A lot of confusion and misinformation exists when it comes to saving for retirement. The picture has become even more complicated due to the coronavirus pandemic, which forced many people into an early retirement that they were not quite ready for, and left others feeling like they may need to work longer than intended to achieve their goals.
Unfortunately, many people have regrets about their retirement planning. Understanding the common mistakes that people make when it comes to retirement planning can help you avoid them. Some of the most common mistakes include:
Not accounting for taxes.
When you save with a tax-deferred account, such as a traditional IRA or a 401(k), you will eventually need to pay taxes on withdrawals, since your deposits grew tax-free. As you look at the balance in your IRA or 401(k), remember that a significant portion of the savings will go to taxes. While you cannot avoid paying these taxes, you can diversify your accounts by including a Roth IRA. Your contributions to a Roth IRA are made after taxes, but qualified withdrawals in retirement are tax-free. Also, you can consider converting some of the tax deferred holdings to forever tax free ROTH status, if the tax bite over the near term makes sense.
A diversified retirement portfolio gives you more flexibility to help control the taxes that you pay. Even more importantly, however, is to plan for taxes. Be realistic about the tax rate you will likely have in retirement and plan on paying that amount. This way, you won’t be surprised when you have much less expendable income than you expected once you retire. A multi-year ROTH conversion process could reduce your taxes in retirement permanently, as well as making the legacy your leave more tax efficient.
Mismanaging your investment risk.
Allocating your investment portfolio according to risk tolerance can be
difficult. However, it is important to think critically about risk. If you do not take on enough risk, your portfolio will likely not grow quickly enough and you may not even outpace the rate of inflation. On the other hand, with too much risk exposure, too much of your portfolio could become virtually lost in a short period of time.
In general, people accept more risk when they are younger, since their retirement is still decades away and they have time to recover from major losses. At the same time, if you overreact in responses to losses, it might make better sense to lower your risk threshold. In any case, as you draw closer to retirement, you should lower risk to protect your nest egg. A future income annuity that offers guaranteed principal plus upside in various market index choices can be a foundational piece of the “safe money” retirement portfolio.
Starting to save too late.
One of the biggest regrets that retirees have is waiting too long to begin saving. Always remember: your retirement savings grow thanks to the concept of compounding interest. Any early gains are re-invested and you earn further gains on those initial ones. Over time, compounding means that even a small upfront investment will be worth more than a much later, but much larger deposit.
Even if you are unable to save a lot in your early 20s, you should still begin contributing to a 401(k) or savings account as that small amount can transform into something much larger down the line. Of course, you should also increase your contributions as you advance in your career and begin to earn more money.
Failing to have a solid plan.
Creating a plan for retirement is challenging because many so factors are up in the air. You likely do not know how much you will really need to retire comfortably, the amount you’ll make later in your career, and the tax burden that you will face. At the same time, you can still make rough estimates and refine these numbers over time. Even if your plan is rough in the beginning, it can give you a sense of whether you are on the right track and the type of retirement you’ll be able to afford.
You’ll also need to update your plan regularly as your financial situation changes and you get a better sense of your anticipated needs in retirement. However, the first step is to create a plan. Without one, you’re basically saving blindly, without any sort of idea whether your actions are sufficient for the retirement you envision.
Underutilizing the company match.
While not all employers offer a match, many do as a way to attract and retain staff. If this is the case at your company, make every effort possible to maximize the match you receive. For the most part, the match is a percentage of your salary. Based on the amount you contribute to your retirement plan, your company will also make a contribution. This money is essentially free, with no strings attached.
Always maximize your company’s match whenever possible. It may even make sense to prioritize this over other financial goals, since the match can boost your savings so significantly, without any other action on your part. Read the fine print associated with your company’s match and figure out a way to get the maximum benefit.