Halloween tries to spook you with ghosts and monsters, but often, the real nightmares that keep us up at night are far more mundane, like surprise bills or running out of money in retirement. These are real risks, but you can reduce the odds of them happening with careful planning now. Here are three retirement planning mistakes you definitely want to avoid.
1. Putting off saving
Retirement sneaks up on you faster than you think, and the longer you wait to start saving, the more difficult your task becomes. If your savings is only invested for a short time before you begin spending the funds, you won't have as much earnings to help you cover your expenses. That means you'll have to set aside even more of your own money every month to reach your retirement savings goal.
For example, if your goal is to save $1 million for retirement by the time you're 65, you'll only need to save about $403 per month if you start at 25 and earn a 7% average annual rate of return. You'll have contributed less than $200,000 yourself, which means that over $800,000 of your $1 million would come from investment earnings.
But if you'd waited to begin saving until you were 30, you'd now have to save $582 per month to reach your goal, assuming the same annual rate of return. Just by waiting five years to start saving, you've now cost yourself an extra $51,000 because you won't have as much investment earnings to help you.
This problem only grows more severe the longer you wait, so it's important to begin saving for retirement as soon as you can. Even if you can only set aside a few dollars each week, it's a good start. Then, increase your contributions as soon as you're able to.
2. Making early retirement account withdrawals
Money you put into a retirement account is typically locked away until you turn 59 1/2. While no one will stop you from withdrawing the money sooner, the government will slap you with a 10% early withdrawal penalty if you take the money out before this age. You could also owe taxes if the money comes out of a tax-deferred account.
There are some ways to get around the penalties. For example, if you're using the money for a large medical expense, higher education, or a first home purchase, you won't have to pay the 10% early withdrawal penalty, though you could still owe taxes on this money.
But even if you don't face penalties, you're still setting your retirement savings back by making an early withdrawal. Just as in our example above, you'll have to save more money going forward every month in order to make up for the amount you've withdrawn. This will make reaching your retirement savings goal a lot more challenging.
Seek out other ways to get the cash you need before you resort to early retirement account withdrawals. Look into loans or see if you can save the money you need by cutting spending in other areas of your life. And build up an emergency fund if you don't have one so you don't need to tap your retirement savings to help with unplanned bills.
3. Choosing the wrong time to pay taxes on your savings
The retirement account you choose determines when you pay taxes on your savings. There are two main types: tax-deferred and Roth. Tax-deferred contributions give you a tax break this year, but then you must pay taxes on your retirement account withdrawals. Roth contributions don't reduce your tax bill this year, but your withdrawals in retirement are tax-free.
While both types can help you save money on taxes, one is usually a better fit than the other. Tax-deferred accounts are usually the smarter choice for those who think they're in a higher tax bracket now than they'll be in once they retire. By deferring their tax bill until retirement, they'll lose a smaller percentage of their income to the government. But those who believe they're in the same or a lower tax bracket now than they will be in once they retire are usually better off paying taxes upfront with a Roth account.
Choosing the right type of retirement account can help you avoid paying the government more of your savings than you need to. But if you think you've chosen the wrong type of account, that doesn't mean you're stuck with the way things are.
You can always open a new retirement account that's taxed the other way and start putting some of your savings there. You might also be able to do a Roth IRA conversion to change some of your tax-deferred savings into Roth savings. However, if you do this, you'll owe taxes on the amount you're converting this year.
Avoiding the three above mistakes will go a long way toward helping you remain financially secure in retirement. If you're still making one of these errors, now's a great time to make a change. Try some of the tips above and then check back in with yourself in a year or so to see how you're progressing toward your goal.