When it comes to retirement planning, everyone focuses mostly on building up the largest retirement savings nest egg they can. But there’s more to preparing for retirement than just building up a large retirement portfolio. Just as important is avoiding common mistakes that can sabotage the best intended retirement savings plan.
Here are just a few of those mistakes.
Tapping your retirement plan in an emergency
For many people, the retirement plan is their only form of savings. Because of this, it serves as a kind of “everything account”. Not only does it exist as a primary retirement account, but it also serves as an emergency fund and as a source of money for large expenditures.
People will partially liquidate their retirement savings in order to put a new roof on the house, to make a down payment a new car or to satisfy the deductible portion of a medical claim. In order to have a successful retirement plan, you will need to establish an emergency fund specifically for this purpose.
Liquidating a retirement account to pay for emergencies nullifies the entire purpose of the plan. In addition, liquidations of retirement accounts are an expensive proposition. Not only do you have to add the amount of the distribution to your taxable income, but you’ll also be subject to a 10% early withdrawal penalty.
Concentrating only on your retirement plan
There’s an almost a religious faith in the power of long-term savings for a retirement plan. In reality, retirement is about more than just a retirement plan. While you are saving for retirement, other financial events are taking place all around you.
In addition to funding your retirement account, it’s equally important to pay down and eventually payoff your debts, and to avoid taking on new debt in the future. Debt raises your cost of living, and if you have them throughout your working life, there is a very good chance that you’ll carry them into your retirement years. That will only increase the amount of money that you’ll need to draw out of your retirement plans.
While you’re funding your retirement plan be sure to be focusing on your debts too. Paying them off is a form of long-term investment that will help you in retirement.
Not building assets outside your retirement plan
Earlier, we discussed how for many people a retirement plan is their only real asset. This can be a problem even in connection with retirement planning itself.
While a retirement plan is the foundation for a sound retirement, you will still have a need for other forms of savings. We already discussed the importance of having an emergency fund to deal with short-term cash needs. But there can be other funding needs that are more medium-term in nature.
One can be providing a college education for your children, but another could be having non-retirement funds available in the event of a job loss or an early retirement. If the job loss forces you to retire at age 60, you may want to have non-retirement assets saved up to help cover your living expenses so that you don’t begin drawing down your retirement savings too early.
Borrowing against your retirement plan
There are two problems with borrowing against your retirement plan. The first, is that borrowing against a retirement plan is a backdoor way of liquidating it. It means that your retirement plan is fair game to cover short-term financial needs. You may not be doing a formal liquidation, but you are degrading the account and its primary purpose.
The second problem is job security. Many employers will allow you to borrow against your 401(k) plan, however that arrangement is contingent upon your maintaining your employment with the company. If for any reason your employment ends you will be required to pay back the 401(k) loan within a specified time frame. If you’re unable to do this, the amount of the loan will be considered a distribution from the plan, and subject to both income tax and early withdrawal penalty.
It’s not a risk worth taking.
Not contributing because you think it‘s too late
Sometimes people don’t save money for retirement when they’re in their 20s and 30s. They may reach their 40s and decide that it’s too late and they don’t even make an effort. But this is a major mistake.
Even though it will be unlikely that you will accumulate a couple of million dollars in retirement assets if you don’t start saving until you’re 40 or older, you can still save up a few hundred thousand dollars. For example, if you begin putting $5,000 into an individual retirement account (IRA) each year beginning at age 45, you will have $310,000 when you hit 65, assuming a return on investment that averages 8% per year over that time period.
That may not get you a comfortable retirement but it will give you a nice cushion that will supplement other income sources. It’s never too late to begin saving for retirement.