Having a 401(k) plan is a great way to save for retirement and take advantage of the tax benefits that come with the plan. If you are not careful, however, you can lose money in your 401(k) plan. While it is rare to lose your entire 401(k) plan, there are circumstances under which you could lose your 401(k) money. For example, if you withdraw money from your 401(k) plan before turning 59.5, or if you default on your 401(k) loan, you will lose 10% of your money in penalties. Making bad investments with your 401(k) money, leaving your job before you are fully vested, or paying too much 401(k) fees are different ways you can lose your 401(k) money.
Here are 6 different ways you can lose your 401(k) money.
1. Your company goes bankrupt
Most publicly traded companies allow employees to buy their shares at discounts as part of employee benefits. For example, your company can give you a 15% discount when you purchase its stocks. This is one way employers share profit with their employees. While you can buy great stocks at a discount, you could also lose your 401(k) money if your company goes bankrupt.
The bankruptcy devalues the company’s stock
If your company goes bankrupt, its share prices will decrease to almost zero which will result in losing money you invested in the stock. While you can lose your 401(k) money invested in the stock, your remaining 401(k) balance will be protected.
The money in your 401(k) is usually kept in a trust that is separate from your company’s assets. In case, your company goes bankrupt, your 401(k) value can go lower if you own the company’s stock, but you will not lose your entire 401(k) plan. The Employee Retirement Income Security Act(ERISA), prevents creditors from coming after your 401(k) money in case your company goes bankrupt, according to Equifax.
You could lose your company’s initial deposit to your 401(k) plan
According to Yahoo, if your company goes bankrupt while the company’s initial deposit to your 401(k) plan is still in transit, you might lose that deposit. This is because the deposit is considered the company’s asset until it is deposited in your 401(k) plan. For this reason, you can lose the deposit during the bankruptcy process.
You can lose unvested balance if your company goes bankrupt
If your company goes out of business before you are fully vested, you could lose the amount in 401(k) that is not vested. Vesting means that your company’s contributions are not 100% yours until you have worked in the company for a given number of years. Some companies have vesting schedules where you earn a small percentage as time goes by. For example, you might be vested at 50% after working there for a year, 75% for 2 years, and 100% for three years. If the company goes under, any percentage that is not vested can be lost.
2. Making bad investment choices
Most 401(k) plans invest in mutual funds, stocks, and bonds. These investments can increase or decrease in value over time. If the investment you have purchased loses value during a bear market, your 401(k) value will also go lower. For example, if you have individual stocks or the stock you have in your mutual fund goes to zero, the value of the fund will go lower which, in turn, will cause you to lose money in your 401(k) plan.
3. Taking early withdrawal penalties due to financial stress
While you might be saving for retirement, the loss of a job can easily force you to take distributions before retirement. Taking money before you turn 59.5 years old leads to losing your 401(k) money with a 10% penalty. Besides the penalty, you also interrupt the compounding effect of your funds, reducing your retirement amount. You will also pay an income tax on your 401(k) withdrawals which will greatly lower your take-home money.
4. You lose your 401(k) money when you default on a 401(k) loan
If you take a loan from your 401(k) plan and don’t pay it back, you could lose a significant portion of your retirement savings. When you borrow against your 401(k), the money must be paid back to the account with interest. Due to financial stress, you can easily default on your 401(k) loan.
Unlike other types of loans where the bank comes after you, defaulting on your 401(k) results in an early withdrawal which triggers a 10% penalty and income tax on the defaulted balance. For example, if you defaulted on a $30,000 401(k) loan, you will pay 10% in penalty and income tax. Paying an early withdrawal penalty is one of the ways many people lose money from their 401(k) plans. To not lose your 401(k) money, only take out 401(k) loans you can afford to pay back.
5. Paying high fees
Another way to lose your 401(k) money is through excessive fees. Usually, 401(k) plans come with many fees compared to IRAs. The fees vary from one plan to another, the plan provider, and the number of participants. The fewer participants, the more expensive your 401(k) plan becomes. Typically, 401(k) fees include administrative fees, investment fees, and individual service fees and they can range between 0.5% to 2% of the account value.
The type of investments you hold in your account can also increase your 401(k) fees. Usually, actively managed funds come with higher fees compared to other types of funds. Any money you pay in 401(k) fees, automatically reduces your account balance which is a sneaky way to lose your 401(k) money.
Fees can eat into your 401(k) over time, reducing the amount of money you’ll have available for retirement. It might sound like 2%, but over 30 years, you will lose dozens of thousands of dollars in fees alone.
To minimize your 401(k) fees, pick passively managed funds and avoid specialized personal services.
Related post: What are the 401(K) fees and how to lower them?
6. You can lose your 401(k) money if you don’t have a rollover IRA when you leave your job
When you quit your job, you will have a few options on what to do with your 401(k) plan. You can either:
- Keep your 401(k) with your former employer
- Have your funds directly deposited in your new 401(k) plan
- Get a paycheck, or
- Roll over your money into an IRA.
Getting a paycheck from your 401(k) plan is treated as a distribution. For this reason, you will pay income tax on your funds and a 10% penalty if you are not 59.5 years old. You can also lose money in tax and penalties if you don’t do a rollover IRA. A rollover IRA allows you to transfer your 401(k) to an IRA and maintain all the tax benefits you have with your plan.
How can you avoid losing your 401(k)?
Opening a 401(k) plan is one of the best financial decisions anyone can make. Without the right strategies, however, you can easily lose money. To avoid losing your 401(k) money, here are a few strategies you use.
- Diversify Your Investments. Spreading your investments across a mix of assets can help mitigate losses if one asset performs poorly.
- Monitor the account regularly. Regularly checking your plan to ensure it’s performing well can help you spot any potential issues early on and make necessary changes.
- Avoid early withdrawal. Except in cases of emergency, do not withdraw funds early from your 401(k) to avoid penalties and taxes.
- Consider a Rollover. If you lose or leave your job, consider rolling over your 401(k) into an IRA or your new employer’s plan to avoid penalties.
- Do not default on your 401(k) Loans. If you borrow from your 401(k), make sure to pay back the loan as quickly as possible to avoid losing portions of your retirement savings.
- Be aware of fees. Pay attention to the fees associated with your 401(k) and consider lower-cost options if they’re available. To lower your 401(k) fees, avoid actively managed funds.
What happens to your 401(k) when you leave your job?
When you leave your job, several things can happen to your 401(k) depending on the choices you make. You can choose to leave the money in your current employer’s 401(k) plan. This option may not be available if your balance is below a certain amount, usually $5,000. Alternatively, you can roll over the funds into a new employer’s 401(k) plan or into an individual retirement account (IRA), which would not incur any immediate tax penalties.
Another option is cashing out your 401(k), which would provide you immediate access to your funds. However, this option is generally discouraged as you will likely trigger a 10% unless you have reached 59.5 years old. Moreover, cashing out your 401(k) early can negatively impact your long-term retirement savings.
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What happens to your 401(K) when you quit your job?
