Sometimes life and your judgment get in the way of your retirement savings. You’re in a dilemma, need some cash, and next thing you know you’re committing one of the 7 most common retirement savings blunders. It’s difficult to see how the choices you make will affect you 30, 20, or even 10 years down the road. In the heat of the moment, you will convince yourself that many of these are justified. However, your retirement self will thank you for not succumbing to the temptation.
1. Delay saving for retirement
You’re young, having fun, just out of college, a new job, want a new car and a place to live other than with your parents. Retirement is years away; there are more important things that you need. Putting off contributing to the 401(k) for a year or two isn’t going to hurt. Oh yes, it will young Jedi! The earlier you start your retirement savings, the more you save, and the easier and better off retirement will be.
I encourage my clients to get their teenage children to begin saving for retirement when they get part-time jobs. As long as you have earned income that is reportable on a tax return, you can contribute to an IRA.
Johnny bagged groceries a few hours a week after school and during the summer. He made $4,000. He can contribute up to $4,000 to an IRA. Encourage him to save $25 or $50 a month in an IRA. Get him involved.
Use this as a teaching moment about saving, investing, retirement, and budgeting. Retirement savings can be started early!
Don’t leave money on the table
2. Not saving enough
Guess what? Saving 2% of your income isn’t going to cut it. How much should you save? Check out my previous post on how to improve your cash flow in retirement to figure that out. I always recommend at least 10% of your income as a good starting point. The number one rule of saving for retirement is you must always, absolutely, positively, contribute enough to get the full matching if your company provides for it in your employer’s retirement plan. That’s free money!
The number one killer of retirement savings
3. The early distribution
Taking money out of your retirement plan, when not for one of the allowed exceptions, is a retirement killer. The withdrawal gets taxed as income plus a 10% early withdrawal penalty. That defeats the purpose that you put it in there for in the first place. I’ve seen people take money out for all kinds of reasons, some good, some not so good. People know it’s not the best idea but still do it. I don’t need to beat a dead horse.
There is a worrying trend I’ve seen with the management of “old 401(k)s,” meaning those from former employers. Instead of rolling them over, they are being cashed out. The days of working for the same company for 30+ years are practically over. You may have a gaggle of retirement plans from former employers. You have options for how to handle your 401(k) when you leave a company:
- Let it sit (depending on the company and the amount of the account)
- Roll it into your new employer’s 401(k)
- Roll it into an IRA
- Cash it out
Option #4 is not recommended for your retirement. .
You’re 40 years old and cash out a previous employer 401(k) of $30K, what do you lose? Assuming a 5% return and you retire at age 60 that $30K would have been $79,598. On top of that, the distribution will be taxed as income the year in which you withdrawal it AND there will be an additional 10% penalty.
An early distribution is an early distribution whether it’s from your current retirement plan or an older one. I’m beating the dead horse again.
Don’t put all your eggs in one basket
4. Own too much company stock
Your employer provides pay and benefits. You have a lot riding on its success. If it doesn’t do well, it may go away. Your current financial success has a lot riding on your employer. Why make your future retirement success rely on your employer as well? For every Google, there’s a Sears, Xerox, or Radio Shack.
I’m not saying don’t invest some of your retirement savings contribution in the company stock. The amount depends on the company’s outlook over the next few years, whether or not you also get stock options, and your appetite for risk. I would say no more than 10%-20% for your average company. If you don’t work for the average company, and if you have to ask you probably don’t, then there is a possibility that the percentage could be a bit higher.
“I’m paying myself back.”
5. 401(k) loans
This mistake is one that may, very rarely, be okay to make. If you are in terrible financial straits, and the only options are to either take a loan or distribution from your 401(k), then the loan would be the choice. The last resort.
There is another risk with taking loans from your 401(k). If you lose your job, you must pay back the remaining loan amount within 60 days. If you cannot, then the outstanding balance will be taxed (if you’re under 59 ½) and you’ll get smacked with the 10% penalty.
You are not paying yourself back; you’re taking (not borrowing) from your future self.
Make your money work at your comfort level
6. Conservative Investing
Every 401(k) has a “guaranteed fund” of some sort. Over the past few years “guaranteed” has meant a return slightly above 0%. The guaranteed fund is guaranteed not to get you to retirement. You work hard to save that money, for goodness sake let the money work for you. Spread it out a bit among some stock and bond funds. You don’t need to go crazy, which leads me to…
7. Aggressive Investing
What if instead of putting all of our savings in the guaranteed fund you did the opposite and put it all in an S&P 500 fund?
In 2008, the S&P 500 lost 38.49%. If you had 100% of your 401(k) in an S&P 500 fund and it was worth $1 million on January 1, 2008, by December it would have been around $615,000.
It took four years to recover. Do you have the time to wait for a recovery? If you’re 25 or 30, 45, even 50, you may. On the other hand, if your investments lose 40% in your 60s, or while you’re taking distributions, you may never recover.
The most important take-away is to get a financial plan in place. The unexpected will happen, just accept that fact. Even though these 7 mistakes are the easiest to make, they are also the ones you can avoid…with a plan. Otherwise, you may end up with a delayed or difficult retirement.
Give us a call if you are thinking about any of these mistakes or share it if you know someone who may.