A 401(k) plan is like a long-haul flight: Minor deviations along the journey can divert you thousands of miles and leave you at a completely unexpected destination.
Unfortunately, many American workers unknowingly make these small deviations that jeopardize their retirement. This could be because many workers have difficulty understanding, tracking and managing their plans properly.
According to a 2024 study by the U.S. Government Accountability Office (1), approximately 92 million Americans have collectively saved more than $7 trillion in their 401(k) plans, but many of them struggle to understand basic mechanisms, such as their distribution options, when changing employers.
Similarly, a study by Pontera and The Harris Poll (2) found that 85% of plan participants have difficulty answering basic questions about the plan.
Given the wide knowledge gap around 401(k)s, it’s no surprise that many workers make small mistakes that turn into big losses over time. These are three of the costliest mistakes that threaten your retirement.
Workers often start with a predetermined contribution rate and never think about adjusting it upwards.
Many employers set the default automatic contribution rate at around 3%, which is too low to build a solid nest egg for retirement.
An increasing number of 401(k) plans now contain auto-escalation features, which ensure that contributions automatically increase, typically by 1%, each year until a limit is reached.
However, there are still many 401(k)s that do not have this feature. And even if they do, every time you change employers and automatically enroll in a new plan, you could revert to the old default 3%.
The impact of this can be enormous. Assuming a constant salary of $100,000 and a constant annual return of 10%, a 3% contribution could take almost 38 years to reach $1 million, which many would consider the bare minimum for a comfortable retirement.
Ideally, you should adjust your contribution rate to a higher level when your income increases. Saving more strategically will allow you to reach your financial destination sooner. Increasing your contribution rate to 5% in the example above would allow you to earn $1 million in 32 years, six years sooner.
Unfortunately, workers are more likely to do the opposite. A survey by Morgan Stanley (3) found that 39% of employees nationwide had reduced their 401(k) contribution due to economic concerns about inflation and recession. Generation Z employees were much more likely to do so: 48% of them said they had recently cut back on their contributions.
Reducing contributions, especially when you’re young, could have a significant impact on the size of your long-term retirement savings.
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Employer matching features are relatively common and surprisingly attractive. About 98% of companies with a 401(k) plan offer some type of match, according to the Plan Sponsor Council of America (4), and the average rate ranges from 4% to 6% of salary, according to Carry (5), an online investment platform.
However, according to a 2024 study by Vanguard (6), only 54% of employees contributed at the equivalent or higher rate than their employer. That means nearly half of all employees are leaving “free money” on the table by neglecting their employer’s match.
Don’t make the same mistake. These features are designed to be an added incentive to save and build your savings, so take the time to learn how your employer calculates matching benefits and try to maximize your match.
Contributions to a traditional 401(k) plan reduce your taxable income, so not contributing or reducing your contributions could put you in a higher, less favorable tax bracket. Even a modest change in income can trigger a higher marginal rate, raising the overall tax bill.
For high-income earners, the difference between staying just below a threshold and crossing it can add up to hundreds or even thousands of dollars once federal, state, and payroll taxes are taken into account.
Many workers overlook this. They make contribution decisions based on current circumstances and the tax implications are not clear until next tax season. By then it will be too late.
Avoid these subtle tax mistakes by taking a long-term view of your finances and planning your contributions well in advance. A single dollar saved on taxes today and deposited into your 401(k) has the opportunity to turn into several dollars in the future.
While there are many ways to increase your retirement savings, from contributing more to investing smarter, reducing taxes is probably the easiest lever to pull. Contact an expert who can help you navigate all the complex tax rules to optimize your long-term strategy.
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US Government Accountability Office (1); Pontera / The Harris Poll (2); Morgan Stanley (3; Plan Sponsor Council of America (PSCA) (4); Carry (5); Vanguard (6).
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
