Ask most people when they hope to retire, and they'll probably have an answer for you. Ask them how they plan to make that happen, and you'll probably hear crickets. Knowing when you want to retire is a good start, but unless you understand what you need to do -- and not do -- to reach your goal, you probably won't meet it.
Poor habits are all too common when it comes to retirement saving, but often, their effects aren't fully realized until it's too late. Here are three of these bad habits you must avoid if you ever hope to retire on schedule.
1. Not creating a retirement plan
You'll never know how much you need to save for retirement or how well you're doing in relation to your goal without a clearly defined plan. To create one, start by estimating the length of your retirement by subtracting your ideal retirement age from your average life expectancy. Those in good health could easily live past 90, so to be safe, plan for a long life.
Next, calculate your estimated annual retirement expenses and multiply them by the number of years of your retirement, adding 3% annually for inflation. A retirement calculator can do this math for you if you don't want to do it by hand. It'll also calculate how much your investments could grow over time. Use a 5% or 6% annual rate of return to be conservative. Then, it should tell you how much you need to save in total and per month to reach your goal. Subtract from this any money you expect from Social Security, a pension, or a 401(k) match to figure out what you need to save on your own. You can estimate your Social Security benefit by creating a my Social Security account.
Your retirement plan will never be completely accurate because there are so many variables involved, but it can get you close. Reevaluate your plan once per year in case your goals change or your investments aren't growing as quickly as you'd expected. These periodic reviews will keep you on track without any drastic lifestyle changes.
2. Not saving regularly
Your retirement plan is worthless if you don't adhere to it. The simplest way to stick to it is to set up automatic withdrawals from each paycheck to your 401(k), if you have one. An IRA might also allow automatic deposits. Contribute at least as much as your retirement plan recommends and take advantage of any 401(k) match offered to you.
Make adjustments to your budget if you can't afford to save as much now as you'd like to. Look for areas to reduce spending, like canceling unused subscriptions, or try to boost your income by working extra or starting a side job. You could also consider making adjustments to your retirement plan, like delaying retirement by a year or two, to see what kind of a difference that makes in the amount you need to save each month.
Choose your retirement savings account carefully. Tax-deferred accounts, like most 401(k)s and traditional IRAs, give you a tax break this year, but then you pay taxes on your distributions in retirement. Roth accounts don't give you a tax break this year, but after you pay taxes on your initial contributions, your savings grow tax-free. Tax-deferred accounts make the most sense if you believe you're in a higher tax bracket now than you will be in retirement; Roth accounts are better if you think you're in the same or a lower tax bracket today as you will be in in the future.
Be mindful of the contribution limits. You're allowed to contribute up to $19,000 to a 401(k) in 2019 or $25,000 if you're 50 or older. You can also contribute up to $6,000 to an IRA in 2019 or $7,000 if you're 50 or older. Exceeding these limits results in a 6% excise tax on the extra every year until you remove it from your account.
3. Borrowing from your retirement plan
Withdrawing money from your retirement accounts before age 59 1/2 typically results in a 10% early withdrawal penalty, but there are exceptions for large medical bills, education expenses, a first-home purchase, or Substantially Equal Periodic Payments (SEPPs), among other things. You can also take loans from your 401(k) without a fine as long as you pay back the borrowed amount plus interest within a given time frame. But just because the government doesn't penalize you doesn't mean 401(k) loans are consequence-free. The loan interest rate is often lower than the rate of return you would have earned on your investments had you left the money alone. As a result, you end up with a lower balance in the long run.
Consider a $10,000 loan with a 10-year repayment term and a 6% interest rate. You'd end up paying back $3,322 in interest over that time, so that $10,000 ends up being worth $13,322 after 10 years. But if you'd left that money alone, it could've earned a 7% annual rate of return based on the long-term average returns on a balanced portfolio of stocks and bonds. That would leave you with a final balance after 10 years of $14,203. That's a difference of $881. This difference could be even more significant if you borrow more money or your investments perform even better than average.
Avoid borrowing from your retirement accounts whenever possible. Save for your other financial goals in a savings account and budget a portion of each paycheck to go toward them. It might take a little longer to reach them this way, but at least you won't put your retirement at risk.