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5 common mistakes people make with their 401(k) plan

“A penny saved is a penny earned” is an age-old but evergreen proverb. And schemes like the 401(k) help one save strategically for their retirement. Provided by one’s employer, this scheme reduces one’s taxable income, but with the traditional 401(k), withdrawals from the fund after retirement are taxable. In contrast, with the Roth 401(k), there are tax reductions from the income but not from withdrawals. However, one should avoid certain mistakes as a 401(k ) user.

Common mistakes people make
Here are a few common mistakes people make with their 401(k) plan:

1. Not knowing about the different types of 401(k) accounts
As mentioned before, the traditional and Roth 401(k) are the accounts one has under this scheme. In the traditional scheme, one isn’t taxed on their income, but the amount withdrawn after retirement is taxable. In contrast, in the case of Roth, one incurs taxes from their income but not during withdrawals. Each strategy has its pros and cons, and account holders should be aware of these before shortlisting either.

2. Withdrawing early from the 401(k)
With 401(k) accounts, it’s always a good idea to be patient with the returns. If one withdraws before the age of 59.5, they face a 10% penalty, over and above the income tax on the distribution. Even if a plan doesn’t involve such a penalty (which is uncommon), one might miss out on any additional returns that can be earned from one’s investments. So, waiting before withdrawing from the 401(k) is always better.

3. Not understanding the fee breakdown
Understanding what fees one pays when holding 401(k) accounts is important. The fees typically include the expense ratio and administrative fees. Usually, 401(k) plans entail a 1% fee, which means that one would pay $10 for every $1,000. Understanding such fees ensures that one knows where one’s money is going so that there is no financial crunch later.

4. Not waiting in the company till one gets vested
In any company, when an employer matches the employee’s match in a 401(k) plan, the vesting period is when one needs to stay at the organization before one can keep the entire match. In some cases, this period might last for even three years, but the amount accumulated at the end is quite high, which makes it a rewarding investment option. Conversely, if one quits the company before this period ends, one loses the opportunity to earn the employer’s contribution. In these cases, employees only keep their contributions.

5. Maintaining the same contribution amount
It is important to increase one’s contribution gradually when it comes to 401(k) because investing the same amount even as time passes limits one’s investment returns considerably. So, it’s a good idea to increase the amount strategically every time one earns a raise at work or receives a reward amount.

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