No-no's for retirement planning

USA Today (Society for the Advancement of Education), April, 2003

The collapse of Enron, Global Crossing, K-Mart, and other high-profile companies has dramatically highlighted the risk of investing too much in company stock in 401(k) and similar employee-funded retirement plans. However, workers often make other miscalculations as well in these plans. Following are common mistakes cited by many Certified Financial Planner professionals:

Failing to participate. According to the Profit Sharing/401(k) Council of America, 20 to 25% of eligible workers don't participate in available 401(k) plans. This means they are missing out on one of the most-tax-effective ways to save for retirement and could end up depending mostly on Social Security benefits when they retire. Failing to participate is especially costly since seven in 10 employers match up to a certain amount of each employee's contribution, according to the Council. Failing to join essentially means passing up free money.

Failing to save while waiting. The majority of 401(k) plans don't allow you to join the plan until you have worked for the employer for a year, and many require you to be at least age 21. If that is your situation, set aside money each month in a savings account. Then, when you join the plan, you can use this extra savings to supplement your family's cash flow so that you can maximize your regular 401(k) contribution over the next year.

Failing to contribute the maximum possible. Not every employee can afford to contribute the maximum allowed by the plan, but many don't contribute the maximum they can afford to put in. The average 401(k) participant contributes less than seven percent of pretax salary, according to the Employee Benefit Research Institute, although plans usually allow higher limits of, say, 15 or 20% of gross pay up to a set limit. At the very least, contribute enough to maximize the employer's matching contributions, but put in more if you can.

Not adjusting automatic enrollment. An increasing number of 401(k) plans automatically enroll workers, unless they opt out. This increases the participation rate, which is good. However, participants often fail to adjust the enrollment's initial default choices. Consequently, they probably aren't contributing as much as they can afford to, and the investment defaults are likely too conservative. Take the time to make adjustments.

Poor diversification. The average 401(k) plan offers around 10 investment choices. This is too few, say critics, though nearly half of all 401(k) participants invest in only one or two mutual funds offered anyway, and the average number of funds participants hold is just 3.3, according to Hewitt Associates. That is poor diversification, particularly if those funds are similar in style, such as two large-cap stock funds. Moreover, remember, if you hold company stock, it is important to diversify away from not only your company, but the industry it represents.

Failing to balance asset allocation with outside investments, Your 401(k) or similar employer-sponsored retirement account is the main investment for most workers (outside of their home). However, you may have other significant investments, such as your spouse's retirement account, individual retirement accounts, real estate, college savings, etc. So, when choosing retirement plan investments, make choices that take into account the outside investments as well. It is your overall portfolio that needs to be properly balanced for risk and return.

Relying heavily on company stock. After all the publicity about Enron and Global Crossing, this seems like obvious advice. Yet, many workers have been quoted as saying they will continue to load up heavily with their company's stock because they are confident their employer's stock will continue to do well. CFP professionals generally recommend that workers keep no more than 20% of company stock in their retirement account.

Borrowing from the plan. It may be financially attractive to borrow from your 401(k), but avoid it unless absolutely necessary. You would be taking money out of the account that otherwise would grow tax-deferred, and if you fail to pay back the money, you could face income taxes and penalties. Instead, build an outside emergency fund you can draw on.

Cashing out the plan account. A majority of workers under age 35 cash out their 401(k) account's accumulated value when they switch jobs, according to the 401k Association. That money can no longer grow tax-deferred, and the withdrawal faces taxes and usually a 10% penalty.