You have probably heard a 401k early withdrawal could kill your retirement plans. This is true, but if your goal is to retire someday there other ways, you may be sabotaging your retirement accounts.
Unfortunately, many couples have no idea how to get to the point of retirement because it can be super confusing. You may think you are doing everything right, but your actions might be keeping from ever reaching your retirement goals or delaying your retirement a decade.
More often than not, I see many people unknowingly sabotage their own retirement. That’s why less than ⅔ of people in the United States have less than $30,000 in their retirement accounts.
You probably already know $30,000 won’t get you too far in retirement.
401k Early Withdrawal and 4 Other Ways You’re Sabotaging Your Retirement Plans
401k Early Withdrawal
A 401k early withdrawal is defined by withdrawing money from your 401k or IRA before the age of 59 ½.
I know you may really want that new flat screen, curved T.V., but a 401k early withdrawal is not the answer.
Withdrawing money from your 401k or IRA before the age of 59 ½ will cause the money to be taxed at a 10% early withdrawal rate and the entire amount taxed at your ordinary tax bracket.
If you withdrawal $10,000, that means the government keeps $1,000 for the 401k early withdrawal. The entire $10,000 is also taxed as ordinary income which could easily be $2,000. You are left with only $7,000.
It may not seem to be a big deal, but you will also miss out on the compounding interest of that $10,000. If you took $10k out at 40, then you could lose over 25 years of growth, dividends, and compounding interest. This would equate to nearly $73,000.
That’s a lot of money lost for a 401k early withdrawal.
Your Retirement Money is in Money Market Accounts
Your retirement accounts are meant for growth, not barely keeping up with inflation.
Too many people have the majority of their contributions in money market accounts (which is basically a savings account) where the average returns are historically 2-3%.
Again, the purpose of a retirement account is for growth, and a savings account won’t accomplish growth.
Let’s look at two parents: Dumb Don invests $100 a month for 30 years in a 2% money market account, and Smart Sally invests $100 in a diversified portfolio that earns just 6% a year (a historically low return).
Dumb Dan will have invested $36,000 and end up with $49,655 while smart Sally will have $100,561.
Stop the madness and diversify your portfolio in stocks, bonds, cash, real estate, and alternative investments. You need the extra return if you plan on retiring!
Investing 100% of Your Money in Company Stock
Having all of your retirement money in company stock is dangerous. It is the equivalent of putting all your money on one number at the roulette and hoping it hits.
Yes, some unicorns have done well with all of their money in company stock. However, there are many more situations where the outcome isn’t so rosy.
We have all heard the stories from people at Enron and Worldcom, but there are thousands of more people who have lost their life savings because of overconfidence in their own company. I lost over $30,000 by keeping a majority of my retirement money in company stock. Luckily it happened to me at 27 and not 66!
The point is don’t have too much confidence in your company stock and limit your portion to no more than 20%.
Many investors think they are diversified because they have mutual funds. However, when we dig deep into mutual funds, there is not much diversification between asset classes.
This means the average investor has a portfolio filled with large-cap value stocks (like companies in the S&P 500) and maybe a few growth stocks. This is not truly diversified.
A truly diversified portfolio spans several asset classes that include value, growth, international, etc. The chart on SeekingAlpha.com does a great job at detailing the different asset classes.
The purpose of diversification is to smooth out the ups and downs of your returns. If you look at the chart on Seeking Alpha, you’ll notice the diversified portfolio doesn’t have nearly the ups and downs as single asset classes.
Not Taking Advantage of the Company Match
The company match is the BEST thing in the world. Where else can you put in a dollar into something and someone else will give you a dollar?
A typical employer match will give you one dollar for every dollar you contribute up to 3% and then match .50 on every dollar for the next 2%.
Here is the math:
Let’s assume you earn $50,000 and contribute 5% of your income (which you should) – that’s $2,500.
Your company will then match dollar for dollar on the first 3% which is $1,500. Then they will match .50 for the next 2% which is another $500. So you will have a total of $4,500 being contributed to your 401(k) every year.
Side Note – In 25 years you would have $359,012! Cha-Ching!
Don’t stress if you have taken a 401k early withdrawal or not taken advantage of your company’s 401k match. Learn from the past and move on!
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