Social Security generally won't provide enough income for you to live comfortably as a senior, so you'll need to save independently in a retirement plan to ensure that you're able to cover all of your expenses later in life. But if you make these mistakes with your IRA or 401(k), you might wind up with a frightening income shortfall on your hands by the time retirement rolls around.
1. Not contributing while you're young
It's easy to blow off retirement savings early on in your career. When that milestone is 40 or more years away, you may be inclined to spend your money on immediate bills and leisure, figuring you'll catch up on savings later on. But if you don't start funding your IRA or 401(k) from an early age, you'll lose out on years of investment growth that could leave you cash-strapped once your career comes to a close.
Imagine you start saving $200 a month for retirement at age 22. By the time you're 67, you'll have roughly $686,000 to your name, assuming your IRA or 401(k) investments deliver an average annual 7% return (which is doable with a stock-heavy investment strategy).
Now, watch what happens if you wait until age 27 to start saving $200 a month. Assuming that same 7% return, you're looking at just $479,000. And if you wait until age 37, you'll have $227,000.
Difficult as it may be to start funding your retirement plan early on in your career, doing so will buy you a lot more financial flexibility later in life. It'll also help you avoid a scenario where you're forced to play catch-up.
2. Investing too conservatively
Many people worry about investing their retirement savings in stocks, since the market can be quite volatile. But the good thing about funding a retirement plan is that you're generally looking at a pretty long savings window, and since the stock market has a tendency to gain value over time, it's really the right way to go.
In the example above, we saw that socking away $200 a month over 45 years resulted in a $686,000 balance with a stock-heavy investment strategy generating an average annual 7% return. But now imagine you choose to load up on bonds in your retirement plan and put a lot less of your long-term savings into stocks. In that case, you might wind up with a 4% average annual return, which would leave you with just $290,000 instead.
As such, it pays to step outside your comfort zone a bit and adopt a stock-focused investing strategy, at least when you're younger. You can always shift toward safer investments once retirement nears.
3. Taking an early withdrawal
The money you have in your retirement plan will serve as a major income source for you later in life, so the more you remove ahead of your senior years, the more you stand to struggle financially down the line. Imagine you take a $15,000 withdrawal when retirement is 20 years away. If your IRA or 401(k) normally gives you a 7% annual return, you'll actually be losing out on $58,000 in total when you factor in lost investment growth.
There are different reasons why you may be tempted to raid your retirement plan early. With an IRA, you can tap your savings without penalty to pay for college or put money toward a first-time home. And during the COVID-19 pandemic, you're allowed to take a withdrawal of up to $100,000 without incurring a penalty if you've been impacted financially by the ongoing crisis. But unless you're desperate, you should really aim to leave your savings alone so you don't wind up with a major income shortfall on your hands.
By saving for retirement in the first place, you're doing your part to secure your future. Don't let that effort go to waste. Avoid the above mistakes to help ensure that you wind up in a financially solid spot by the time you're ready to leave the workforce behind for good.