When you've worked hard all your life and have finally reached retirement, you deserve to enjoy your golden years without financial worries. Unfortunately, making some common mistakes could cost you that chance. Here are three key errors that could affect your ability to live out your golden years with enough money in the bank.
1. Withdrawing too much money too fast
No matter how much you've invested, your nest egg won't last if you withdraw too much of it. You need to leave enough in your account to earn reasonable returns so your account balance doesn't dwindle down to nothing as you make withdrawals. To do that, you'll need to decide on a safe withdrawal strategy.
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You have a number of options, including withdrawing a fixed amount or a fixed percentage, and there are pros and cons to each approach. One common guideline, the 4% rule, allows you to take out 4% of your account balance in the first year you retire and then adjust the amount for inflation each year. Some experts caution this could leave you running short of cash, however, so you may wish to pick a smaller percentage if you want to make sure your money doesn't run out.
2. Not understanding tax rules
Retirees may still owe federal and state taxes on some income, even after leaving the workforce.
For example, Social Security benefits become taxable on the federal level once your income hits a certain threshold, and there are 13 states that tax your benefits under certain circumstances. You need to know the rules on retirement benefit taxes so you can budget for them and -- if you're close to the threshold -- try to avoid them. You also need to understand how to pay taxes on Social Security because if you don't have some money withheld from your checks, you may need to make quarterly estimated tax payments to avoid possible IRS penalties.
Tax rules on Social Security aren't the only ones you need to know, either. Some pension income is taxed, too. And, perhaps most importantly, required minimum distribution (RMD) rules require you to begin withdrawing a certain amount from tax-advantaged investment accounts -- including a traditional 401(k) and IRA -- after you've reached the age of 72.
The CARES Act did suspend RMDs for 2020, but this rule will be back again, and not following it could lead to a penalty equaling 50% of the amount you should've withdrawn. You don't want to make that mistake and lose your hard-earned retirement funds to the IRS.
3. Failing to maintain the correct asset allocation
As a retiree, it's more important than ever to ensure you aren't exposed to too much risk with your investments. But that doesn't mean you should pull all of your money out of the stock market, as there's a danger in that, too -- your returns may be too low without equity investments, and you could run out of money.
One common rule of thumb is to subtract your age from 110 and invest that percentage of your portfolio in the market. That would mean 65-year-olds should have 45% of their portfolio in stocks, while 80-year-olds should have only 30% of their money in the market. You may decide to take an approach that's slightly more or slightly less conservative, but be sure you understand what that will do to your potential returns.
By paying attention to your withdrawal rate, the way your assets are invested, and the tax rules affecting your income sources, you can hopefully ensure you have the funds you need for the rest of your retirement.
