The Federal Reserve states that just 40% of the non-retired adult population in the US are confident with their retirement planning. This means that as much as 60% of Americans aren't currently on track with their retirement savings. Which group among these would you like to belong to?
Well, you may be prioritizing your short-term financial goals and immediate expenses. Amidst high inflation and recession, retirement saving seems to be a distant priority. However, you are actually squandering your precious days to accumulate funds for your future. The earlier you start saving for retirement, the better financially poised you will be. With high inflation likely to erode a significant chunk of your savings, it's time to start saving for your future now.
Every individual craves financial freedom during retirement days after toiling their entire life. Therefore, it's wise to zero upon costly investment mistakes early in your life. We have developed this guide to help you identify possible retirement-saving mistakes you are making. This way, you can mend your strategies before it's too late!
Key retirement mistakes to avoid
Take care not to commit these costly financial mistakes that can throw you out of track with your retirement planning.
1. Failing to start saving early
Regardless of your age, starting your retirement saving mission early translates to significant growth of your funds. Why not capitalize on the power of compounding with a longer tenure on your retirement savings?
One of the perks of starting your retirement savings in your twenties is that you can contribute lesser amounts on a monthly basis. Try to channel around 15% of your monthly income for retirement. As you get into your thirties, map where you stand and adjust the percentage accordingly.
Suppose you start saving $200 a month at the age of 25. Considering your retirement age to be 65, you will accumulate more than $1.2 million in the next 40 years. If you decide to start saving from age 35, you need to put aside $500 a month instead of $200 to reach the same goal.
Many individuals wait till their forties or even their fifties to begin their retirement savings. This deprives them of the compounding effect of interest. Besides, a person opening a retirement savings account in their forties would have to save much more each year to reach the goals compared to someone who started the journey 20 years earlier.
2. Not having a proper retirement plan
Have you calculated your monthly expenses by the time you reach 60? Postponing your retirement plan is one of the cardinal mistakes people tend to commit. Depending on your lifestyle, it's imperative to figure out how much you need to accumulate as your retirement savings.
While planning for your retirement, factor in aspects like the time available to accumulate your funds, your retirement location, the number of dependents, the lifestyle you prefer, and your health.
Financial advisors recommend the following accounts to start saving for your retirement.
401(k)
If you are employed, your employer should offer a 401(k) account. Start channeling funds as per your capacity to this account. While you divert your pre-tax funds into this retirement savings account, you also reduce your taxable income.
One of the prime benefits of contributing to the 401(k) account is that the earnings and interests remain free from tax. When you retire and eventually withdraw the amount, you need to pay the income taxes only on the distributed value.
The IRS states that employees can contribute $22,500 annually to this account. Thankfully, this has been increased from the upper cap of $20,500 in 2022. Individuals over 50 can contribute an additional $7,500 to their 401(k) in 2023.
IRAs
If there's no 401(k) in place or you are self-employed, it's wise to contribute to a traditional IRA or Roth IRA. Regardless of the type of IRA you contribute to, the upper contribution cap is $6,500 a year. This cap has also been increased by $500 in 2023. For individuals over 50, there's a scope of contributing $1000 more annually.
3. Sabotaging your retirement savings
When you start saving for retirement, try not to channel these funds to manage other priorities. As a direct outcome of not having a planned retirement strategy, individuals tend to sabotage their retirement savings prematurely.
Do you know that as much as 52% of Americans are forced to use their retirement funds earlier than planned? Among this population, 23% of the people had to tap their retirement savings just to pay their debts off. This reflects the sheer lack of financial planning and indiscipline in money handling.
17% of the respondents in a survey stated that they had to tap their retirement funds to make a down payment while purchasing a home. 11% had to use these funds to clear their college fees. Another 9% didn't have their medical expenses planned. As a result, they were forced to sabotage their retirement savings.
People between 22 and 37 are most likely to tap their retirement savings early. As much as 59% of the well-established millennials are ready to use their retirement money early to fund their kids' education and thereby avoid getting into student loan debts.
This explains why weighing your priorities is crucial before you start saving for retirement. The worst thing people repent of is losing out on the benefits of compounding when they use up their retirement savings early.
4. Banking on social security
Let's bust the popular myth: social security doesn't warrant your income replacement. Rather, these financial privileges tend to supplement your income.
A significant population committing this mistake tends to collect social security benefits as soon as they qualify for them. While calculating your retirement savings, ensure not to factor in the benefits of social security. Remember, social security is not meant to fund your retirement expenses. These benefits will never come close to your financial requirement at a time when inflation refuses to dip.
Moreover, depending on their financial inflow, the State can slash the benefits and alter the program anytime. Relying on social security is the gravest mistake when planning for retirement. These benefits don't come anywhere in the calculation.
Try not to jump to your social security benefits
Well, you might be eligible to tap your social security benefits at the age of 62. Try not to make full use of these privileges as soon as you are eligible for them.
Suppose you retire at 66 and start tapping the benefits from the age of 70. This would bring you a monthly income of $1,320. However, taking advantage of your social security benefits at 62 would reduce the monthly check to just $750, a deduction of 25%. Again, retiring at 66 and instantly tapping the benefits would stream a consistent monthly income of $1,000. With the cost of living increasing, it's wise to use your social security benefits intelligibly.
5. Failing to rebalance your investment portfolio
It's nice to have a calculated mix of assets in your retirement portfolio. From time to time, make sure to rebalance the mix. Being strategic with your retirement planning, talk to a financial expert to rebalance the portfolio annually.
A tactical approach to rebalancing your investment portfolio works like magic. While bonds add to your financial security, equities and stocks give you an aggressive growth portfolio. As you inch towards your retirement, you will likely slash the equity percentage in the asset mix and rely more on bonds.
However, being too conservative about risk-taking gives you an overtly defensive stance. You would end up retiring after investing in too many bonds. A bond-heavy asset allocation won't generate the desired retirement income amidst rising inflation. As you near your eighties or nineties, you will find your savings drying up!
Rebalancing your retirement portfolio involves factoring in other asset classes. Try to diversify your portfolio by investing in other types of assets. Have you considered investing in dividend-generating stocks or mutual funds? How about investing in REITs amidst an upscale real estate industry? Did you consider investing in CDs and high-yielding savings accounts that deliver higher returns?
If you are yet to rebalance your retirement portfolio, it's high time you talk to a financial expert.
6. Poor tax planning
The lack of foresight in tax planning happens to be an expensive retirement saving mistake. When you start saving for your future, it pays to evaluate the tax implications based on your age and income.
For instance, did you consider which tax bracket you would be in after your retirement? Would you be paying more taxes then or now? For most individuals, the income quotient keeps rising as they age. This implies you might be paying less if you are taxed now, compared to the higher amounts you would be shelling out for tax after retirement.
If your tax bracket after retirement is higher compared to your working years, it's wise to invest in a Roth IRA or Roth 401(k). Since you will be paying an upfront tax, you can enjoy tax-free withdrawal even after moving into a higher tax bracket. Besides, all the money that these investments earn for you would remain tax-free.
However, if you feel that your income after retirement is likely to dip and you may move into a lower tax bracket, go for a traditional 401(k) or IRA. This way, you can ditch high upfront taxes. When you withdraw the funds after retirement, you would be paying a lower tax amount.
Again, it's a bad idea to count on your regular 401(k) account for a loan. This would simply invite double taxation on the funds you borrow. After all, you need to pay off the loan using your after-tax money. Again, when you withdraw these funds after your retirement, you will be taxed for the second time.
How does consistency influence your retirement savings?
While planning for your retirement, make sure not to deviate from your planning. Consistency in putting aside the funds allocated for your retirement savings ensures you can capitalize on the power of compounding. When you translate saving into a habit, you can benefit from a higher interest rate.
Whether you are a self-employed professional using a simple IRA or are contributing to a 401(k) provided by your employer, consistency defines the key to successful asset building. Just like you set aside funds for purchasing groceries and paying your utilities, allocate at least 15% of your income for your retirement savings.
As you mature professionally, try to stream in more income channels and contribute to your retirement savings. Each time you get a salary hike, your contribution to your retirement savings accounts should correspondingly increase. As a thumb rule, you should raise your retirement contribution by 1% of your annual income each year.
Be realistic with your retirement planning, and maintain consistency as you save for your holden days!
Endnote
Now that we have discussed the adverse fallouts of poor retirement planning, you should be financially better poised as you rectify your investment flaws. Never underestimate the length of your retirement. Considering the average retirement age in the US to be 64, you can well live another 25 years. Well, that's a quarter of a century! Unless you allocate adequate funds and recurring sources of income, you remain susceptible to running out of funds.
Factor in the tax implications in case you are not paying the same now. Moreover, the cost of living is likely to crawl up consistently in the next four to five decades. Invest intelligibly to counter this impact of inflation. Considering the average inflation rate in 2022 to be over 6%, it pays to invest in accounts that generate at least 6% interest for you.
Lastly, never tap your retirement funds prematurely. The secret to successful financial planning lies in screening your fixed expenses before you start saving!
FAQs
What are the common mistakes in saving for retirement?
One of the common mistakes individuals make during their retirement planning is their failure to contribute to accounts like 401(k). Besides, people tend to make the most out of their social security benefits early. Another common mistake while saving for retirement is not diversifying or rebalancing the financial portfolio.
Which asset classes should I invest in for retirement?
Depending on whether you are employed or run a business, you need to choose the assets to invest in for retirement. These should include a traditional IRA or Roth IRA account, 401(k), real estate, REITs, stocks, bonds, CDs, and mutual funds.
At what age will you start receiving your social security benefits?
The eligibility age to tap your social security benefits is 62. However, financial experts recommend not to tap into these savings right away since you would receive limited benefits at this age. Only when you attain the age of 70, can you receive the full amount.
At what age can you withdraw from your 401(k) without paying any penalty?
Withdrawing your retirement funds before you reach the age of 59.5 would attract a 10% penalty from the IRS. So, it's wise to withdraw your funds after reaching this age to avoid penalties. However, there's a "Rule of 55' in place. If you quit the job or are fired at or after the age of 55, you can withdraw funds from your current employer's 401(k) account without any penalty.
From what age should I start saving for my retirement?
It's wise to start saving for your retirement as early as possible. Try to channel funds to your retirement accounts from your early twenties to benefit from the compounding effect of interest.
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