As members of the FIRE movement, achieving financial independence and being able to retire early were our main goals. But to actually achieve financial independence, it was crucial that we had the proper retirement accounts in place.
Some of you may not know what you should and shouldn’t do to get the most out of your retirement accounts. It’s not always entirely straightforward. But that’s what I’m here for! Here are my tips on eight things you should NOT do when investing in your retirement account.
1. Not Maxing Out Retirement Accounts
I know this is a double negative (don’t NOT max out your retirement accounts), but think of it this way: You should ALWAYS try to max out your retirement accounts whenever possible. If you’re pursuing financial independence and early retirement, you must contribute the most you can to your retirement accounts. Whatever limitations those accounts have, you must try to meet those limitations. By maxing out your retirement accounts, you’re able to take full advantage of the tax breaks offered with these accounts. That means, ultimately, more money in your pocket!
Maxing out your retirement accounts also provides a greater level of security for you once you retire, especially considering there is so much uncertainty around the stability of social security and pensions in the future. It is a real possibility that when you retire in 10-20 years, your expected pension may not be available to you. General Electric recently did a complete rehaul of their pension plan - freezing its pension plan for almost 20,000 employees. If GE can do it, what’s to stop other employers from doing the same?
2. Being Too Conservative
You have so many different options for investing in your retirement accounts. Personally, Amon and I invested mostly in index funds that covered the total stock market. You can also invest heavily in bonds, but this strategy tends to be too conservative for most people. We chose to invest more aggressively and investing in stocks was how we grew our portfolio to the level that it is at now.
3. Not Getting your Employer Match
Your employer match is essentially free money that your employer gives you when you contribute to your 401K. Employers only give you this money if you first invest money yourself. Typically, employers match up to a certain percentage of your contribution. This is FREE MONEY people - take advantage of it! By contributing the full amount for employer matching, you’re receiving the largest matched contribution from your employer. By NOT contributing the full amount, you’re basically just throwing away free money..
4. Borrowing from your 401K
When people borrow from their 401Ks, they usually think they’re getting a great deal on the interest rate, especially if you only need to pay 2 or 3% on it. But the thing is, even at a lower interest rate, you’re still paying your 401K interest back with after-tax dollars, only to pay taxes AGAIN when you withdraw it!
Even more important though, is that when you take money out of your 401K, what you’re actually doing is taking it out of the stock market. It is this money that’s in the stock market that makes the best return. But, when you use your retirement account as a bank account by pulling money in and out, you’re losing so much momentum in terms of growth. You are significantly reducing the amount of time that your money has to compound, which can have a huge impact on the overall growth of your portfolio.
5. Transferring Accounts to Brokerage Firms with High Fees
Another common mistake people make after leaving their employer is moving their accounts to a higher-cost brokerage. You really need to make sure that you shop around before you move in order to find the best rate for you. Many brokerage firms charge 1-2% or more in fees.
Amon and I use Vanguard, Schwab, and Fidelity and really love them because they charge such low fees. Personally, I contributed to a 401K which I was able to roll over into a Vanguard account when I left my employer. If you’re unfamiliar with the rollover process, make sure you do your research beforehand and ensure you truly understand where your money is being transferred.
6. Cashing Out Your 401K
When you leave your employer, you are usually given the option of either rolling the account over to a personal account like I described above, or cashing your 401K out. NEVER CASH OUT! Cashing out is a terrible idea because of the harsh tax consequences: You will be hit with a tax penalty AND the money will be taxed as income. So, don’t cash out your 401K unless you absolutely have to.
7. Leaving Your Account with an Unorganized Employer
If your employers aren’t running a great 401K program, they might be moving your money around and not even tell you when or where they’re moving it. Employers have the option of changing who manages the 401K and they have the power to do so without even letting you know. If you feel like the money in your 401K account is not going to be in safe hands, then that is a really good reason to move it.
8. Not being Fully Vested Before Leaving Your Employer
A lot of employers will match your money but have a policy in place where they can, under certain circumstances, take back the money they contributed. If you’re not fully vested in your retirement account you don’t actually own 100% of your account balance and your employer can take back its contributions to your account when you leave. So to avoid this loss, you need to be aware of your company’s policy and use that information to make strategic decisions in terms of when you leave, why you’re leaving, and where you’d be going. In some cases, it may be worth it to take a new job, even with the forfeiture of employer retirement account contributions, so always take the time to assess the pros and cons when deciding to stay or leave.
So these are the top mistakes that you can make with your retirement accounts. If you’ve already made some of these mistakes, don’t worry: It’s ok, you can recover! But if you haven’t made any of these mistakes, now you know exactly what NOT to do! In either case, moving forward, always focus on strategies that will allow your investment portfolio to grow. Avoid these mistakes can help with that!
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