The 6 Most Common 401k Mistakes

Just watch an hour of TV and you’ll find a half dozen 401k companies vying for your attention.

This one wants you to follow a green line. That one wants you to listen to that guy from “Law & Order.” The other one has a talking baby. And they all make your eyes glaze over when they start talking about markets and investing and retirement.

Given how confusing and daunting retirement savings can be (especially in the wake of a struggling economy) it’s no wonder there are so many gimmicks — not to mention so many mistakes made — in regard to 401(k) plans.

But neither companies nor individuals should let talk of tax codes and portfolios bully them into denying their employees a valuable benefit or opting for a retirement-savings-sized piggy bank instead of investing. To administer or participate in a plan successfully, all you have to do is avoid these common pitfalls:

Companies …

1. Not matching your employees contributions correctly: Keeping track of which employees are contributing to a 401(k), which aren’t, and which are owed a company match and when can be a headache for plan administrators — and sometimes employees who are eligible for a match get overlooked or don’t receive the correct contribution. To avoid making these mistakes, the IRS recommends employers review the 401(k) plan to ensure they’re using the right formula for determining matching contributions as well as the definition for compensation used to calculate matching contributions. In addition, make sure you are following the plan when it comes to the timing of deferrals — some plans say the match is based on a percentage of annual deferrals while others say it’s based on weekly deferrals. Finally, be sure that anyone involved with servicing the plan (employees, tax professionals, vendors) are aware of any changes you make to the plan.

2. Not reviewing your plan regularly: Any company offering a 401(k) plan is legally required to have a formal written document that both states the terms of the plan and complies with Internal Revenue Code. But lest you think this is a one and done document, don’t forget you’re dealing with the IRS and with tax laws, which means your plan must be updated whenever new tax laws are adopted (cue migraine). And plans that are not amended in a timely fashion no longer qualify for favorable tax treatment (cue angry employees). Luckily, the IRS has created a schedule for companies to review and update their plans. Companies with individually-designed plans are required to amend and restate their plans every five years (those with pre-approved plans are every six years). In between cycles, companies are required to review and adopt interim amendments released by the IRS annually. To ensure you’re up-to-date on any changes to 401(k) tax laws, the IRS recommends businesses review their plans annually, use a calendar to note deadlines for completing amendments, and that they check in with the company that sold them the plan annually about any changes.

3. Excluding eligible employees: Sometimes businesses overlook employees when it comes to deciding who’s covered by their 401(k) plan — assuming part-time workers are ineligible or treating employees who chose not to make elective deferrals as if they’re ineligible. Don’t assume anything about your plan, though.┬áMake sure your plan document specifically states the definition of “employee” and include when employees are eligible to make contributions to the 401(k). To reduce the risk of omitting any employees, the IRS recommends treating any employee who receives a Form W-2 as a potentially eligible employee unless you can exclude them under the terms of your plan. Also, keep accurate records of dates of birth, hire and termination; number of hours worked; compensation for the plan year; 401(k) election information and any other pertinent information related to plan administration to help with identifying eligible employees.

Individuals …

4. Not having a goal: According to the Wall Street Journal, you should spend less time deciding how your assets are allocated (ie: agonizing over which fund to select or how much to invest in stock vs. mutual funds) and more time figuring out how much you need to save and your strategy for doing it. And while most 401(k) participants contribute 7 to 8 percent of their salary to retirement, advisors say that number should be at least 10 percent before the employer match.

5. Waiting for your company to match: Some folks don’t contribute to a 401(k) until their company is willing to match their contributions, and even then they only contribute enough so they get the match. However, with the latest economic downturn, many companies have gotten rid of their match in an effort to trim budgets, and don’t necessarily have plans to bring it back. And even with many companies that still offer a match, it can take up to three years before an employee sees that match, and up to six years for them to receive the maximum, according to the Wall Street Journal. With companies less committed to helping employees save for retirement, it’s even more critical that individuals become responsible for their own savings — maxing out contributions at $16,500 annually ($22,000 for those 50 and older).

6. Relying too much on company stock: Since the Lehman Brothers and Enron debacles, the percentage of companies matching employee contributions with company stock was down to 17 percent compared with 36 percent in 2005, according to the Wall Street Journal. And individuals with company stock options are now able to diversify more than they were in 2005. Experts recommend that company stock should make up no more than 10 percent of an individual’s portfolio — so if you have the option to diversify, take advantage. Leaning too much on your employer to meet your retirement goals can be dangerous.

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