One of the toughest aspects of retirement planning is that nobody has all the right answers. There's not necessarily a correct answer as to exactly how much the average person should save, or what age is best to retire because it will depend greatly on your unique situation.
Even though there's no single "right" way to save, there are a few wrong ways to prepare for the future.
Some retirement planning mistakes may seem harmless at first glance but can actually cause a significant amount of long-term damage. The good news, though, is that the sooner you catch these blunders, the easier they are to correct.
1. Forgetting about how taxes will affect your retirement income
If you're investing in a tax-deferred retirement account -- like a 401(k) or traditional IRA -- you won't pay taxes when you make the initial contributions, but you will owe income taxes when you start making withdrawals in retirement. And if you haven't accounted for these taxes in your retirement plan, that could throw off your whole financial future.
Not accounting for taxes could lead you to withdraw more than you should from your retirement fund each year, which may result in running out of money sooner than you anticipated. And if you expect to spend more money annually in retirement than you do now, you may push yourself into a higher tax bracket and owe Uncle Sam an even bigger chunk of your savings.
In addition, you may have to pay taxes on your Social Security benefits too. Depending on where you live, you might owe taxes on your benefits at the state level. Additionally, you may also have to pay federal taxes on your monthly checks if your income reaches a certain level.
For unmarried individuals, you'll pay taxes on up to 85% of your benefits if you're earning more than $34,000 per year in combined income -- which is half your annual benefit amount plus any other retirement income you have. Married couples can expect to pay taxes on up to 85% of their benefits if their combined income is more than $44,000 per year.
Between income taxes on your retirement account withdrawals and potential state and federal taxes on Social Security benefits, that's a lot of retirement income you won't be able to spend. And if you're not prepared for those costs, you could be in for an expensive surprise.
2. Not considering how much you're paying in retirement account fees
Whether you like it or not, you're paying fees when you invest savings in your 401(k) or IRA. However, not understanding what you're paying in fees can be incredibly costly, because paying even a fraction of a percentage more than you should amounts to tens of thousands of dollars over a lifetime.
The average 401(k) plan charges fees of around 1% of total assets under management, according to a study from the Center for American Progress. So if you have $100,000 in your retirement fund, 1% in fees amounts to $1,000 per year.
Over a lifetime, the average worker paying annual fees of 1% will end up paying more than $138,000 in fees alone, according to the study. But if that same worker were paying slightly higher annual fees of 1.3%, that number increases to more than $166,000 in fees over a lifetime.
To figure out what you're paying in fees, dig through your plan's statements to look for the expense ratio -- which is the percentage of your funds devoted to fees. If you can't find that number, talk to your plan administrator.
If you find that you're paying higher-than-average fees, consider switching to a less expensive retirement account. But if you're investing in a 401(k) that offers employer matching contributions, you should continue saving enough to earn the full match. Free money outweighs high fees, so it's a good idea to allocate at least a little money there. After you've maxed out the match, you can consider investing the rest of your cash in an IRA with lower fees.
3. Choosing the wrong financial advisor
Not everyone needs a financial advisor, and some people can save a lot of money by handling their finances themselves. But if you don't want to manage your money, or you have a complicated financial situation, it may be beneficial to work with a professional.
However, choosing the wrong person for the job can be costly. Not all advisors are created equal, and some of them receive commissions by selling certain products or investments -- even if they know those investments aren't in their clients' best interests. That type of conflicted advice costs Americans $17 billion in lost potential earnings every year, according to a 2015 report released by the White House.
So how can you tell whether your advisor has your best interests at heart? First, look at their qualifications. The term "advisor" is broad and doesn't necessarily mean a person is qualified since nearly any finance professional can call themselves an advisor.
Instead, look for those who are certified financial planners. CFPs are required to pass rigorous tests and are held to high standards of quality to maintain their CFP status, so they're typically more qualified than the average advisor.
Second, ask any potential advisors how they're paid. Commission-based advisors earn money based on what they sell to their clients, while fee-based advisors charge a flat hourly rate or take a percentage of the assets they're managing for you. Commission-based advisors are generally less expensive, and some of them may be superbly qualified. But it's important to ask lots of questions to make sure you can trust them to give you unbiased financial advice.
Ask questions and prepare well
Everyone prepares for retirement in slightly different ways, and that's not a bad thing. But as you're saving for the future, be sure to look out for these hidden obstacles that can potentially cost you thousands of dollars.
The better understanding you have about where all your money is going, the more prepared you'll be going into retirement.