Recent surveys have reported that most employees do not understand how their employer-sponsored retirement accounts work.
In an age where pensions are no longer common and Social Security is on the verge of running out of money, employees have been forced to become more responsible for their comfort in retirement.
However, employees have not been apt to embrace this new responsibility.
Today, we will look at three of the most common mistakes employees are making with their retirement accounts.
Lack of participation The economic instability of the last couple of years has changed America's habits when it comes to the use of earned income.
One of the worst effects has been in how employees make contributions to retirement accounts.
One sad statistic that I read about is the fact that about half of employees are not taking advantage of their employer-sponsored retirement account.
While it is better to have a retirement plan where our employer is contributing to the account on our behalf, not having a match should never be a reason not to contribute money ourselves.
Any contributions we make to our retirement account not only reduce our current taxable income, but also get us closer to having a sizable retirement nest egg to help us live comfortably in retirement.
We cannot let market volatility convince us that it is unwise to contribute to the plan.
We should contribute as much as our budgets can comfortably allow.
Cashing out upon termination When an employee leaves a job, whether the reason is a career change, a layoff, or retirement, that employee is free to take the retirement account assets.
The challenge, however, is the method used.
More than half of employees cash out their retirement account when leaving a former employer.
They look at the cash as "free money," in a sense.
Unfortunately, that choice costs more than most people realize.
Cashing out a retirement account before age 59½ triggers a double-taxable event.
Since those funds were invested pre-tax, they are taxable upon distribution.
The funds are taxed as ordinary income.
The second tax is a penalty for being under the age 59½.
The government provides the tax deferred benefit as a way to encourage saving for retirement.
If the funds are used before retirement, an additional 10% penalty is assessed.
Some employees find that they lose close to half of their account value when they choose to cash out.
Not only have they set themselves back in saving for retirement, but they have also lost a large portion of their own contributions, which came out of their paychecks.
Taking loans Many employees look at the ability to take loans from their retirement account as a bonus.
I argue the opposite.
Granted, the interest rates charged on these loans are lower than on credit cards and other unsecured loan options.
It can also be considered a plus that the interest is paid back to the retirement account.
However, there is also an opportunity cost involved.
Opportunity cost refers to the cost of not having access to another option.
For example, an employee may be paying back a 5% annual return on the funds borrowed, but they may be missing out on a year where their portfolio could have earned an 8% or 10% return.
There is also a concern about the employee's ability to pay back the loan.
If financial concerns forced the decision to take the loan in the first place, what happens if the employee is unable to keep up with the payments? A lack of timely payments may cause an employer to issue a Form 1099 at the end of the year.
That changes the loan to a distribution.
As a result, the withdrawal is now taxable as ordinary income.
If the employee is under age 59½, the 10% penalty will also apply.
I have attempted to address a few of the most common retirement account mistakes that I have seen in working with employees over the years.
The best way to reduce our exposure to these mistakes is to increase our understanding of our retirement accounts.
We can seek information from our employer, the plan custodian, or the plan's advisor.
Fully understanding the consequences of our actions can enable us to prepare better for a great retirement.
In an age where pensions are no longer common and Social Security is on the verge of running out of money, employees have been forced to become more responsible for their comfort in retirement.
However, employees have not been apt to embrace this new responsibility.
Today, we will look at three of the most common mistakes employees are making with their retirement accounts.
Lack of participation The economic instability of the last couple of years has changed America's habits when it comes to the use of earned income.
One of the worst effects has been in how employees make contributions to retirement accounts.
One sad statistic that I read about is the fact that about half of employees are not taking advantage of their employer-sponsored retirement account.
While it is better to have a retirement plan where our employer is contributing to the account on our behalf, not having a match should never be a reason not to contribute money ourselves.
Any contributions we make to our retirement account not only reduce our current taxable income, but also get us closer to having a sizable retirement nest egg to help us live comfortably in retirement.
We cannot let market volatility convince us that it is unwise to contribute to the plan.
We should contribute as much as our budgets can comfortably allow.
Cashing out upon termination When an employee leaves a job, whether the reason is a career change, a layoff, or retirement, that employee is free to take the retirement account assets.
The challenge, however, is the method used.
More than half of employees cash out their retirement account when leaving a former employer.
They look at the cash as "free money," in a sense.
Unfortunately, that choice costs more than most people realize.
Cashing out a retirement account before age 59½ triggers a double-taxable event.
Since those funds were invested pre-tax, they are taxable upon distribution.
The funds are taxed as ordinary income.
The second tax is a penalty for being under the age 59½.
The government provides the tax deferred benefit as a way to encourage saving for retirement.
If the funds are used before retirement, an additional 10% penalty is assessed.
Some employees find that they lose close to half of their account value when they choose to cash out.
Not only have they set themselves back in saving for retirement, but they have also lost a large portion of their own contributions, which came out of their paychecks.
Taking loans Many employees look at the ability to take loans from their retirement account as a bonus.
I argue the opposite.
Granted, the interest rates charged on these loans are lower than on credit cards and other unsecured loan options.
It can also be considered a plus that the interest is paid back to the retirement account.
However, there is also an opportunity cost involved.
Opportunity cost refers to the cost of not having access to another option.
For example, an employee may be paying back a 5% annual return on the funds borrowed, but they may be missing out on a year where their portfolio could have earned an 8% or 10% return.
There is also a concern about the employee's ability to pay back the loan.
If financial concerns forced the decision to take the loan in the first place, what happens if the employee is unable to keep up with the payments? A lack of timely payments may cause an employer to issue a Form 1099 at the end of the year.
That changes the loan to a distribution.
As a result, the withdrawal is now taxable as ordinary income.
If the employee is under age 59½, the 10% penalty will also apply.
I have attempted to address a few of the most common retirement account mistakes that I have seen in working with employees over the years.
The best way to reduce our exposure to these mistakes is to increase our understanding of our retirement accounts.
We can seek information from our employer, the plan custodian, or the plan's advisor.
Fully understanding the consequences of our actions can enable us to prepare better for a great retirement.
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