Retirement should be viewed as a lengthy process, not just something that happens when you turn 65. Ideally, you’re either building your nest egg — or you’re enjoying your retirement.
Whether you’re young and you’ve just started saving for retirement or you’re older and are playing catch-up, there are several costly mistakes that can jeopardize your retirement plans.
Take a few minutes to familiarize yourself with what not to do. You’ll thank yourself in retirement.
9 retirement mistakes to avoid at all costs
Planning for retirement means taking advantage of the things that will benefit you in the long run and avoiding the costly mistakes that can derail your retirement goals.
Here are nine retirement mistakes you should try to avoid.
1. Poor planning (or no planning)
You don’t automatically get to retire when you’ve reached a certain age. You need money coming in after you leave the workforce, and relying solely on Social Security might not be enough.
According to the 2020 annual report of the Social Security and Medicare Board of Trustees, the combined reserves of the trust funds that pay out retirement and disability benefits will be depleted by 2035. This doesn’t mean Social Security will no longer be around at that time, as ongoing taxes will be enough to cover 79% of the benefits available to retired and disabled workers. It does mean, however, that you may not want to rely solely on government programs to secure your retirement.
Poor planning can be costly. Neglecting to plan for your retirement entirely can have a detrimental effect on your future. According to a recent report from the U.S. Federal Reserve, nearly 25% of Americans have no retirement savings or pension at all. It’s easy not to feel the urgency when retirement is years into the future, but, again, saving for retirement is a lifelong process. One that is best approached with a plan.
2. Leaving a job before you’re vested in a 401K
Vesting in a retirement plan like a 401(k) simply means taking ownership over the funds in the account. Although you always own 100% of the funds you contribute to the plan, this isn’t the case with employer contributions. As each year passes, you vest (or own) more of a percentage of your account. So when you are 100% vested, you own 100% of the funds within that account. At that time, your employer can’t forfeit or take back the money for any reason. However, you’ll forfeit the employer contribution to your 401(k) if you leave a job before you’re vested.
There may be reasons outside your control that force you to leave a job early and before you are fully vested. Maybe the job just isn’t the right fit. But voluntarily leaving before you own 100% of the funds in your account means you’re leaving money on the table. If you have to leave your job, consider how much you are vested to avoid missing out on those extra savings.
3. Saving the minimum amount
Online calculators can give you an idea of how much money you will need in retirement and the amount you need to save to reach your goals. To make these estimations, you need to consider a number of factors, such as how long you will live in retirement, what other sources of income you might have, what sorts of profits your investments will return, and inflation, among other things. With some planning, you can estimate how much money you will need to reach your retirement goals. But life happens, too.
Saving only the minimum recommended amount might not be enough in reality. Your investment returns might not be adequate, Social Security might cease paying out, or you might have unforeseen medical costs that require more money than you saved. You might be able to reach your retirement goals by saving just the minimum amount, but you’ll have more peace of mind if you give yourself some wiggle room.
4. Failing to consider taxes
About five months before his death, Benjamin Franklin wrote what was, perhaps, his last great quote in a letter to French scientist Jean-Baptiste Le Roy:
“Our new constitution is now established, everything seems to promise it will be durable; but, in this world, nothing is certain except death and taxes.”
When you're planning for retirement, you need to be mindful of the taxes you will pay on distributions from your retirement accounts. With a traditional 401(k) and IRA, withdrawals in retirement are taxed as ordinary income. How much you will pay in taxes will depend on your tax bracket in retirement. Even if you believe your marginal tax rate will be lower in retirement than it is now, it’s important to plan for these tax payments so they don’t catch you off guard.
5. Cashing out too early
In situations of true hardship, cashing out your retirement savings early may be unavoidable. We’ve seen this with the COVID-19 pandemic. Thankfully, the government passed the CARES Act, which allows qualified individuals to take distributions up to $100,000 without incurring the 10% additional tax on early withdrawals applied under normal circumstances.
Unless it’s an emergency, cashing out your retirement savings is typically a costly mistake. When you take money out of the market too soon, you limit your retirement savings later on. This is primarily because you miss out on compound growth, which can significantly reduce your earnings. Unfortunately, once you miss out on the compounding interest effect, it’s lost. Unless you absolutely have to, don’t cash out your retirement savings before retirement.
6. Stopping contributions
Regular, consistent contributions toward your retirement are key to ensuring you have enough saved up when it comes time to withdraw from the labor force. Most importantly, it, again, allows you to maximize the wonderful effect of compounding.
Simply put, compounding is earnings on earnings. Compounding has a snowball effect, especially in a tax-deferred account such as a traditional 401(k) or IRA in which tax on earnings is deferred. The returns you earn on your investments are reinvested and generate more returns. Those returns are then reinvested, which generates more returns, and so on. The earlier you begin saving, the greater the compounding effect.
7. Being too conservative (or too aggressive)
The general rule of thumb is that you’ll need to replace about 80% of your pre-retirement income to enjoy the same standard of living you had before retirement. However, no rule of thumb fits everyone.
Part of retirement planning is determining how much you need to contribute to come as close as possible to hitting your goals down the road. If you’re too conservative, you might not have enough. If you’re too aggressive, it might be at the cost of your current financial situation, which could lead you to not having enough money in the present. As a result, you might be more tempted to dip into your retirement saving early, which will come with a 10% penalty.
8. Retiring too early
As much as you might fantasize about retiring early, there are several reasons you might not want to be in too much of a hurry. If you retire earlier than you planned, you run the risk of running out of money. The last thing you want is your reliance on your nest egg to outlast the money you have in it. Then, you’ll be forced to find ways to earn extra money in retirement instead of doing what you enjoy.
Second, early retirees give up active income, which is the key contributor to funding your savings for retirement. Depending on where you’re at in your career, you could be giving up potentially high earnings.
Lastly, many 401(k) plans and individual retirement accounts require participants to reach the age of 59 1/2 before they can start taking distributions without penalty. If you retire too early, you simply might not have access to your savings when you need it.
9. Retiring too late
This, of course, doesn’t apply to everyone, but you may be regretful if you’ve spent your entire life preparing for retirement and then wait too long to enjoy it. Unfortunately, the reality is that some people don’t have the financial means to retire.
If you planned properly and are able to retire when the time comes, you’ll want to consider the downsides to postponing retirement and staying in the workforce. For example, making the transition will be a lot easier while you’re still healthy. Plus, don’t you want to enjoy the years of freedom you’ve spent your life preparing for?
The final word on retirement mistakes
Retirement isn’t as simple as reaching a certain age and being able to walk off into the sunset. It takes a plan, the fortitude to put that plan into action, and the discipline to stick with it for several years. Although a lot is riding on the actions you take today, understanding the steps you need to take and the mistakes you need to avoid is a great place to start.
If you’re young, start saving now. If you feel you’re behind, try to figure out what you can do to get yourself in a better position to reach your goals. As Marcus Tullius Cicero said, “More is lost by indecision than wrong decision.”