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What You Don't Know About Your 401(k) Can Hurt You


Many take 401(k) plans for granted -- they get the paperwork and choose investments without reading the fine print. But by not understanding your retirement plan, you may end up missing out on "free money," or paying more taxes than you should. Here are some examples.

Many savers take their 401(k) retirement savings plans for granted. As soon as they enroll in the plans, they get the paperwork, choose some investments, and make their selections without looking at the fine print. By not reading your plan’s terms carefully, however, you may be missing out on “free money.”

“If you contribute too little to your 401(k), you may not get the full employer match,” says Robert J. DiQuollo, CFP, CPA, president of Brinton Eaton, a financial planning firm in Madison, N.J. “On the other hand, if you contribute too much, too fast, you can short-change yourself.”

Take, for example, a physician making $20,000 a month who contributes 20% to his or her 401(k), with a 5% company match. He or she will reach the IRS’s annual contribution limit of $16,500 in May and is prohibited from contributing to the account for the rest of the year. That means, if your company only matches based upon your own contributions, you may limit your match as well.

In the example above, the doctor receives a 5% company match of only $4,500, if he or she frontloads the contributions through May. If, instead, the physician chose a 7% contribution rate instead, he or she would not have reached the $16,500 yearly maximum until December, and would have received the full company match of $12,000 -- or $7,500 more -- just by understanding the rules.

“Know the fine print in your 401(k) plan so you get the maximum amount of ‘free money’ available through the company match,” DiQuollo says.

Penalty-Free Withdrawals

If a physician removes money from a 401(k) or 403(b) plan (for nonprofit employees) before age 59½, he or she would normally have to pay a 10% penalty, in addition to ordinary income tax, on the distribution.

There are exceptions to the 10% penalty rule. One exception is using the withdrawal to fund your children’s education. But ideally you don’t want to jeopardize your retirement; leave your money in the plan, DiQuollo says, and look elsewhere for tuition money.

If you leave or lose your job, you can withdraw money penalty-free from your plan starting at 55. That can be valuable for people taking early retirement, or who are long-term unemployed.

Shifting Assets When Changing Jobs

Consider moving your assets to a rollover IRA, in the interim, if you are changing jobs and planning to roll over your 401(k) or 403(b) to the new job. Don’t make any new contributions to the rollover IRA or commingle it with other retirement money, as you won’t be able to transfer it to your new employer’s plan.

If you have one or more 401(k) or 403(b) plans with one former employer or more, consider rolling the accounts into a single IRA or plan so you can more effectively manage your money.

“Having all your money in one place makes it easier to monitor your investments and rebalance your asset allocation regularly,” DiQuollo says.

Required Minimum Distributions Are Not Always Required

If you’re retired and have 401(k) or 403(b) plans with your previous employers, you must take required minimum distributions (RMDs) annually from each plan starting at age 70½. One exception: If you’re still working for the company, RMDs are generally not required from that employer’s plan.

That’s an advantage over an IRA, DiQuollo says. With IRAs, RMDs are always required beginning at 70½. So if it’s likely that you’ll continue to work into advanced retirement age, an employer-sponsored plan may have an advantage over an IRA.

Brinton Eaton is a Madison, N.J.-based advisory firm with a long history of serving individuals and their families across multiple generations. The firm helps its clients protect, grow, administer, and ultimately transfer their legacy of wealth through a full range of integrated services, including lifetime cash flow projections, financial/tax/estate/retirement planning, investment management, charitable giving, and business succession planning. Brinton Eaton's clients tend to be corporate executives, professionals, entrepreneurs, retirees, and multi-generational families.

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