There are few challenges for the American public that are tougher than saving for retirement.
We're a "spend first, ask questions later" society, with approximately 70% of our GDP dependent on consumption. Not surprisingly, the personal savings rate in the U.S. is well below that of other developed countries. The St. Louis Federal Reserve pegged the personal household savings rate in August at just 5.7%, which is half of what it was 50 years ago, and well below the recommended 10% to 15% of income that financial advisors recommend workers save for retirement.
We're also a society that really doesn't have a good grasp of basic financial principles. A recent survey by the FINRA Investors Education Foundation found that just 37% of respondents have "high financial literacy" and could answer four or more questions correctly in a five-question financial literacy quiz that covered basic financial topics. What's more, this once-every-three-year quiz has demonstrated financial literacy regression, with 39% presenting high financial literacy in 2012 and 42% in 2009.
In other words, retirement is already hard to prepare for, and making mistakes appears to come easy to the American public. Recognizing these mistakes is the first step to avoiding them.
How to sabotage your retirement in eight easy steps
What are some of the easiest ways to sabotage your retirement, you wonder? Here are eight you'll certainly want to avoid if you hope to retire comfortably and on your own terms.
1. Live without a budget
One of the easiest ways to sabotage your retirement is to live your life without a detailed monthly budget. This is something two-thirds of American households are already doing according to a 2013 Gallup poll. Without a detailed monthly budget it's nearly impossible for Americans to understand their cash flow, which makes it difficult to maximize their ability to save and/or reduce their spending.
Not maintaining a budget prior to entering retirement can be a mistake since your income is likely to drop off once you leave the workforce. This sudden drop in income can be a shock for new retirees, especially those without budgets.
2. Toss tax considerations to the wind
Casting aside tax planning is another way to derail your retirement.
The American public has a small arsenal of tax-advantaged retirement plans at its disposal, such as the Traditional IRA and 401(k), which are tax-deferred plans that allow your money to grow but require you to pay ordinary income tax once you begin taking withdrawals in retirement. There's also the Roth IRA, which is funded with after-tax dollars and allows investment gains to grow tax-free for life. Withdrawals from a Roth IRA don't affect your adjusted gross income, which could help you stay in a lower tax bracket during retirement.
3. Rely on your home for wealth creation
Another faux pas that can lead to disappointment is relying on your home to fund your retirement.
In Robert Shiller's Irrational Exuberance, Shiller examined the real value created by owning a home versus the national inflation rate. What he found was that between 1890 and 1990 homes appreciated at a rate of just 0.21% per year over the rate of inflation. Between 1950 and 1997 the outperformance was even more minuscule at 0.08% per year. In other words, history tells us that your primary residence is probably going to tread water instead of lead to real wealth creation over time relative to inflation.
4. Leave free money on the table
Who doesn't like free money? Apparently the 1 in 4 workers who fail to take full advantage of their employer's 401(k) matching contribution.
According to a May 2015 report from Financial Engines, these 1 in 4 workers who've failed to maximize their companies' matching contributions to their 401(k)s are leaving an estimated $24 billion on the table every year. This works out to $1,336 in potential "free money" for each employee, or about 2.4% of the annual income of a typical employee. For a 45-year old hoping to retire in 20 years, we're talking about a loss of nearly $43,000 for turning down this matching contribution, according to CNN Money.
5. Invest too conservatively (or not at all)
Throwing your money under the mattress or investing it in a savings account is (at least right now) another surefire way to enter retirement disappointed.
It's understandable to be a bit leery of the stock market. Since 1950, the S&P 500 has tumbled at least 10%, when rounded to the nearest whole number, on 35 occasions. But here's the intriguing thing: it's also erased all 35 of those losses within weeks, months, or in rarer cases years. The stock market has historically averaged a 7% rate of return, including dividend reinvestment, over time. By contrast, savings accounts and CDs are likely yielding 1% or lower at the moment, meaning you'd be making nominal profits, but losing purchasing power since the rate of inflation is higher.
Putting your money under the mattress accomplishes a similar effect. Doing so will shield you from nominal losses, but it ensures that as long as the inflation rate remains positive, your purchasing power in the future will be lower than what it is now with the same amount of cash.
6. Put your kids before your retirement
If you're looking to delay or seriously hurt your chances of retiring comfortably, consider funding your child's college education before your own retirement.
Though it's only natural to want your kids to get off on the right foot financially, your kids have a lifetime ahead of them where they'll be able to take on student loan debt and pay it off. As a parent approaching retirement age, your window to compound your nest egg is much smaller. You also can't borrow against your retirement. The smartest thing you can do is ensure that your own retirement remains on track and allow your child to take out a loan to cover their college education expenses.
7. Pile up too much debt
Piling up too much debt can also be a retirement-killer.
Though student debt isn't necessarily a killer, not taking into consideration the cost of the college you choose relative to its average return on investment can lead to a situation where you wind up with an excessive amount of student loan debt. At the moment around 43 million borrowers are carrying nearly $1.3 trillion in student loan debt.
Furthermore, the number of homeowners aged 65 and up with mortgage debt increased from just 22% in 2001 to 30% by 2014 based on data from the Consumer Financial Protection Bureau. Entering retirement with a mound of debt could spell doom.
8. Fail to understand your Social Security options
Finally, putting your financial future in jeopardy could be as easy as ignoring your options when filing for Social Security benefits.
Based on your personal financial situation, filing for benefits early and taking reduced benefit payments for the rest of your life may be optimal, whereas other seniors could benefit from signing up as late as age 70 and allowing their eventual monthly payments to grow at approximately 8% per month.
One of the most common mistakes is filing for benefits as soon as possible (age 62) with little or nothing in savings, thus locking in a reduced rate for life. Retirees without much saved are better off working for as long as possible and holding off on claiming Social Security benefits, thus maximizing their eventual payout. But if you don't understand the ins and outs of Social Security, it would be pretty easy to make a poor claiming decision.
Now that you have a better idea of some of the most common retirement shortcomings, you can do your best to avoid falling for these traps.