Life is expensive right now, largely thanks to inflation driving up costs of everyday goods, bills, travel and more.
As a result, most people want to do what they can to make sure their money isn’t being wasted. And one way to protect your finances during these expensive times is by optimizing your 401(k) if you have one.
A 401(k) is a convenient way to save for retirement, said Kate Ashford, the lead wealth writer at NerdWallet. “Because the money comes out without you really seeing it. You don’t pay taxes on it. It has a long time to to earn money and gain value. It’s a it’s a great tool to have in your retirement toolbox.”
There are some common mistakes people make with their 401(k), which directly impacts how much they have when they eventually hit retirement age. Below, financial advisers and financial experts share the 401(k) rules they wish everyone would follow.
1. If your company offers a 401(k) match, try to contribute at least enough to get the match.
Many companies offer a match for the contribution that you put into your 401(k), up to a certain percentage of your salary.
“If your employer offers a match for this account, it’s a good idea to try to contribute enough to get the match because that’s basically free money for you,” Ashford explained.
“Your employer might offer to match 50% of your contributions up to 6%, say,” she continued. “So, if you put in 6% they’re going to match 50% of what you’ve put in, so that’s another 3% for you. That’s just free money.”
“You want to make sure that you’re contributing up to the company match, because if you’re not, you’re honestly leaving some of your pay on the table, because a company that offers a match, they consider that part of your pay, part of the benefits package. You really want to take advantage of that,” said Vincent Renaut, a certified financial planner and founder of Pier 42 Advisors in Massachusetts.
The maximum you can contribute to your 401(k) each year is $24,500, said Hayley Dickson, a certified financial planner and owner of RIPPL Wealth Management. This is a good goal to aim for among those who are able.
“A mistake that [many beginners] make is they only contribute enough to the 401(k) to maximize the match … and so many people are under-contributing because they’re only maximizing the match. They’re not maximizing their ability to contribute,” Dickson said.
It’s generally good advice to save 15% of your income, including your employer match, in your 401(k) each year, according to Ashford. This isn’t a reasonable goal for all, though, especially as inflation soars throughout the country.
2. It’s a good idea to sign up for your 401(k) plan’s auto-increase contribution option.
If you’re trying to boost your 401(k) savings, it’s a good idea to sign up for auto-enrollment, which automatically increases your 401(k) contribution by 1% every year, said Heather Townsend, a certified financial planner and owner of Townsend Financial.
“And no one normally feels a 1% [increase],” Townsend said. This is especially true if you get an annual raise, even if it’s a small 3% or 4% cost of living raise.
“That 1% over time compounded can make a massive difference over someone’s lifetime,” Townsend added.
That annual increase in saving advice may not apply to everyone, though. If you can’t pay your bills, adding more and more money to your 401(k) likely isn’t a wise choice, Renaut noted.
“If you’re carrying credit card debt or any other high-interest debt, instead of going above and beyond the employer match, I would use those extra dollars to pay those things down first,” Renaut said. “And then once those are paid down, you can then start contributing more and more.”
Renaut defines high-interest debt as anything that has a double digit interest rate, such as a credit card or a personal loan.
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3. If you need to pick your investment, a target date fund is a good choice for most people.
Many 401(k) providers require you to pick your investments, although some automatically sign you up for an investment option.
If your provider requires you to pick your investments, Dickson said it’s a good idea to choose “user-friendly” target date funds, which don’t require you to manually select individual stocks and bonds.
These funds have a date in it, she noted, such as 2040, 2045 or 2065. This is the year you plan to retire, Dickson explained.
“So, if I plan to retire in 2045, I could pick the target date 2045, which will immediately diversify and then choose the right selection of stocks to bonds, the right risk tolerance that correlates with my how long I have until I am going to be able to use that money,” Dickson said.
4. If you leave a job, consider opting for direct rollover for your old 401(k).
Since 401(k) plans are sponsored by your workplace, it can be confusing when you leave your company for a new one.
“When you quit your job, there’s typically some communication that’s going to come at you as to what do you want to do with your 401(k),” Ashford said. “If it’s over $7,000, you can just leave it where it is if you want to.”
Townsend recommends consolidating past 401(k) accounts into one central account. “It’s more motivating to see a bigger balance,” Townsend added.
“If it’s under [$7,000], you should probably consider rolling it over into … a rollover IRA,” Ashford said.
When signing up for this rollover IRA, you want to make sure you move your money via a “direct rollover,” Renaut said. “Let’s say your 401(k) is held at a big bank like Fidelity, a direct rollover means they’re going to send it directly to the other bank that is holding your 401(k),” he explained.
“They never make the money directly out to you, and that’s really important because if they ever make the money directly out to you via check, there’s an automatic 20% tax withholding that has to come with that, and then you have a 60-day timeline to move that money into the new account and also pay back that 20% withholding,” Renaut added.
5. Withdrawing from your 401(k) before age 59.5 should be a total last resort.
You have to be 59 1/2 years old to withdraw money from your 401(k) without penalty, but more Americans are withdrawing money from their 401(k) before then, according to research from Vanguard. Approximately 6% of Americans are withdrawing money early now, compared to 4.8% in 2024. This is likely because of the high costs so many folks are faced with every day.
“If you have no choice, you have no choice. But it would not be the path that I would be suggested for most people,” Ashford said. “Generally, early withdrawal should be a last possible resort act because you’re going to pay not only income taxes on that, but if you’re not 59 1/2, you’ll pay a 10% penalty, which is just not great.”
You’ll lose roughly 20% to 30% of your money to fees and taxes if you withdraw early, Renaut said.
“Most of it happens when you change jobs. As you’re leaving a job with a 401(k), you want to make sure you fully understand how to either properly leave it in that current 401(k), which you’re allowed to do … and if you want to move that money, you’re doing it the right way to your new 401(k) plan at your new job,” Renaut added.
According to Ashford, a 401(k) “is a great account, and I think too many people cash in little accounts that they don’t think are going to add up to anything.”
“The longer you leave them there, it is really astounding, the power of compounding,” she said. “Honestly … you do end up with a lot more in the end than you think you’re going to.”