Financial professionals have been sounding the alarm for a long time, warning that a retirement crisis is coming. The National Council on Aging says more than 25 million Americans age 60 or over are economically insecure. And still, much of the working class is ignoring the warnings and the struggles of those around them.
According to GOBankingRates, 64% of Americans will retire broke. Moreover, 45% of Americans say they have no money aside for retirement while about 19% of consumers expect to retire with less than $10,000 to their names.
If you don’t want to join the millions of senior Americans teetering on the poverty line, you need a sound retirement plan that steers you off the path of common planning pitfalls. Otherwise, you risk making common mistakes that will hinder your ability to retire when you want, or otherwise will create financial problems for you after you do retire.
Common Retirement Savings Mistakes
Inflation is a reality you can’t ignore. Over time, costs of living are sure to go up.
Take real estate for example. The Motley Fool says the cost of rent will increase between 3% and 5% on an annual basis. It’s hard enough to handle price spikes when you’re working, but when you’re not, it can be much harder, if not impossible. No one wants to struggle to pay the rent or other basic living expenses during their retirement years, but the only way to avoid it is by saving during your working years.
These are the most common mistakes people make with regard to their retirement savings.
1. No Retirement Savings
Not saving for your golden years is the most grave retirement mistake anyone can make. Retiring with little or no savings raises your risk of struggling and living in poverty.
Many people who retire without savings have only Social Security to rely on. However, Social Security was designed to be a financial supplement, not a primary lifeline.
According to AARP, the average Social Security income came in at $1,543 per month, which works out to just $18,516 per year. Meanwhile, the poverty line for a one-person household sits at about $12,880. Retirees who have no income other than Social Security are extremely vulnerable — and a lot of people appear to be headed toward this risky lifestyle.
According to Northwestern Mutual’s Planning & Progress Study 2019, 22% of non-retired people have less than $5,000 in retirement savings and around 15% of Americans have no retirement savings at all.
According to the Employee Benefit Research Institute (EBRI), the main reason people don’t save is because of day-to-day expenses and the cost of living. When you’re barely scraping by today, it’s definitely hard to focus on building financial security for tomorrow.
But it takes most people decades to save enough to support their retirement — which means you simply cannot afford to put it off. Therefore, if you can’t save a lot, save something. Putting aside $20, $50, or $100 at a time is much better than not saving anything.
With more time, due to compound interest, those small sums of money can grow substantially. For example, if you only save $25 per month but do so for 40 years, your savings will grow to nearly $50,000 — and that’s at a modest earnings rate of 6% annually.
If you can’t see a way to save even a small amount, like $25 per month, it’s time to make changes. Either take steps to boost your income — such as asking for a raise, changing jobs, or getting a part-time gig – or find ways to lower your expenses, such as moving to a cheaper apartment and reducing your entertainment spending.
2. Not Saving Enough
Many folks have some savings but hardly enough to say they’re on the path to success. According to the 2020 EBRI Consumer Retirement Confidence Survey, 40% of people who have calculated how much money they will need to retire say they will need $1 million or more.
While some people are genuinely struggling to make ends meet and save for retirement, many more are undersaving because they’re overspending. According to USA Today, the average American spends nearly $18,000 on things they don’t need.
Considering the extent of unnecessary spending, it’s fair to say that quite a few people are at risk of facing financial troubles once they reach full retirement age because they’re prioritizing today’s wants over tomorrow’s needs.
3. Saving Without a Plan
Some people make noble efforts to save for retirement. They pinch pennies, set aside money regularly, and have accumulated a sizable stash as a result. However, they’re still at risk of a shortfall during retirement.
Steve Anderson, financial advisor and head of Schwab Retirement Plan Services, warns that in many cases there’s a significant difference between how much people need for a comfortable retirement and what they’re actually saving.
The problem is that a lot of folks have no idea how much they’ll actually need. According to EBRI, less than half of Americans have calculated what their retirement will cost. To reduce the risk of financial hardship during your retirement, developing a comprehensive vision of your retired life is essential:
- Average Family Lifespan. Considering the longevity of your relatives helps you gauge the potential length of your retirement.
- Preferred Retirement Age. Your target retirement age also helps determine the length of your retirement, how aggressive your financial plans should be, and by what point you need to develop a retirement nest egg.
- Location. Your city, county, or town greatly affects your costs of living. Beyond expenses such as medical care and housing, consider the effect state and local sales tax have on your expenses.
- Living Arrangements. Will you still have a mortgage? Will others, such as your children, live in your household to share expenses? Or do you expect to live in an independent senior living community? You need an idea of your living arrangements to work out your living costs.
- Hobbies and Lifestyle. How do you plan to spend your days? Do you want to travel? Will you and your spouse have vehicles? If so, how many times do you expect to buy new cars during retirement? Do you plan to work during retirement? Consider realistically how long you’ll be capable of working if you don’t plan to completely retire from the workforce.
- Insurance and Health Coverage. Do you expect to have adequate health coverage? Will you buy long-term care insurance? Will you need to save enough money to afford to pay for certain types of care, such as long-term care, out-of-pocket?
The younger you are, the fewer solid details you have about your retirement because those years are shaped by circumstances that unfold over the course of your life. It’s OK to start with some vague assumptions and plug in more specific details as you get established and move closer to retirement.
If you’re young, even though retirement seems a long way off, the most important thing is to start saving and investing now. And don’t forget that there are resources to help you, including the Social Security Administration’s Retirement Planner.
4. Stashing Money in a Savings Account
Making a commitment to save is the first step. Next, you must determine how to do it.
Having your money grow during your working years is a priority — and a regular savings account isn’t an ideal place for adequate growth. In years when interest rates are low, the growth you can expect to see from savings account interest payments may not keep up with inflation, much less outpace it. And if your money isn’t keeping up with inflation, it’s losing value.
Trading Economics estimates the inflation rate to be 1.6% through 2022, but returns on cash investments in savings accounts only earn a fraction of a percent in interest annually. What’s worse is that earnings in a regular savings account are taxable.
You need to invest your money in a financial vehicle that gives you exposure to assets, such as stocks, which historically have outperformed savings accounts over the long-term. The U.S. Department of Labor advises anyone without access to an employer-sponsored retirement plan, such as a 401(k), to request that their employer start one. If that’s not an option, invest in an individual retirement account (IRA).
Investments in traditional IRAs, Roth IRAs, and employer’s retirement plans like 401(k)s or 403(b)s aren’t taxable. Plus, you can deduct contributions to traditional IRAs and non-Roth employer-sponsored retirement plans on your taxes, and withdraw funds tax-free during retirement with a Roth IRA.
5. Relying on a Spouse
Expecting to rely on resources from your spouse is not a retirement plan — it’s a gamble. And it could leave you in financial straits.
Relying on someone else means you’re making two risky assumptions. First, you’re assuming you won’t get divorced. Everyone likes to think they’ll be married forever, but statistics suggest otherwise. According to Time Magazine, 39% of U.S. marriages end in divorce.
Increasingly, people are getting divorced later in life when many probably assumed they were past the risk of a breakup. Women’s Divorce suggests divorce among people over age 50 doubled between 1990 and 2015. Divorcing later in life and being single during retirement raises your risk of being poor.
The second risky assumption you make by leaving your retirement to someone else is that your spouse can and will adequately prepare to care for two aging people. What if your spouse makes risky investments and suffers major losses? Or what if your spouse doesn’t save enough?
People commonly underestimate how much money they need for themselves, especially when it comes to health care costs, so they are even more likely to miscalculate when trying to plan for a couple.
Don’t think spousal Social Security benefits are the answer either. They don’t produce enough money to take care of you. According to the Social Security Administration, workers’ Social Security benefits are generally about 40% of their pre-retirement income, and a spouse can get up to half of a worker’s entitlement.
Roughly speaking, people who earned $2,000 per month while working may get $800 per month from Social Security, which means their surviving spouse can only get up to $400 per month.
Having your own retirement savings protects your interests and helps you better assess how prepared you are. If you don’t work or don’t earn much, there are options, like getting a taxable investment account or a spousal IRA, which allows an employee to contribute to a retirement account on behalf of the nonworking spouse.
Money Mistakes at Work
Working-age people are in the earning phase of their lives, but many make common mistakes with their retirement contributions that come back to cost them later.
6. Not Contributing Enough for Company Match
Many companies that have 401(k) plans offer to match a certain percentage of employees’ contributions. However, many people do not take full advantage of those offers. According to CNBC, only 72% of employees who have access to these types of plans took advantage of them, meaning that 28% did not.
Failing to take full advantage of your employer’s match may not seem like much of a loss in a given year, but when you consider the effects of compound gains — whereby you earn interest on top of interest you’ve already accrued — your losses really add up.
If you were to miss out on $1,336 in matching employer contributions, you would lose almost $43,000 over a 20-year period, assuming a modest 4.5% growth rate.
Always contribute enough to receive all the matching funds your employer is willing to pitch in, and don’t assume because you’re in an automatic enrollment plan that your contribution rate is set at the appropriate level to ensure you get the full company match. Companies often set the default contribution rate too low, and their workers miss out on matched money.
Pro tip: Periodically, make sure your employer-sponsored 401(k) has you on the right track financially. You can sign up for a free 401(k) from Blooom, and they’ll check your asset allocation to make sure you’re properly diversified. Plus, they’ll check to see if you’re paying too much in investment fees.
7. Leaving a Job Before Vesting
Many employers require you to stay on the job for a certain amount of time before you qualify for your pension benefits or before the company’s contributions to your 401(k) or profit-sharing funds actually become yours. Leave early, before you’re vested, and you lose the money.
That may sound like a strong incentive to stick around, but a lot of people jump ship anyway. It’s a mistake that’s most common among millennials because they tend to prefer changing jobs more often than older workers.
According to CNBC, 39% of millennials who change jobs aren’t vested and forfeit an average of 23% of their retirement savings. Switch jobs before you’re vested several times during your career and you could lose tens of thousands of dollars when you consider the growth potential of those funds.
If you consider leaving a job before you’re vested, determine whether your new salary and your likely tenure on that job are worth any losses to your retirement account. You might be encouraged to stick around until you reach an anniversary or milestone. Otherwise, negotiate a salary or sign-on bonus that makes up for your losses.
8. Holding Too Much Company Stock
Diversification is key in any investment portfolio, so holding too much of any single stock is a bad idea, and the fact that it’s your employer’s stock doesn’t change that. Many financial professionals advise limiting the amount of employer stock to less than 10% of your portfolio.
“Keeping 10% to 15% of your wealth in your employer’s stock is where the danger zone begins,” Jim Cody, director of estates and trusts with wealth-planning firm CTC Consulting told Forbes. Your company’s stock price may be stable for a long time, or even soaring at some point, but you have to be positioned for a downturn. There’s the possibility that the company may go bankrupt — or worse, fail.
Don’t think just because you work for a large, established company it won’t happen — look at Kodak, Washington Mutual, and Lehman Brothers. If you’re enrolled in an employee stock purchase program, pay attention to your automatic purchases to make sure you don’t go above the 10% benchmark, or 5% benchmark for more risk-averse investors.
Poor Money Management Decisions
Building a nest egg is a great step toward securing your financial future, but there are still pitfalls to avoid. These are the most common mistakes people make when managing the money they’ve set aside for retirement.
9. Cashing Out and Starting Over
Cashing out a retirement account isn’t a decision to take lightly. You lose important growth opportunities, and the younger you are, the steeper those opportunity costs. According to Fidelity, one pre-tax IRA contribution of $5,500 could grow to more than $58,000 in 35 years, provided you earn a 7% annual return each year — which shouldn’t be difficult with the average return rate in the stock market being closer to 10%.
Plus, if you take money out of a qualified retirement account like an IRA or 401(k) before the age of 59 1/2, the IRS considers it an early withdrawal and imposes a 10% penalty in addition to the income tax you owe on the withdrawal.
Say you cash out a 401(k) — your employer will likely withhold 20% off the top to account for penalties and taxes. According to Fidelity, people in the top income bracket may be charged nearly 50% in taxes and penalties on early withdrawals.
Resist the temptation to use your retirement funds to tide you over between jobs or to solve financial difficulties. In the vast majority of cases, the benefits of an early withdrawal don’t outweigh the costs and losses.
10. Taking Loans Against Your Retirement Fund
What about borrowing from your retirement fund? In that case, you lend yourself money and pay yourself back. Many people do it — in fact, according to the Investment Company Institute, 15.6% of plan providers had outstanding loans in 2019.
However, taking a 401(k) loan is not as harmless as it may seem. It derails retirement savings efforts in numerous ways.
First, if the money isn’t in your account, it isn’t growing. These losses become larger in years when the stock market is doing particularly well. On top of missing out on the profits, people who are repaying themselves tend to get off track with their contributions, which boosts their opportunity costs even higher.
According to the Society for Human Resource Management (SHRM), about 57% of people who borrowed from their 401(k) reduced their contributions during the loan payoff period.
By taking a 401(k) loan, you also subject yourself to a double-whammy with taxes. Originally, your 401(k) contributions went into the plan without being taxed. Take a loan and you have to repay the money plus interest using taxed dollars.
However, all too often the scenario gets worse. According to Stash Wealth, half of 401(k) borrowers become serial borrowers and impose setbacks on themselves multiple times.
11. Making Rollover Mistakes
“Rollover” refers to moving retirement funds from one plan to another. For example, you might leave a job and want to transfer your 401(k) funds to your new employer’s 401(k) plan or move the money to an IRA.
However, there are rules when you move money that’s held in IRAs and 401(k)s, including the important 60-day rule, which gives you 60 days to get your funds into another qualified retirement account. When making the switch, some people take possession of their funds as a way to get a short-term loan.
However, if you don’t get the money back into a qualified account within the 60-day window, you’re subject to taxes and penalties like any other early withdrawal if you’re not at least age 59 1/2.
Don’t forget to factor in the 20% withholding that your employer takes from the account to cover potential taxes and penalties if you take possession of the funds. You need to return that amount of money out of your own pocket to bring your account up to its previous level.
For example, say you’re rolling your 401(k) into an IRA by taking possession of the funds directly. If you have $10,000 in your account, your employer withholds $2,000, and you get $8,000. You need to come up with that additional $2,000 to start your IRA, or you’ll only have $8,000 in the account — the $2,000 your employer withheld will be treated as an early withdrawal. If you open a new account with $10,000, the money your employer withheld is returned after you file your income taxes.
To avoid the risks, it’s best to request a direct rollover or trustee-to-trustee transfer, which involves transferring the funds directly from one plan or account to another. That way, you don’t have to worry about being tempted to spend the money or holding it longer than intended.
And better yet, no money is withheld by your employer for potential taxes and penalties — the entire amount is transferred into your new retirement account and set to start working for you immediately.
Another common mistake people make is that they leave a few thousand dollars in a 401(k) after hopping jobs without specifying what they want to do with the funds. When this happens the plan often conducts a forced transfer and moves the money into an IRA. The law allows a plan to open an IRA on your behalf if your account contains less than $5,000.
The move is intended to protect the money, but the U.S. Government Accountability Office found that fees charged on the investments generally outpace returns on the forced transfer of IRA funds and whittle away the balance. Don’t leave it to other people to decide what happens to your money. They might not always act in your best interest — you will.
12. Not Naming Beneficiaries
A lot of people save for retirement but fail to protect their assets (and their heirs) because they don’t name beneficiaries. Without any stated beneficiaries, your retirement funds go to your estate when you die, where they are subject to probate — a legal process that’s often lengthy, expensive, and complex. Having retirement money pass to your estate can also make the funds fair game for creditors.
Spare your loved ones the drama by specifying your beneficiaries by name. Don’t use vague terms like “my kids” or “my sister.” And don’t forget to update your beneficiaries. Otherwise, your hard-earned money can go to someone you don’t want to have it, like an ex-spouse.
If you don’t update your beneficiary information, even your will is powerless over your retirement account. According to an article by Ric Edelman of Edelman Financial Services, beneficiary designations override wills for retirement accounts, IRAs, annuities, and life insurance policies.
13. Retiring With Too Much Debt
According to Dave Ramsey, about 80% of Americans are struggling with debt.
Retiring with a stack of bills is riskier than it can seem. You may think you can manage to pay your bills, but you’re probably considering your capability under ideal circumstances, or when you have an income.
What will you do when you face those unforeseen events that strike us all from time to time? The car engine blows up. The roof needs to be repaired. Or you need a pricey medical device that isn’t covered by insurance.
What if those unforeseen events come at a time when you’re trying to tackle a spike in living costs, such as a hike in property taxes, an increase in heating costs, or rising gas prices? If you’re a prudent planner, you can realize that having many monthly obligations you could otherwise avoid during retirement makes you financially vulnerable and is an invitation for trouble.
It’s easy to neglect things that don’t seem to be an immediate concern, but you don’t want to do that when it comes to retirement. Time is only on your side if you’re making savvy financial decisions today. Otherwise, it’s working against you.
Retirement planning isn’t only important to ensure you have a bit more money in the pot — it’s important because your finances impact nearly every aspect of your golden years, from your comfort and happiness to your ability to access quality health care and to offer financial support to loved ones.
The older you get, the harder it is to come up with quick-fix solutions. Start planning your retirement strategy today — the best time to begin is now.