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 23 million Americans age 60 or over are already living at or below the federal poverty level. And still, much of the working class is ignoring the warnings and the struggles of those around them.
According to the Federal Reserve, only 13% of Americans have given their financial planning for retirement “a lot” of thought. Half of Americans say they either only thought about it a little bit or they haven’t thought about it at all. Yet the Employee Benefit Research Institute (EBRI) shows that confidence about being prepared for retirement spiked in 2014 and again in 2015 after sitting at record lows between 2009 and 2013.
However, that growing level of optimism isn’t grounded in better preparation, the EBRI notes. Savings levels are low and most people aren’t even taking the basic steps necessary to prepare for retirement – many seem to believe things will just work out in the end. That approach simply doesn’t work.
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 mistakes that will hinder your ability to retire when you want, or otherwise will create financial problems for you after you do retire.
Inflation is a reality you can’t ignore. Over time, costs of living are sure to go up.
Take housing, for example. MarketWatch says rents in the third quarter of 2015 rose 5.7% compared to the previous year. 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 during their retirement years, but the only way to avoid it is by saving during your working years.
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 the Huffington Post, in January 2015 the average Social Security payment was $1,328 per month, amounting to $15,936 per year. Meanwhile, the poverty line for a one-person household was $11,770. 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. A Federal Reserve survey found that 31% of non-retired people have no retirement savings and no pension.
According to the 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 very modest earnings rate of 6% annually.
If you can’t see a way to save even a small amount, such as $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 EBRI, 28% of the people in the 2015 Retirement Confidence Survey have less than $1,000 in savings.
While some are genuinely struggling to make ends meet and save for retirement, many are under-saving because they’re overspending. 69% of the respondents in the EBRI survey admitted they could save at least $25 more per week for retirement. Meanwhile, according to a Federal Reserve survey, more than half of Americans spend all or more than they earn. This means a lot of people are at risk of facing financial troubles in retirement 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. In a press release, Steve Anderson, 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. The U.S. Department of Labor says 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. 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 live in your household, such as your children, to share expenses? Or do you expect to stay in an assisted 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, such as marriage, children, and your career. It’s okay 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 now. And don’t forget that there are resources to help you, such as 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.
Charles Schwab estimates the long-term inflation rate to be 1.8%, but returns on cash investments will also only be 1.8% compounded 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 with access to an employer-sponsored retirement plan, such as a 401k, to contribute to it. If that’s not an option, invest in an individual retirement account (IRA).
A traditional IRA, Roth IRA, and employer’s retirement plan, such as a 401k or 403b, 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 prove otherwise. According to the American Psychological Association, 40% to 50% of U.S. marriages end in divorce.
Increasingly, people are getting divorced later in life when many probably assumed they were past the likelihood of a breakup. Research in the Chicago Tribune shows divorce among people over age 50 doubled between 1990 and 2013. 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 healthcare, 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. 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, spouses who earned $2,000 per month while working may get $800 per month from Social Security, which means you can only get up to $400.
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, such as 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
6. Not Contributing Enough for Company Match
Many companies that have 401k plans offer to match a certain percentage of employees’ contributions. However, many people do not take full advantage of those offers. According to research from the investment advisory firm Financial Engines, in 2014, one in four employees did not save enough to receive their full company match. On average, those employees left $1,336 on the table that year.
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 interest, whereby you earn interest on top of interest you’ve already accrued, your losses really add up. Those people who missed out on $1,336 in employer contributions in 2014 will lose almost $43,000 over a 20-year period, assuming a modest 4.5% growth rate, according to Financial Engines.
Always contribute enough to accrue all the 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 assure you get the full company match. Companies often set the default contribution rate too low, and their workers miss out on matched money.
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 401k or funds from profit-sharing 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 since they tend to prefer changing jobs more often than older workers.
According to Fidelity Investments, half the millennials who change jobs aren’t vested and forfeit 25% of their retirement savings. On average, they leave $1,400 behind, which could turn into $4,500 to $10,200 over a 37-year period, assuming a growth rate of 3.2% to 5.5%. 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. Or, negotiate a salary or sign-on bonus that accommodates for your losses.
8. Holding Too Much Company Stock
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. According to Aon Hewitt, in 2013 employees with defined contribution plans were allocating an average of nearly 13% of their funds to their employers’ stock. However, 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.
Poor Money Management Decisions
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, providing you earn a 7% annual return each year. Plus, if you take money out of a qualified retirement account (such as an IRA or 401k) 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 401k – 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 because, in many 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 Fidelity, 11% of workers took 401k loans in 2014.
However, taking a 401k loan is not as harmless as it may seem. It derails retirement saving efforts in numerous ways.
First, if the money isn’t in your account, it isn’t growing. The Wall Street Journal says 401k loans were especially costly in 2013, a year when the stock market was offering double-digit returns. And 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. Fidelity found that about 25% of people who borrowed from their 401k reduced their contributions within a year, and 9% stopped saving altogether.
By taking a 401k loan, you also subject yourself to a double-whammy with taxes. Originally, your 401k 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 Fidelity’s research, half of 401k borrowers become serial borrowers and impose setbacks on themselves multiple times.
11. Making Rollover Mistakes
“Rollover” is a term used to refer to moving retirement funds from one plan to another. For example, you might leave a job and want to transfer your 401k funds to your new employer’s 401k plan or move the money to an IRA. However, there are rules when you move money that’s held in IRAs and 401ks, and one that’s important to know is the 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 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 401k 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 monies are withheld by your employer for potential taxes and penalties – the entire amount is transferred into your new retirement account.
Another mistake people make is that they hop jobs and leave a few thousand dollars in a 401k 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 IRA funds and whittle away the balance. Don’t leave it to other people to decide what happens to your money.
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 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, such as 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
In the EBRI‘s 2015 Retirement Confidence Survey, about half of workers and one-third of retirees considered their level of debt to be a problem. People were most concerned about mortgages, credit card debt, and car loans. If you have these types of debts, you may not be ready to retire.
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 has to be replaced. 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. Otherwise, it’s working against you.
Retirement planning isn’t important just 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 healthcare and offer financial support to loved ones. The older you get, the harder it is to come up with quick-fix solutions.
Do you have any tips to help avoid retirement planning mistakes?