Personal Finance

5 Pitfalls to Avoid If Most of Your Retirement Savings Is in a 401(k)

Maurie Backman

Published: January 29, 2025 7:35 am

There are plenty of good reasons to participate in an employer 401(k) plan if you have one available to you. For one thing, it’s super easy to fund a 401(k). All you need to do is sign up with your employer, and contributions will be deducted from your paychecks automatically.

Also, many employers offer a 401(k) match, which is basically free money for you. Granted, some matches are subject to a vesting schedule, and it’s important to see if yours is. But if it’s a flexible one, or if you’re not subject to one, then you have a prime opportunity to score free cash in your retirement plan.

But there are also certain pitfalls 401(k) savers risk falling into. So if you’re using a 401(k) to save for retirement, do be mindful of these potential problems.

Pitfall #1: Getting stuck with investments that aren’t conducive to meeting your goals

One major flaw of 401(k) plans is that they typically do not allow you to hold individual stocks in your portfolio. That could mean having to settle for investments that don’t lend to your long-term goals.

It’s common to find broad market index funds in a 401(k). And while there’s nothing wrong with saving in one for retirement, you’re also not going to beat the market that way.

Target date funds are another common 401(k) investment, and like index funds, there’s certainly nothing wrong with putting money into one. But target date funds have a tendency to err on the side of being conservative, which could limit your 401(k)’s growth.

If you want the option to invest a portion of your retirement portfolio in specific stocks, you may want to keep some of your savings in an IRA. An IRA gives you similar tax benefits to a 401(k) with more flexibility as far as your individual investments go.

Pitfall #2: High fees

Saving in a 401(k) might expose you to high fees in a couple of ways. First, if you happen to load up on mutual funds with high expense ratios, you’ll lose money to fees that way. And target date funds are also notorious for imposing higher fees.

Also, some 401(k) plans impose hefty administrative fees that you can’t really do much about. Investment fees are within your control, because you could always opt for lower-cost index funds over actively managed mutual funds. But you don’t get a say in the administrative fees that are passed on to you as a saver.

Pitfall #3: The risk of penalties for touching your savings too soon

With a 401(k), a 10% early withdrawal penalty can apply for removing funds before age 59 1/2. There can be exceptions if you leave your employer the calendar year you turn 55. In that case, you may be entitled to penalty-free withdrawals from that employer’s plan specifically.

But you never know when you might end up retiring early. Even if you intend to work until well into your 60s, life might throw other plans at you. So it’s best to keep some of your long-term savings in an unrestricted brokerage account so you don’t have to worry about penalties for accessing your money.

Pitfall #4: The risk of forgetting about an old workplace plan

Job hopping is a pretty common thing. The problem, though, is that when you move from one employer to another, you risk forgetting about an old 401(k).

Of course, this issue can be remedied pretty easily. If you’re going to participate in a workplace plan, always make a point to roll your 401(k) into another qualified retirement plan when you leave an employer — whether by choice or otherwise. And if you don’t have access to a new employer plan after leaving an old job, aim to roll your 401(k) into an IRA.

Just as importantly, whenever possible, make it a direct rollover, where funds from your 401(k) land in a new retirement plan without you having to get involved. With an indirect rollover, where you receive a check for your 401(k)’s balance and are tasked with depositing that money into a new retirement plan, there’s a greater risk of penalties for not transitioning that money on time.

Pitfall #5: Setting it and forgetting it

When you’re saving in an employer’s 401(k), it’s easy enough to take a “set it and forget it” approach. But doing that could leave you with less money over time.

Instead of ignoring your 401(k), review your investments a few times a year to make sure they still align with your strategy, and to make sure their performance is reasonable. And also, if your pay increases from year to year, aim to save more from year to year. In fact, an easy way to increase your retirement savings is to send your raise into your 401(k) every year before you get used to having or spending that extra money.