4 Costly Mistakes To Avoid When Planning For Your Retirement
It’s never too soon to start planning for your retirement and creating a clear savings strategy can help you to achieve your financial goals. As you build your nest egg, it’s important that you understand how today’s choices can impact tomorrow’s financial outlook. Knowing what you should do is just as important as knowing what not to do when it comes to retirement planning. Whether you’ve been saving for years or you’re just getting started, recognizing what the most common retirement planning mistakes are and how to avoid them can help you to safeguard your financial future.
Mistake #1: Underestimating Your Needs
One of the biggest mistakes you can make when planning your retirement is to underestimate how much money you’ll need to live on once you stop working. This number is different for everyone, but it typically depends on a number of factors including your current income, your current lifestyle, the current and projected future value of your home and other assets and how you plan to live after you retire. For example, your retirement needs may be lower if you plan to downsize your home or work in a part-time capacity. If your retirement plans include traveling the world for an extended period of time or indulging in expensive hobbies, you need to be realistic about what you can afford.
Another area that people often underestimate is health care. While you may be in good health now, you could experience a serious illness or other health crisis that may not be covered by Medicare or other insurance if you have it. If you have a child or other dependent that requires full-time medical care, this will also have to factor into your budget. In some cases, retirees find themselves providing financial support to their adult children or covering college costs for one or more grandchildren. When calculating how much you’ll actually need to retire, you need to consider all of the possible scenarios to ensure that your nest egg is large enough. (To learn more about what Medicare does and does not cover, see What Medicare Covers: Health Coverage For When You Retire.)
Mistake #2: Putting All Your Eggs In One Basket
Another common mistake that many individuals make is relying on one or two investment vehicles for all of their retirement savings. For example, you may be contributing to your employer’s 401(k) plan but haven’t looked into opening an IRA. An IRA or individual retirement account can be used to bolster your retirement savings and enjoy some tax benefits, depending on what type of IRA you invest in. As of May 2012, you could contribute up to $5,000 per year to either a traditional or Roth IRA, depending on your income. The IRS allows you to make a “catch-up” contribution of an additional $1,000 per year if you’re over age 50. (For more information on the differences between a traditional and Roth IRA, see Differences Between Roth And Traditional IRAs.)
In addition to not utilizing every savings option available, another mistake to avoid is not diversifying your investment portfolio. Ideally, your retirement plan should include a wide range of investments including stocks, bonds and mutual funds. The risk level for each of these vehicles generally corresponds to the expected return. How you allocate your money generally depends on how much risk you’re comfortable with. As a general rule, many financial experts advocate moving towards a more conservative investment balance as you grow closer to retirement. The key is to ensure that all of your savings is not concentrated in a single vehicle so that your investments can better adjust to market fluctuations. (To learn more about how to diversity your retirement investment portfolio, see Understanding How To Diversify Your Investment Portfolio.)
Mistake #3: Borrowing Against Retirement Savings
Unless you’re in dire financial straights and have no other option, borrowing against your retirement savings is one of the worst money mistakes you can make. While you may think borrowing your own money makes more sense than borrowing from a bank, it can actually end up being a recipe for financial disaster. (For more information on borrowing from your 401(k), see What You Need To Know About Borrowing From Your 401(k).)
There are several reasons why you should avoid taking money out of your retirement savings. First, if you take out a 401(k) loan and then lose your job, your employer may require you to repay the loan in full. If you can’t repay the loan, then it may be treated as an early distribution and you’ll end up having to pay taxes plus an early withdrawal penalty on the amount you took. Second, even though you’re paying the money back to yourself, you can’t pay back the interest and gains you would have gotten had you left the money alone which can reduce the size of your nest egg in the long run. (To learn about when you can withdraw retirement funds without facing a penalty, see When You Can Withdraw Funds From An IRA Or 401(k) Without A Penalty?)
Mistake #4: Not Taking Advantage Of Free Money
One final mistake to avoid when planning for your retirement is not taking advantage of employer plans that offer a matching contribution. With these plans, you can make regular contributions via a payroll deduction and your employer will match the amount of your contribution up to a certain amount, effectively giving you free money. The amount you may contribute and the amount the employer will match typically depends on the type of plan offered.
There are a number of different types of qualified retirement plans employers can choose to participate in including 401(k) plans, pension plans, profit sharing plans, employee stock ownership plans (ESOP), 403(b) plans and thrift savings plans (TSP). If you’re not currently investing in an employer-sponsored plan, taking the time to explore your options can help you to grow your retirement savings more quickly.
If you’ve avoided kick starting your retirement plan or you’ve started but you’re not sure you’re on the right track, ask yourself whether you may be making any of these mistakes. Identifying potential trouble areas and taking steps to correct financial missteps can help you to ensure that your retirement plan is built on a solid foundation.