Saving for retirement independently is a good way to help ensure that you'll have enough money to pay your living expenses as a senior. And if you don't have access to a 401(k) plan through your employer, then saving in an IRA is great option.
But be careful -- if you mismanage your IRA, you could leave yourself with a lot less money down the line. Here are a few mistakes to avoid.
1. Not maxing out when you can
Maxing out a 401(k) plan is difficult. Right now, the annual contribution limits sit at $19,500 for workers under 50 and $26,000 for those 50 and over.
Maxing out an IRA is a different story. The current yearly contribution limits are $6,000 for savers under 50 and $7,000 for those 50 and over.
This isn't to say that maxing out an IRA is easy. But it's more attainable than hitting the limits on a 401(k).
Furthermore, if your earnings are such that you have the potential to max out, it pays to do so. Over time, maxing out could leave you with a serious pile of cash.
Say you contribute $6,000 a year to your IRA between the ages of 30 and 50, and you then contribute $7,000 a year from 50 to 65. If your investments generate an average annual 7% return, which is a bit below the stock market's average, you'll wind up with an impressive $855,000.
2. Starting too late
The great thing about IRAs is that they allow your money to grow in a tax-advantaged fashion. And the sooner you start funding one, the more wealth you can accumulate. On the other hand, if you wait too long, you may end up unhappy with your ultimate savings balance.
Imagine that you first start saving for retirement at the age of 50 and retire at 65. Even if you max out your IRA contributions at today's levels during that time and score an average annual 7% return, you'll wind up with only $176,000. That's not really a lot of money over what could be a 20- or 30-year retirement.
3. Investing too conservatively
IRAs allow you to buy individual stocks, whereas you can't do that with a 401(k) plan, which will limit you to different mutual funds. That could, in turn, help you invest your money in a manner that really fuels its growth. But if you play it too safe in your IRA by sticking to bonds, you'll lose out on higher returns.
We saw how maxing out an IRA at today's levels between ages 30 and 65 would lead to a balance of $855,000 with a 7% average annual return. If you invest conservatively and cut your average yearly return to 4%, you'll wind up with only $462,000.
4. Assuming a Roth is off the table
Higher earners are not allowed to fund a Roth IRA directly. But if your income is too high to qualify for a Roth, you can still contribute to a traditional IRA and convert it to a Roth afterward. Doing so will give you the benefit of tax-free withdrawals in retirement.
But that's not all. Roth IRAs are the only tax-advantaged retirement plan to not impose required minimum distributions, or RMDs. Avoiding those gives you a lot more flexibility with your money on a long-term basis.
Opening an IRA is a great step on the road to securing your retirement. Avoid these mistakes to put yourself in an even better position once your senior years arrive.