A financial planner has revealed the biggest mistakes workers make when it comes to their 401(K)s – as figures show America is facing a retirement crisis.
Andrew Latham, a content director at financial services site Super Money, said savers are frequently shortchanging themselves by withdrawing cash from their retirement pots too soon and not making the most of their employer contributions.
Speaking to Dailymail.com, he also warned against an increasingly prevalent trend of ‘job change cash-ins.’
This is where an individual moves jobs and decides to withdraw their whole 401(K) rather than roll it over to their next employer or place it into an IRA.
Latham said: ‘Regrettably, ‘job-changing cash-ins’ are not uncommon, and it’s a financially harmful trend.
Financial planner Andrew Latham has revealed the biggest mistakes workers make when it comes to their 401(K)s
Latham said savers frequently shortchange themselves by withdrawing cash from their retirement pots too soon and not making the most of their employer contributions
‘While it provides immediate cash, the long-term cost is far greater – not just due to penalties and taxes, but also the lost opportunity of compounded growth.’
According to a study by the Harvard Business Review last year, more than four in ten employees cash out some or all of their 401(K) when they change jobs.
Of those that do, 85 percent withdraw the entire sum. But Latham points out these individuals miss out on years of compound interest – which is when you earn interest on the money you have initially put aside plus the interest you accrue.
For example, if you invested $10,000 with a 10 percent annual return, after one year you will have $11,000. The next year the 10 percent interest is applied to the $11,000 rather than the original figure.
Finance website The Motley Fool estimates that a 30-year-old with $10,000 in their 401(K) could see that swell to $174,000 by the time they’re 60 if they keep the money in their pot and refrain from withdrawing it.
This assumes the money is invested in funds that earn an average of 10 percent interest each year – mirroring the S&P 500 index.
Latham added that another ‘major mistake’ was workers not contributing enough to get their full employer match.
Last week a study by the National Institute on Retirement Security (NIRS) found that a typical Generation Z household – those aged between 43 and 58 – have just $40,000 saved for retirement
Auto-enrollment means a fraction of a worker’s salary goes straight into their 401(K) from their paycheck, which is then matched or partially matched by the employer.
The Financial Industry Regulatory Authority says most employers use a 3 percent default contribution.
But many companies often match a portion of their employees’ contributions – which is why advisors recommend workers increase theirs especially as their salary increases.
Latham told Dailymail.com that not making the most of this option is ‘essentially leaving free money on the table.’
He added that current financial turbulence may make workers more likely to stop contributing to their 401(K) altogether.
But he warned against the trend as he advised the measure only be implemented in an emergency.
‘Financial turbulence often triggers a rise in inquiries about halting 401(K) contributions. It’s understandable, as many individuals seek immediate relief,’ he said.
‘However, it’s important to remember that a 401(K) is a long-term investment.
Across the board, Americans of all generations are failing to save enough for their retirement, figures show
‘Stopping contributions can significantly affect future retirement security. It’s like turning off the engine mid-journey; you might save fuel, but you won’t reach your destination.’
His comments come as multiple reports suggest America is on track for a retirement crisis with workers from every generation under-contributing to their 401(K)s.
Last week a study by the National Institute on Retirement Security (NIRS) found that a typical Generation X household – those aged between 43 and 58 – have just $40,000 saved for retirement.
This is despite the fact the oldest members of the cohort are less than two years away from being able to withdraw funds from their 401(K)s, aged 59 and a half.
And they are four years away from being able to claim social security at 62. At present, it means the cohort would have just $1,600 a year to see them from 60 to 85.
Consequently Generation X – long considered the ‘Forgotten Generation’ – is falling well short of the recommended amount needed for a comfortable retirement.
As a rule of thumb, workers should have three times their annual salary saved up by the time they’re 40, Latham said.