A financial planner reveals the biggest mistakes workers make when it comes to their 401(K)s — as statistics show America is facing a retirement crisis.
Andrew Latham, a content director at financial services site Super Money, says savers often shortchange themselves by withdrawing cash from their retirement pots too early and not making the most of their employer’s contributions.
Speaking to Newstimesuk.com, he cautioned against the increasingly prevalent trend of ‘job change cash-in’.
This is where a person moves jobs and decides to withdraw their entire 401(k) instead of rolling it over to their next employer or putting it into an IRA.
Latham said: ‘Sadly, ‘job change cash-in’ is not uncommon, and is a financially damaging trend.
Financial planner Andrew Latham reveals the biggest mistakes employees make when it comes to their 401(k).
Latham says savers often shortchange themselves by withdrawing cash from their retirement pots too early and not making the most of their employer’s contributions.
‘While it provides immediate cash, the long-term costs are high – not just in fines and taxes, but also in lost opportunities for compounding growth.’
According to a Harvard Business Review study last year, more than four in ten employees cash out some or all of their 401(k)s when they change jobs.
Of them, 85 percent withdraw the full amount. But Latham points out that these people miss out on compound interest rates over the years — which is when you earn interest on the money you initially put aside and the interest you accumulate.
For example, if you invest $10,000 with a 10 percent annual return, you will have $11,000 after one year. Next year 10 percent interest is applied to the $11,000 instead of the principal amount.
Finance website The Motley Fool estimates that a 30-year-old with $10,000 in their 401(k) could grow to $174,000 by age 60 if they keep the money in their pot and refrain from withdrawing it.
It assumes the money is invested in funds that earn an average of 10 percent interest per year — mirroring the S&P 500 index.
Latham added that another ‘major mistake’ is that workers don’t contribute enough to get their full employer match.
A study by the National Institute on Retirement Security (NIRS) last week found that the typical Generation Z household — those between the ages of 43 and 58 — has only $40,000 saved for retirement.
Auto-enrollment means a fraction of a worker’s salary goes directly from their paycheck to their 401(K), which is matched or partially matched by the employer.
The Financial Industry Regulatory Authority says most employers use a default contribution of 3 per cent.
But many companies often match a portion of their employees’ contributions—which is why advisors recommend employees pay especially as their salaries increase.
Latham told Newstimesuk.com that not making the most of this option is ‘essentially leaving free money on the table.’
He added that the current financial turmoil could make workers more likely to stop contributing to their 401(k)s altogether.
But he cautioned against this trend as he suggested that the measure would only be implemented in an emergency.
‘Financial instability often leads to an increase in inquiries about stopping 401(K) contributions. This is understandable, as many people want 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, statistics show
‘Stopping contributions can significantly affect future retirement security. It’s like in the middle of the journey the engine shuts off; You may save fuel, but you may not reach your destination.’
His comments come as multiple reports suggest America is on the verge of a retirement crisis in which every generation of workers contributes less to their 401(k).
A study by the National Institute on Retirement Security (NIRS) last week found that the typical Generation X household — those between the ages of 43 and 58 — has only $40,000 saved for retirement.
That’s 59 years old, despite the group’s oldest member being less than two years away from being able to withdraw funds from their 401(K).
And they are four years away from being able to claim Social Security at age 62. Currently, that means the group will have just $1,600 a year to look after those aged 60 to 85.
As a result Generation X – long considered the ‘forgotten generation’ – is falling short of the recommended amount needed for a comfortable retirement.
As a rule of thumb, workers should save three times their annual salary by age 40, Latham said.
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