When you're in your 20s or 30s, retirement isn't exactly a priority. You've probably got a lot of other things going on in your life: starting your career, starting a family, paying off your student loans, buying a house, and lots of other financial concerns. Unfortunately, not prioritizing retirement during the early part of your career can cause massive problems once you do reach retirement age.
1. Not saving for retirement
The combination of relatively low income during your first few jobs and lots of new expenses -- housing, student loan payments, car payments, and so on -- may make saving for retirement a challenge during the first decade or so of your career. But if you can save even a little bit every month, this money will have decades to grow.
Thanks to compounding, saving early has much better returns than saving late. For example, if you save just $50 per month, you'll have $600 after one year. Assuming you put that $600 into stocks that return an average of 7% per year, after 30 years your $600 will have become $4,567. That's some pretty impressive growth! And if you keep putting $600 in every year, after 30 years you'll have $65,211. So over 30 years you'll have put $18,000 in your account and will get back $65,211.
On the other hand, if you wait until, say, your mid-forties to start saving, saving $600 per year will only get you $28,641 after 20 years. Putting in $12,000 to get $28,641 is still pretty nice, but it's nowhere near as good as the returns you get over a longer time window. And if your employer offers matching contributions, you can double your money at no extra cost to yourself.
2. Dipping into retirement savings
Once you manage to get money into those retirement savings accounts, consider it sacrosanct. After all the effort you put into saving that money, if you take it out before retirement, you'll have basically wasted your time. Worse, not only will you have to pay taxes on that money when you take it out, you'll also owe the IRS a 10% penalty for tapping your retirement money before you turn 59 1/2. So if you take $2,000 out of your retirement savings early, you'll owe regular income taxes on that $2,000 plus an extra $200. Bottom line: don't touch the money, no matter what.
3. Not having other savings
Of course, if you're suffering a major life crisis, you may feel that you have no other option but taking funds from your retirement savings. That's why having a dedicated emergency savings account is an important part of retirement planning. If you've got a few thousand dollars tucked away outside your retirement savings accounts, then when trouble arises you can turn to that money instead.
If you've got a fairly stable source of income and no dependents, having the equivalent of three month's worth of expenses in your emergency savings account is probably plenty. If your situation is a little more complicated, consider saving six month's worth or even a year's worth of expenses. Yes, it's painful to carve yet more savings out of your budget, but if it gets you the retirement of your dreams, isn't it worth it?
4. Running up lots of debt
If you don't have an emergency savings account and don't want to tap into your retirement savings to pay for an emergency, that probably leaves you only one option: credit cards. Unfortunately, running up a big credit card bill will have a seriously negative impact on your finances.
Early on in your career, you're probably already juggling student loans, car payments, and maybe a mortgage as well. Adding more debt to this mix will strain your budget even further. And even if you don't run into any catastrophes, credit cards can be very seductive -- it's awfully tempting to buy that new TV now, instead of waiting six months until you've saved up enough to pay cash for it. Debt is a retirement killer because the payments make it even harder to save regularly every month, while the interest erodes any returns you are making on your investments.
5. Abandoning your 401(k)
It's unlikely you'll work for the same company throughout your entire career; switching jobs is particularly common in the first decade or two of working life. When you move from one employer to another, the question arises as to what you should do with your 401(k) -- particularly if your new employer doesn't offer a workplace retirement account.
When switching jobs, the absolute worst thing you can do is to cash out your 401(k). You'll get hit with the same taxes and 10% penalty that you get for tapping into your account in an emergency.
The next worst thing you can do is just leave your 401(k) sitting there and forget about it. In that case, the money you've already put in the account will at least keep growing, but you'll no longer be adding to it. And whatever investments you chose for that 401(k) probably won't match up with the asset allocation you've chosen for any new retirement accounts you open. That's why it's important to roll any old 401(k)s over, either to a new 401(k) or (if that's not an option) to an IRA. That way you can keep an eye on those investments, make any necessary changes if they are not performing as well as they should be, and work those investments into your overall portfolio strategy.
6. Thinking it's impossible
With all the other financial responsibilities you're juggling, saving for retirement on top of that might seem downright impossible. It's not. The trick is to start small: set up an automatic transfer of $1 per day (or one $30 transfer per month, if your bank has monthly transfer limits) from your bank checking account to a savings account or retirement account.
Or if you have a 401(k) at work, set your contribution at 1% to begin with. After a few months, you'll have stopped even noticing the missing money and you can raise the amount a bit -- say, 2% instead of 1%. Before you know it, you'll have a respectable amount tucked away in savings and your retirement dreams will be safe.