10 Common 401(k) Mistakes to Avoid (and How to Fix Them)

Your 401(k) is one of your most powerful tools to escape the rat race and reach financial independence. But like any tool, using it correctly makes a big difference.

Even smart savers sometimes miss out on thousands of dollars (and years of growth) because of a few small mistakes.

Here are 10 common 401(k) mistakes — and how to make sure you’re getting the most out of your plan.

1. NOT UNDERSTANDING YOUR 401(k) TYPE

When 401(k)s were first introduced, there was only one type. You had no choice in the type of 401(k) plan to enroll in. Now, most employers offer both the traditional and Roth 401(k) plans.

So, which should you choose if given the option? You actually can’t go wrong with either, but the two types of 401(k)s offer different tax advantages.

Similar to a traditional Individual Retirement Account (IRA), the money you contribute to a traditional 401(k) is considered pre-tax money. Therefore, your contributions lower your taxable income now. You’ll owe less in taxes during tax return season. It doesn’t mean you’ll never owe taxes, though. You’ll still pay taxes on any growth when you withdraw in retirement.

Roth 401(k)s work similarly to Roth IRAs. Your contributions to a Roth 401(k) are made wth after-tax money. Since you pay taxes up front, you pay no taxes when withdrawing from your account in retirement.

The general rule of thumb is to choose a Roth 401(k) if you expect to be in a higher tax bracket in retirement and choose a traditional 401(k) if you expect to be in a lower tax bracket.

The problem with this rule is that you can’t be sure what your future tax bracket will be. Your income will probably change, and tax laws will definitely change over time.

So don’t overthink it. The main thing to consider is when you want to enjoy the tax advantage. If you want lower taxes now, go with the traditional 401(k). If you don’t mind paying taxes now in exchange for paying no taxes when you withdraw, choose the Roth 401(k).

2. CONTRIBUTING THE WRONG AMOUNT

There are three rules of thumb when deciding how much to contribute to your 401(k).

RULE 1: ONLY CONTRIBUTE MONEY YOU WON’T NEED IMMEDIATELY

Like any retirement account, the money in your 401(k) is meant to be accessed at retirement age, specifically age 59½ or older. Withdrawing any earlier can trigger taxes and penalties.

If you are living paycheck to paycheck or have nothing saved for an emergency, reduce the amount you contribute or don’t contribute at all. Secure enough cash for immediate needs and emergencies before contributing to a 401(k).

RULE 2: CONTRIBUTE AT LEAST ENOUGH TO GET YOUR EMPLOYER’S FULL MATCH

One of the best things about 401(k)s is the company match. The overwhelming majority of companies match employee contributions to some degree. Don’t leave free money on the table—contribute at least enough to get the full company match.

Companies commonly match 50 cents for every dollar you contribute, up to 6% of your salary. If you’re confused as to what this means, you’re not alone. I misunderstood this for years. This just means they’ll contribute up to 3% of your salary if you contribute 6%.

To clear things up, here are three different contribution scenarios and how they affect the company match.

• Contributing exactly 6% of your salary

  If your salary is $50,000 and you contribute $3,000 (6% of your salary) to your 401(k) plan, the company will contribute $1,500 (half the amount you contributed).

  
  

• Contributing less than 6% of your salary

  If your salary is $50,000 and you contribute $2,000 (4% of your salary) to your 401(k) plan, the company will contribute $1,000 (half the amount you contributed).

  
  

• Contributing more than 6% of your salary

  If your salary is $50,000 and you contribute $5,000 (10% of your salary) to your 401(k) plan, the company will still only contribute $1,500. The company stops matching contributions once you’ve contributed 6% of your salary.

A company match of 50 cents for every dollar you contribute is essentially a guaranteed 50% return on your investment. You won’t get that guaranteed return anywhere else. So, at the very minimum, contribute enough to get that full match.

RULE 3: ADJUST YOUR CONTRIBUTIONS AS YOUR SALARY AND NEEDS CHANGE

You can change your contribution percentage at any time, so make adjustments as things change in your life. As your salary grows, your savings rate should too. If you can afford to, bump your contribution by 1–2% each year or enable auto-escalation if available.

On the flip side, if your expenses grow because of a new child or rent increases, for example, adjust your contribution percentage as needed. Make sure your immediate needs are taken care of first.

3. TAKING EARLY WITHDRAWALS OR LOANS

As mentioned, any withdrawal from your 401(k) before age 59½ or older is considered an early withdrawal, which can come with penalties and taxes.

HEFTY EARLY WITHDRAWAL COSTS

Early withdrawals from a traditional 401(k) are generally subject to a 10% penalty. This is on top of any income tax owed because withdrawals from traditional 401(k)s are always taxed.

For example, let’s assume you withdraw $15,000 and you’re in the 22% tax bracket. In this case, you’d owe $3,300 in taxes and $1,500 in penalties. That's $4,800 total. Your $15,000 withdrawal turns into $10,200.

Early withdrawals for Roth 401(k)s are a little different. With a Roth 401(k), the amount you contributed can be withdrawn at any time, penalty-free. This is the same as a Roth IRA. Your gains, however, are still subject to the 10% penalty if withdrawn before age 59½.

WHAT ABOUT 401(K) LOANS?

Borrowing from your 401(k) doesn’t trigger penalties, but it’s not all good news. Even though you’re technically borrowing from yourself, as with all loans, you’re required to pay back the money plus interest by a set date.

Typically, payments are automatically deducted from your paycheck. But if you separate from your employer before the loan is paid off, it doesn’t mean you’re off the hook. In fact, you may have to pay it back in a much shorter timeframe. If you can’t pay up, this can force an early distribution, triggering those penalties and taxes again.

LOSS OF GROWTH

It’s too much to list here, but there are some exceptions to the early withdrawal penalty. However, even with the exceptions, your early withdrawals would still be subject to taxes. And these taxes work against any growth in your account.

It’s the same with taking a 401(k) loan as well. Taking any money out of your 401(k) slows the growth process.

Compounding is like a car accelerating. Withdrawing money from your 401(k) is like pumping the brakes when you’re trying to build momentum.

Again, this is why it’s important to only contribute to a 401(k) money you won't immediately need.

4. CONTRIBUTING UNEVENLY

Did you know that even if you contributed enough into your 401(k) to get the full company match, there’s still a chance you won’t? How you contribute to your 401(k) is as important as how much you contribute.

Using a previous example, assume the company matches 50 cents for every dollar you contribute up to 6% of your $50,000 salary. If you contribute 6% every paycheck, you’d contribute $3,000 by year’s end, and the company would’ve added $1,500.

What if, though, instead of contributing every paycheck, you decided to wait until the final paycheck of the year to make a $3,000 lump-sum contribution?

Even though you’re still contributing 6% of your salary, you will probably not receive the full $1,500 company match. In fact, you’ll probably only receive about $58 total.

The reason for this has to do with how the company match works for most 401(k) plans. Most companies match per pay period, not as a year-end total. This means for each paycheck, the company looks at what you contributed for that period. Then they add the matching amount based on that contribution.

If your $50,000 salary is paid biweekly, your biweekly pay would be about $1,923. The company then matches 50% up to 6% of that paycheck:

• 6% x $1,923 = $115.38

• 50% of that = $57.69

Some companies do offer a year-end “true-up,” where they ensure employees receive the full match even if they contribute unevenly throughout the year. But most likely, your company will only match per pay period.

Consistently contributing per paycheck is the best way to ensure you get the full match you’re entitled to. Plus, contributing on a regular schedule allows you to take advantage of dollar-cost averaging on your investments.

5. NOT CHOOSING AN INVESTMENT

A common mistake made by people new to 401(k)s is assuming that the 401(k) itself is an investment.

A 401(k) is simply an account, just like a checking account. Unless you choose what to invest in, at worst, your money sits there doing nothing. You may still get your company match, but that’s it—it won’t grow. And if it’s not growing, then you’re simply losing money to inflation.

Some companies automatically choose an investment for you if you don’t choose one. But it might not be an investment you want. It may be too aggressive or too conservative for your liking. Or it may charge hefty fees that eat into your gains.

So once you start contributing to a 401(k), it’s important to review your investment options and choose one that works for you. And don’t forget to review and update your options as your financial situation changes.

6. IGNORING FEES

Investment choices through 401(k)s are usually limited to a handful of funds selected by your company. And investing in these funds comes with fees.

These fees impact the growth of your investments. Even a 1-2% difference can reduce your returns by thousands of dollars in the long run.

For example, let’s say two investors—John and Candace—each invest $500 a month for 30 years. Both also average a 7% annual return before fees.

The only difference between the two is that John pays a 0.5% annual fee and Candace pays a 2.0% annual fee. This turns John’s net annual return into 6.5% and Candace’s into 5.0%. It’s only a 1.5% difference in fees.

But after 30 years, John will have $489,000, while Candace will have $377,000. That 1.5% difference would cost Candace about $112,000 in gains over 30 years. That’s more than nine years’ worth of contributions! Fees don’t just take money once—they reduce every future gain that could’ve been built with that money.

Always check the expense ratios of investment options. Lower fees equal more compounding power. Choosing investments with lower expense ratios is an easy way to boost returns.

7. OVERLOOKING VESTING SCHEDULES

Most companies that match 401(k) contributions also include a vesting schedule to incentivize employees to stay with the company. With a vesting schedule, company matches may not be fully yours until you’ve stayed a certain number of years. This includes any growth the company match received.

Think of your contributions and the company match going into two separate accounts. You immediately have full ownership of the account you contributed to, whereas you slowly gain ownership of the account the company contributed to.

A vesting schedule could look something like this.

1 Year: 20%

2 Years: 40%

3 Years: 60%

4 Years: 80%

5 Years: 100%

With this schedule, you’d gain 20% ownership of the company match after each passing year. After five years, you’re entitled to everything the company contributed and its growth. If you leave the company before five years, you could still take home a percentage of it.

If you plan to switch jobs, check your plan’s vesting schedule and your anniversary date. Leaving even one day before your anniversary date could mean giving up thousands of dollars.

8. LOSING TRACK OF OLD 401(K)S

It’s easy to forget about 401(k) accounts at old jobs. Fortunately, you won’t lose ever lose access to the money. But it’s important to plan for what to do with it.

You can roll over the funds into another retirement account as soon as you’ve separated from your old employer. Simply contact your old 401(k) administrator to make arrangements.

But what happens if you forget? One of three things could happen:

• If your vested balance is $7,000 or more, you have the option of leaving it with your old account administrator. Doing so, however, may incur annual fees that will reduce any growth. You also won’t be able to contribute additional money to this account.

  
  

• If your balance is between $1,000 and $7,000, your old employer can roll over the funds into an Individual Retirement Account (IRA) of their choosing. You’ll still need to choose investments, though.

  
  

• If your balance is less than $1,000, your old employer can cash out your account and send you a check. You then have 60 days to deposit it into another retirement account or pay taxes and penalties.

9. ROLLING OVER FUNDS TO A NEW 401(K) INSTEAD OF AN IRA

If you choose to move the funds out of an old 401(k), you have two options:

• Roll it over to your new employer’s 401(k)

• Roll it over to an IRA

Rolling over the funds directly into either a new 401(k) or IRA avoids taxes and penalties. Many people choose the first option of consolidating 401(k) for the sake of convenience. But the second option—rolling over into an IRA—has a distinct advantage: more investment options.

Most 401(k) plans typically offer a very limited number of investment options. Usually, it’s a handful of funds, such as target-date funds, bond funds, and index funds. These may not be the best-performing investments or have the lowest fees. And if you want to invest in individual stocks, you’ll probably be out of luck.

Rolling over your 401(k) into an IRA opens up your investment choices to practically everything out there.

10. FORGETTING TO UPDATE BENEFICIARIES

It’s estimated that 40% to 60% of retirement plan participants forget to add or update beneficiaries on their accounts.

You work hard to grow your 401(k), and therefore, you should be the one to decide who gets the money if you die, not the state. Check to see if you need to add or update your beneficiaries. Don’t mistakenly assume a will can override an old beneficiary designation, either. For retirement funds, like a 401(k), beneficiary designations legally supersede any will instructions.

Make sure your beneficiaries are up to date, especially after marriage, divorce, or having children.

BUILDING YOUR FUTURE ONE PAYCHECK AT A TIME

Your 401(k) isn’t just a retirement account—it’s your future financial freedom.

By avoiding these common pitfalls and paying attention to how your plan works, you can keep more of your money growing toward your financial independence goals.

Let me know if you found the information helpful in the comments below.

See you at the finish line!

Disclaimer: I’m not a licensed financial professional. This blog shares my personal experiences and opinions around money, investing, and early retirement. It’s for informational and educational purposes only—not financial, legal, or tax advice. Always do your own research or consult with a qualified professional before making any financial decisions.