Americans are "living on the edge" -- at least according to the August 2014 release of Bankrate's monthly Financial Security Index.
Based on statistics in Bankrate's report that looked at the steps Americans are taking to prepare for retirement, more than a third of respondents (36%) noted that they hadn't begun saving for retirement. Even more worrisome, more than a quarter of respondents in the 50 to 64 age bracket haven't saved a dime for their retirement.
As Bankrate's chief financial analyst Greg McBride noted, "What concerns me most is the high percentage of people that haven't started saving for retirement." He went on to note that, "Many of those that are saving aren't saving all that much."
It's reports like this that are a slap in the face reminder that we aren't doing a very good job, as a whole, of preparing for retirement -- and that's a problem. It's a problem because Social Security benefits aren't designed to replace the majority of your income from when you worked. It's a problem because the Social Security program could be facing benefits cuts by 2033 or sooner if its revenue shortfall isn't address by lawmakers. And, it's a problem because only you are responsible for your retirement; and you likely have the tools at your disposal to make it a good one.
While I'll be the first to admit that making mistakes when planning for retirement is easy, I'd also chime in that these mistakes and ways of thinking are also easy to correct.
Here are five easy mistakes you need to be on the lookout for when planning for retirement.
1. Investing too conservatively
One of the scariest pitfalls Americans can fall into is going into money conservation mode far too early in life.
Time is the ally of the young investor, meaning he or she should be willing to take more risks when younger in order to achieve a greater reward over the long-term. This doesn't mean safer investments like bonds and CDs don't belong in the investment portfolio of someone in their 20s, but it does mean these types of low-yield investments should represent a small component of their overall assets relative to other investment vehicles, such as stocks.
The concern with investing too conservatively via bonds, CDs, and savings accounts, is that the mind will perceive nominal gains as progress. Unfortunately, inflation stands still for no man or woman. Historically, inflation (or the rising price of goods and services) tends to average more than 3% per year, meaning if you aren't netting at least 3%-3.5% per year on your CDs, bonds, and savings accounts, then you're actually losing real money each year. The stock market, on the other hand, has grown by 8% over the long run.
Whether you're in your 20s or 50s, the stock market is a critical investment tool when planning for retirement.
2. Not paying attention to tax implications
Another easy way to get sidetracked in your retirement planning is to forget about the possible tax implications of your investments.
For example, investing in a Traditional IRA means an individual can net upfront tax benefits and reduce their taxable income within a given year. However, Traditional IRA investors are going to pay long-term capital gains taxes on what they earn over the life of the account upon withdrawal. Currently, this can mean a tax rate of up to 20%!
However, a Roth IRA offers no upfront tax benefits, but it allows your investments to grow completely free of taxation for life. As long as you don't make any unqualified withdrawals, the IRS can't collect a cent of your capital gains. This should allow you to keep a lot more of your money relative to the upfront tax break associated with a Traditional IRA since you'll have time and compounding working in your favor.
By a similar token, investing with a short-term mind-set can be a killer, too. Short-term capital gains, or those investments where you didn't hold for a minimum of one year, will be taxed at your ordinary marginal tax rate (or as high as 39.6%!). Do yourself a favor and stick to quality long-term investments, even in your standard investment account.
3. Failing to create a withdrawal plan
An easy mistake when planning for retirement that I covered just last week is that a majority of people, even if they have hit their "retirement number," fail to map out how they'll withdraw their funds in retirement.
This point builds on what was discussed in the prior example, but there's more to it than simply saving money by avoiding taxes in retirement -- albeit saving money on taxes can be a substantial boost that can extend the life of your nest egg.
Pre-retirees need to take the time to formulate a budget and consider what their spending will be like during retirement. Some people struggle while attempting to make the transition, meaning it's often a good idea for workers to consider gradually easing into their retirement spending routine months, or even years, in advance. By doing this you'll avoid spending more than you can afford and you'll ensure the survival of your nest egg throughout your retirement.
4. Counting on your home to save you
A long-standing retirement mistake -- or myth as I'd like to call it -- is that your primary residence is going to support you in retirement. Although it's certainly a smart move to have your mortgage paid off prior to retiring, counting on your home to create wealth is often a bad idea.
The reason is that your home has historically appreciated in value more or less in line with inflation. We have seen a bit of an anomaly over the last 15 years with home prices soaring, then bursting, but between 1950 and 1997 the value of real appreciation (meaning actual gains once inflation was removed) in homes was just 0.08% per year according to Robert Shilller's Irrational Exuberance. I'm sorry to break the news to you, but 0.08% isn't going to give you the retirement you've been dreaming of.
The lesson here is simple: your home is meant to be lived in. If you want to create other income streams by purchasing and renting real estate, that's another story altogether, but when it comes to your primary residence, leave its value out of your retirement savings calculations.
5. Not saving when you should be
Last, but not least, it's easy to become complacent and procrastinate on saving for retirement. The problem with the "I can do it later" strategy is that time and compounding work against you with each moment you let pass by. Even waiting a few years to start saving can mean a big difference in what you're able to earn for retirement.
For example, using Bankrate's return on investment calculator, a 25-year-old who begins with nothing in their saving account and puts away $2,000 per year would have close to $700,000 when they hit full retirement age (age 67), assuming an average stock market return rate of 8% per year. However, if nothing changes in the prior example except for the age an individual begins saving, we can observe a huge difference. If our individual begins saving at 19 years of age, then the amount at full retirement age rises to $1.1 million. Six years of not putting away $2,000, or $12,000 cumulative, cost our fictitious investor about $400,000 come retirement!
As I said, these are easy mistakes to make when planning for retirement, but being aware of them should allow you to make relatively easy fixes, too!