Avoiding 401(K) Mistakes

By Gini Scott

2001-05-21

When are benefits not beneficial? The answer is when employees don't take advantage of all that is offered to them. A prime example of this phenomenon is the 401(k) plan, which ironically may be the most important benefit some employers offer their employees.

Although 401(k) plans can be excellent investment vehicles for employees' retirement savings, they're worthless if employees aren't investing. Here are some common mistakes employees make with their 401(k)s and how to avoid them.

Failure to Participate

Although most employers offer 401(k) plans, not all employees join - - particularly younger employees. A retirement plan study by Hewitt Associates, a global management consulting and outsourcing firm, found that only 77% of all employees joined a plan, and of those in the 20-29 year-old category, only 59% enrolled. Employees who aren't in a 401(k) miss tax benefits, the interest-compounding benefits of putting money away for their retirement, and matching funds that may be available from employers. For instance, if you make the maximum pre-tax contribution of $10,500 in 2001, you will realize a tax savings of $2,940 if you are in the 28% tax bracket.

Unfamiliar with Eligibility Requirements

Some employees miss out because they don't know when they can join. For example, some companies allow employees to enroll in the 401(k) plan right away; in others, employees sometimes have to wait three to 12 months. Other times, the number of hours worked can be a factor in eligibility. If employees aren't able to join immediately, they should note when they become eligible so as not to delay joining, or even worse, fail entirely to join a plan.

Failure to Maximize Matching

While almost all employers offer some kind of company match as an incentive for employees to join the plan as part of the company's overall benefits package, most employees don't take full advantage of this. This match is made either through cash from the company or company stock. Typically, matching funds range from 25% to 100% of what the employee contributes, up to a certain limit, such as 6% of an employee's contribution.

However, when Hewitt Associates studied nearly 150,000 employees, they found that 59% of the employees eligible for a match did not take advantage of the benefit at all or fell short of the maximum offered by the company.

The vast majority of those who didn't seek this benefit in the first year didn't seek it in their second year with the company, either. Thus, to avoid missing out, employees should find out how much their company is offering and when the match is applied in order to fully profit.

After all, getting matching money is like getting extra cash for free. For example, if an employer is matching a contribution at the rate of 50 cents on the dollar, then an employee can make a quick 50% return on his or her contributed funds. On the other hand, if a company has a cap on its match, an employee won't benefit by contributing beyond that amount to the plan, so it may be better to invest the money beyond that cap elsewhere.

Failure to Join Sooner Rather Than Later

Although an increasing number of employees are setting up 401(k) plans as they near retirement, many younger employees don't participate and fail to put away money for life after work. The result is missing out on the compounding effect of investing money early, not to mention losing out on the additional gains from these funds as a result of deferring taxes until money is withdrawn from the plan.

Still other mistakes occur from not carefully investing these funds for the best return based on your risk tolerance, income needs, and investment time horizon.

By Gini Graham Scott, Ph.D., J.D. Gini is the Director of Changemakers and the author of three books on creativity and innovation: Mind Power: Picture Your Way to Success in Business and The Empowered Mind: How to Harness the Creative Force Within You (both from Prentice-Hall) and The Innovative Edge (out in September 2001 from Ronin Publishing). Gini’s Web site is at www.giniscott.com.