. Know about the tax and penalties.

2. Review your percentage contribution whenever you experience major life events (marriage, a new job, or a pay increase). It is best to review it at least every year since your financial situation doesn’t remain the same all the time. Always opt for an annual increase option if your company has one. Annual increase options automatically keep your percentage match the same even if you get a pay increase.

3 (The most important action item). Once you’re eligible for maximum employer match, make sure you take full advantage of it. Make the required contribution to maximize your employer match.

4. There is no need to roll over your money from 401(k) account into an IRA at the time of switching jobs or retirement. It isn’t compulsory. If you’re satisfied with your current plan, then keep your money there. Also, many companies allow you to roll your 401(k) account from a previous job to the new job. Be aware of your options.

Comment from FinancialGinger: My Dad kept old 401(k) accounts from jobs worked 20 years ago. That may be good, or may be bad in your situation. Ask a Professional for guidance in investing. (Or wait until I pass my exams in Spring of 2018 and I can be your professional guidance!)

5. Several 401(k) plans have automatic annual rebalancing feature. Read the terms and conditions of this feature minutely to determine if it’s good for you. In case your plan doesn’t have an automatic rebalancing feature, you can select a date to adjust your portfolio every year. Many financial companies and ETF’s will rebalance at least once a quarter, this may not be best for you, but at a minimum, most professionals recommend at least annual rebalancing.

Conclusion
Depending on the rules, you may qualify to enroll in the 401(k) plan within 1-12 months. If you’re eligible to contribute from December, then don’t wait till the next year to establish your retirement account since (a) you can lower your taxable income for the current financial year by contributing your pretax dollars (b) your employer can contribute next year but make it count for the existing year. When you start a new job, try to set up your 401(k) account by December 31st if by all possible.

 

About the Author: Stacy B Miller is the content editor at Oak View Law Group. Her articles revolve around topics related to debt, credit, laws, money, personal finance, etc. You can connect with her on Twitter

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Guest Writer: The Envelope Budget And Running Away

From guest writer: Flia

Running away taught me a lot. It taught me a lot about trust. It taught me a lot about making my own decisions. It taught me a lot about budgeting my money. It taught me that what might seem like a terrible decision could be the best thing that I’ve ever done for myself.

WAIT! WHAT?

Back up a little bit!

It taught me about budgeting? Believe it or not, yes it did.

And that’s just what I’m here to explain.

I realize that most of you reading this do not know me and so a little background is necessary. Shortly after my 19th birthday, I ran away from home. I am not going to go into details as to why, because that’s not what I’m writing about.

Three days beforehand, I bought a train ticket from Indiana to Utah. That same day, I started cashing out my bank account. My specific bank would only let me withdraw $300 a day. Although you could get around this rule by also using an ATM that was not associated with a bank (such as an ATM at a Wal-Mart).

By the time I got on the train and left Indiana, I had about $1,500 in cash, my backpack, and my duffel bag. And I had a 48 hour train ride to figure out what to do next.

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Forty-Eight hours on a train

About six hours into the trip I was really bored and hanging out in the snack cart where I knew I would be left alone. Because of how bored I was, I was starting to become delusional. That was the point that I decided to budget my money.

It’s not that I’d never done any budgeting before, but all of my previous budgeting had been done on electronic day planners and such. I didn’t have any of that with me so I had to do a little creative thinking.

The first thing I did was brainstorm and write down a list of everything that I would need money for. My list ended up something like this:

  • Travel & Gas (for whoever would be picking me up at the train station)
  • Food (on the train)
  • Food (elsewhere)
  • Lodging (hotel or staying with a friend)
  • Non-Food Necessities (toiletries/clothes/medication)
  • Emergency/Extra

After I had categorized everything, I began to determine about how much (or what percentage) of my money needed to go towards what. Things such as gas money for the friend that picked me up at the station was relatively easy. I looked up the number of miles between his place and the station and back. Then I determined the average miles per gallon on the specific type of truck that he had, and figured in the average price of gas in the area. After I knew how much gas the trip would have taken him, I could effectively reimburse him. All of that math was probably not necessary, but like I said, I was delusional.

Every other category followed similarly.  Food on the train is ridiculously expensive, even the prepackaged snacks. I found the cheapest food with the most nutrients (which was kind of a joke by the way-it is a snack cart-it’s all garbage) and rationed that extremely carefully. Also, because I had spent a majority of my time in the snack cart, I ended up befriending the guy that ran it. He’s a pretty neat guy. And I ended up getting some free snacks out of it too. That was a bonus!

After I had figured out each of the categories and how much money I would allot to each one, I had to figure out how to separate the money physically. It would be much easier to spend responsibly when I could actually have a visual.

NOTE CARDS!

budget20-20istock_000041295790_largeI had a package of note cards in my purse! I never leave home without them. Each budget got one note card. I folded it in half, lined side inward, and on the outside wrote which category it was. The lined inside would serve as a ledger. Every time I spent money from that card, I would subtract the amount that I spent and write in the new total.

And I am not quite sure why I just explained that because you really should already know how to use a ledger.

Any leftover money that did not get spent would go into my Emergency/Extra fund. This money was kept in an entirely separate compartment of my wallet.

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Out of Sight, Out of Mind

Out of sight, out of mind. It would be used in case of emergency, depleted funds, of on something necessary that I would inevitably forget about. For instance, I had no cell phone. I ended up shelling out a little less than $25 for a burn phone and some minutes.

Although I was not out in Utah very long before continuing on to my next place, I still use this method of budgeting. I get paid through a paycard (a bank less debit card) and cash out 85% of my earnings every payday. Savings go into a tin under my bed (out of sight, out of mind) and everything else is separated into neat little note cards in my wallet.

So yeah, I guess you could say that running away taught me about budgeting.

Thanks to Flia for the guest post! The envelope is a basic budget that really gets stuff done. What do you do to keep track of your money? What is your story?

I always love to hear your money ideas, so email me at [email protected]

Flia is a college student studying forensic biochemistry. She is an avid artist and is currently working on multiple commissioned pieces. Although she is now residing in Kansas, she has lived a little bit of everywhere and isn’t overly attached to one particular place. In her spare time, Flia likes to read, practice new art techniques, and baby-sit for family-friends.