The uncertainty inherent in retirement planning is understandably worrisome for a lot of people. There are so many ways it could all go wrong — you might live longer than you anticipated, you could develop serious health problems, or your savings might not grow as quickly as you’d thought if the markets take a turn for the worse — and there isn’t much you can do to prevent any of these things from happening.
Some retirement planning crises arise from human error, though. It’s important that you avoid these to give yourself the best shot at a secure retirement. Here are five mistakes you can’t afford to make.
1. Not establishing a solid retirement savings plan
You’ll never achieve the retirement you want if you’re prioritizing today’s wants first and haphazardly saving for retirement when you have a little extra cash. You probably also won’t get to where you want to be if you’re just guessing at how much you need for retirement. You need an actionable plan rooted in your best estimates of your retirement length and expenditures.
Start by multiplying your annual expenses in retirement by the estimated length of your retirement, adding 3% annually for inflation. While it’s possible to do this math on your own, a retirement calculator makes it easier. It can also help you estimate how much your personal contributions might grow to over time. Use a 5% to 6% annual rate of return estimate, though your money could grow more quickly than this. Once you have your total and monthly savings goals, subtract the income you expect from Social Security, a pension, or a 401(k) match. Create a my Social Security account to estimate your benefits at different ages if you don’t know how much you’ll get from the program.
Try to adhere to this schedule as best as you can. Set up automatic contributions if you struggle to remember to save on your own, and reevaluate your plan at least once per year in case your goals or income change.
2. Not choosing your retirement accounts carefully
Where you save for retirement affects how much you can save per year and how much you owe in taxes, both this year and in retirement. The two most common types of retirement accounts are 401(k)s and IRAs. 401(k)s are popular because they offer higher contribution limits ($19,000 in 2019 for adults under 50 and $25,000 for adults 50 and older), and some employers offer a matching contribution. IRAs only have contribution limits of $6,000 in 2019, or $7,000 for adults 50 and older, but anyone can open one, which makes them a good alternative for workers who don’t have access to a 401(k) through their job. IRAs also give you more investment choices and often have lower fees than 401(k)s.
Retirement accounts can also be broken down into tax-deferred and Roth accounts. This matters because it affects when — and likely how much — you’ll pay in taxes on your savings. Tax-deferred contributions reduce your taxable income this year, but then you pay taxes on your distributions in retirement. These accounts make sense if you believe you’re in a higher tax bracket this year than you’ll be in when you retire. Roth accounts make more sense for those who think they’re in the same or a lower tax bracket now as they will be in retirement. Your contributions to these accounts don’t reduce your taxable income this year, but after you pay taxes on them this year, they grow tax-free.
Choosing any retirement account without thinking about how it will affect your taxes could result in you forking over more to the government than you needed to. Think about your income today and your projected income in retirement to decide which type of account is best for you.
3. Skipping your 401(k) match
Your 401(k) match is free money your employer gives you for retirement, and it helps reduce the savings burden on you. Unless you need every penny you earn to cover your basic living expenses, you should be taking advantage of this perk. If you don’t know how your employer match works, ask your company’s HR department. Then, contribute at least as much as you need to to get the full match.
Familiarize yourself with your company’s vesting schedule. This determines when your employer-matched funds are yours to keep. Leaving your company before you’re fully vested could cost you some or all of your employer match.
4. Taking early withdrawals from your retirement plan
There’s usually a 10% early withdrawal penalty if you take money out of your tax-deferred retirement accounts or earnings from your Roth accounts before age 59 1/2, but there are exceptions. Medical expenses that cost more than 10% of your adjusted gross income (AGI), educational expenses, and Substantially Equal Periodic Payments (SEPPs) are just a few of the ways you can withdraw money penalty-free. But just because the government doesn’t charge you a fee doesn’t mean there’s no cost.
You’ll owe income tax on the withdrawals if they come from a tax-deferred account, and you’ll also hamper the growth of your retirement savings. This could derail your existing retirement plan and force you to save even more in the years following to get back on track. You’re better off stashing money for emergencies in an emergency fund and saving for medical bills in a health savings account (HSA), if you’re eligible for one.
5. Carrying debt into retirement
Like I said at the beginning of this article, retirement is uncertain, and even the best-laid plans can go awry through no fault of your own. Carrying debt into retirement increases the threat to your financial security because if a major expense does arise, it could leave you unable to repay what you owe. This could ruin your credit, cause you to lose items you put up as collateral, and it’ll almost certainly keep you up at night.
Make a list of all of your debts, and come up with a plan to pay those off before you enter retirement. Prioritize high-interest debt, like credit card debt, first. Explore refinancing if you think it could save you money, and put any windfalls, like a year-end bonus or tax refund, toward your debt to pay it off faster.
No retirement plan is ever going to be 100% invincible, but if you avoid these five mistakes, you should be able to withstand most of the challenges that come your way.
