Investing in retirement accounts is a smart way to plan for your future, but they could also cost you if you don’t handle them correctly.
Retirement accounts may have government regulations and penalties if you don’t properly withdraw from them. There may be mistakes you make as an investor that could hurt your retirement savings as well. If you're tight on cash and considering withdrawing from you retirement funds, look into ways to build wealth after 40 first.
Here are a few mistakes to keep in mind before you withdraw that cash from your retirement accounts.
Withdrawing too soon
Retirement accounts like a 401(k) account allow you to start withdrawing money without penalty at 59 1/2 years old, but that doesn’t mean you should start digging into that cash right away. One of the reasons your accounts grew was due to compounding interest.
Your retirement accounts will still continue to earn you money both from the investments themselves and from the compounding interest regardless of your age. Keeping your money in investments could be an easy way to build wealth for retirement.
Not withdrawing enough
You may think that you have plenty of cash on hand already, so why not leave your retirement funds alone? Because that could cost you as well.
Some retirement funds carry a required minimum distribution (RMD), which means you have to withdraw that minimum amount each year once you turn 72. If you don’t, the IRS will charge you a 50% tax on the money you were supposed to withdraw.
Withdrawing on a downturn
You may have had those moments of panic due to all the red numbers in your retirement portfolio. That may have led you to make a mistake pulling the money out of your retirement funds, which could lead to taxes and penalties.
The market will have its dips and corrections. While there are many ways to prepare for the next recession, leaving your money in during those downturns will let you take advantage of the market going back up. Taking it out could cause you to miss out on upswings in the stock market.
Retirement funds can be confusing, particularly when it comes to withdrawing money. There may be tax implications depending on where you’ve invested your money. You could also be taxed or penalized for taking funds from the wrong place or at the wrong time.
As you plan your retirement, sit down with a financial advisor who can help you get a better grasp on how to withdraw your money without penalties. Some advisors may charge a fee to help you invest your money, but you may also be able to find one for free through your employer-provided plan.
Not rebalancing your account
One costly retirement mistake could be forgetting to rebalance your portfolio after withdrawals. If you withdraw cash from one account only, you may be leaving yourself vulnerable to market fluctuations or other issues moving forward.
As you get further into retirement, you might want to rebalance your investments so they are more risk-averse. You’ll likely need that money sooner and won’t want to wait for the market to recoup from higher-risk investments.
Taking money from a Roth IRA first
A traditional IRA is a retirement fund that allows you to invest pre-tax income and only pay taxes on your investments when you withdraw the money. By contrast, a Roth IRA is funded with after-tax dollars and offers tax-free withdrawals.
While you may think a Roth IRA is better, it could be wiser to withdraw money from your traditional IRA first. That way, your Roth IRA will continue to earn money tax-free while you pay taxes on your IRA distributions.
Not planning for your budget
If you don’t have a budget in place, you could end up withdrawing too much from your accounts too soon and find yourself without any funds left and a lot of money stress in retirement.
Your budget should include utilities and housing as well as money for vacations, hobbies, and other activities. You’ll also want to factor in inflation, dividend payments, or investment performance to account for any fluctuations.
Ignoring the tax implications
The benefit of a Roth IRA is that you don’t have to pay taxes on the money you withdraw in retirement. But other accounts, such as an IRA or 401(k), may require you to pay taxes on any withdrawals you make. You could end up with a surprise from the IRS if you don’t factor taxes into your retirement budget.
Pro tip: Remember to take into account the taxes you might have to pay on other sources of income, such as Social Security, a pension from your employer, or other supplemental income.
Paying yourself back too late
One of the benefits of a 401(k) plan is that you can borrow from it before retirement age. Perhaps you need just a little more money for a down payment on a house or car, or you want to make some home improvements.
But withdrawing that money could be costly. First, if you don’t pay your retirement account back in time with interest, you could incur a penalty. Any money you withdraw also isn’t making you money. Instead, think about tapping into non-retirement investments and use your retirement accounts as a last resort.
Retirement funds could be a great way to plan for your post-working days, but be careful about how you handle withdrawing money from them. It could cost you cash if you don’t know some of the consequences of withdrawing money. Before withdrawing, look into ways to boost your bank account first.
If you remember the mistakes that can occur, you have a better chance of avoiding them in the future.