More than 40% of pre-retirees say running out of money during retirement is their greatest fear, and six in 10 older Americans are actually more afraid of spending their retirement stash than they are of dying. To avoid running out of cash, it's important to save as much as possible for retirement. It's also important to avoid mistakes that could undermine your efforts at financial security -- like these three big blunders that could ruin your retirement.
1. Borrowing against your 401(k)
If you have high-interest debt or a financial emergency, your 401(k) balance may look like a nice source of funds to tap into. Unfortunately, taking a 401(k) loan is a risky gamble, because the entire unpaid loan balance becomes taxable if you can't pay back the loan on time.
The price for failing to repay a 401(k) on time can be devastatingly high: You'll owe state taxes, federal taxes, and a 10% withdrawal penalty on the outstanding balance. If you still owe $10,000 at the end of the repayment period, and you have to pay a 25% federal tax, an 8% state tax, and a 10% penalty, you'll pay a total of $4,300 in taxes.
You may plan to pay back your loan and avoid the tax consequences, but if you leave your job for any reason, then you'll suddenly have a narrow time frame -- usually around 60 days -- to repay the entire 401(k) loan. If you unexpectedly find yourself in the unemployment line, then you don't want to be forced to pay back a huge sum of money in order to avoid a big tax penalty.
Even if everything goes right and you pay back your loan on time, you'll still miss out on the investment gains you'd have made by leaving your money invested -- which could be substantial if the market is doing well. And when you repay the money you borrowed from your 401(k), you repay it with after-tax dollars as opposed to pre-tax contributions -- but you're still taxed on withdrawals as a senior. In other words, you'll be double-taxed on the amount paid back.
In a worst-case scenario where you never repay the cash at all, between the tax penalties and the forgone capital gains, your $10,000 loan could cost you over $40,000 over the course of 20 years (assuming your portfolio earned 7% per year). It's easy to see why a mistake like borrowing from your 401(k) could be a recipe for disaster.
2. Cosigning for your kids' student loans
As a parent, you want what's best for your kids. Unfortunately, if you help your children out by cosigning for student loans, you could put yourself at serious financial risk.
The problem is that if your kids can't pay back student loans, the responsibility will fall on your shoulders. And this possibility isn't all that remote: 11.5% of borrowers who began repayment Oct 1, 2013 were in default three years later, according to the U.S. Department of Education.
Even if you think your kids are too responsible to default, if they suffer a job loss or pass away, you could become responsible for repayment depending upon the type of loan.
If you can't afford payments, the government could make you pay anyway. The government collected $171 million on defaulted student loan debt by reducing Social Security payments in 2015. When the government garnishes Social Security to collect student loan debt, it has serious financial consequences. In the past decade, the number of seniors whose Social Security payments were reduced below the poverty level by garnishments due to unpaid student loan interest rose from 8,300 to 67,300.
Having your Social Security benefits garnished, or being forced withdraw a huge sum of money from your retirement accounts to pay off an unpaid student loan, is a surefire recipe for financial hardship for a senior.
3. Retiring too early
Because of historically low bond rates and Americans' longer life spans, many longstanding ideas about retirement -- like the assumption that you can withdraw 4% or more from your retirement accounts each year without running out of money -- no longer apply. In fact, in 2013 researchers from The American College and Morningstar found that a senior following the 4% rule stood a 57% chance of running out of cash when returns were calculated based on current rates.
Retiree spending falls into predictable patterns. Retirees spend more during early retirement, when they're healthy enough to travel and indulge their hobbies. They spend less during the middle of retirement as their health declines and energy wane, and in the late stage of retirement they spend more as costly health issues arise. This means that if you exhaust your savings, you're likely to be short on cash at a time when you're too old to work.
To avoid this predicament, it's imperative you accurately calculate how much you'll need for retirement and how much you can safely withdraw without putting your future at risk. If your projected withdrawals don't provide enough money to cover your expected costs, think about working longer or lowering your costs of living.
Avoiding money mistakes during retirement
By investing in tax-advantaged retirement accounts, wisely managing your investments, and avoiding these big mistakes, you should be able to get through your retirement without running short of cash. Just make a plan, stick to it, and avoiding the hazards that could derail that plan, and you won't have anything to fear.