There are two things virtually everyone can agree on when it comes to saving for retirement. First, it's necessary if you ever plan to exit the workforce. Second, figuring out how much you need to save and the best place to stash those savings can be challenging. This difficulty leads many to guess at how much to save, or to latch on to simplistic "rules" that may not apply to them.
That might help you avoid some confusion or stress in the short term, but it could create even more problems in the long run. Here are three of the most dangerous misconceptions people have about saving for retirement, none of which you can afford to believe.
1. You can only save for retirement in an IRA or a 401(k)
IRAs and 401(k)s are the most common retirement savings vehicles because they offer tax advantages that can help you save for your future. But they're not your only options. If you've already maxed out your IRA and you don't have access to a 401(k) through your employer, you can still save money for your future with a health savings account (HSA) or a taxable brokerage account.
HSAs are available to anyone with a high-deductible health insurance plan, which is defined as one with a deductible exceeding $1,350 for an individual or $2,700 for a family in 2019. Individuals may contribute up to $3,500 in pre-tax dollars to their HSA in 2019, while families can contribute up to $7,000. Those 55 or older are allowed another $1,000 in catch-up contributions.
Most people think of HSAs as being just for medical expenses, and this is their most popular use. If you use your HSA for medical or dental expenses, you won't pay tax on the money. But you can also use it for nonmedical expenses, though you will pay income tax on these withdrawals, plus a 20% penalty if you're under 65. After 65, this penalty goes away; your HSA becomes like a traditional IRA except you don't have to worry about required minimum distributions (RMDs) when you turn 70 1/2, so you have more freedom in when and how you use this money.
A taxable brokerage account is not a retirement savings account and doesn't offer the same tax benefits as 401(k)s, IRAs, or HSAs, but it's still an option for your retirement savings if you cannot put them in one of these other accounts. Anyone can open and contribute money to a taxable brokerage account. You don't get any kind of tax break on your contributions, but you could get a tax break on your earnings.
Assets you hold for longer than one year become subject to long-term capital gains tax instead of income tax. These tax brackets are lower than income tax brackets. While the highest-earning Americans could pay as much as 37% in income tax, they'll pay at most 20% in capital gains tax. So holding your assets for at least one year can help you save some money on your investment earnings.
2. You should save 10% of your income for retirement annually
Saving 10% of your income each year for retirement is better than not saving anything. But this arbitrary measure isn't likely to be very accurate because everyone has different expectations for retirement. Some may enjoy a quiet life at home while others want to travel the world. These involve two very different budgets, and no cookie-cutter formula will apply to everyone.
Calculate your true retirement needs by first subtracting your preferred retirement age from your estimated life expectancy (plan to live to at least 90 if you're reasonably healthy) to get the number of years you're likely to be retired. Next, add up your estimated annual living costs in retirement and multiply this total by the number of years of your retirement, adding 3% annually for inflation. A retirement calculator can do this step for you. If it asks about investment rates of return, choose 5% to 6%, even though your investments may grow more than this. Your calculator should then tell you how much you need to save in total and per month to hit your goal.
But you're not responsible for all of this on your own. Social Security will cover some of your expenses in retirement; create a my Social Security account to estimate how much based on your current work record. If you're eligible for a pension or a 401(k) match, this can also help reduce your savings burden. Subtract these other sources of income from your retirement estimates to figure out how much you need to save on your own.
3. You should invest heavily in bonds as you near retirement
It makes sense to place more of your savings in bonds as you near retirement because bonds are less volatile than stocks. This reduces your risk of losing a lot of your savings on the eve of your retirement.
But bonds don't have the same growth potential as stocks, which typically see an average annual rate of return around 10%; bonds usually only see a 5% to 6% annual return. Taking too much of your money out of stocks could hamper the growth of your retirement savings, which is a problem if that money has to last you for several decades.
The old rule of thumb for figuring out the percentage of your savings you should invest in stocks was 100 minus your age (if you're 80, under this rule you should have 20% of your savings in stocks). But with people living longer now, a better rule of thumb is 110 or 120 minus your age. An even better option is to consult with a financial adviser who can give you tailored recommendations based on your goals and lifestyle.
These aren't all the misconceptions about saving for retirement, but if you can avoid these three and you make an effort to save money each month, you'll be doing better than the majority of Americans.