With just a bit of discipline, you can start building toward a great retirement today
In our opinion, without a doubt, the biggest mistake people make when planning for retirement is procrastination. Saving for retirement needs to be a priority, which sometimes means putting off other expenses. This does not mean retirement savings has to be the number one priority. Making smart financial choices is about balancing spending today to enjoy life, while at the same time saving for tomorrow to cover big events like retirement and creating a rainy-day fund for unexpected expenses.
Many of those who are just beginning their careers see retirement as a long-term goal and think they will have plenty of time to save. However, neglecting good saving strategies from the beginning can breed financial apathy. A mentality of “I’ll start saving tomorrow” or “I’ll save when I get my next raise,” can lead to problems later on. Most employer-sponsored plans offer incentives, such as pre-tax contributions and tax-deferred growth, which can grow significantly over time. Delaying participation in these plans can cause you to miss out on matched contributions and tax-deferred growth.
A second retirement planning mistake is not saving efficiently. Just like investors diversify in order to minimize risk, retirement savings needs to be diversified to minimize income taxes and provide flexibility. Some people saving for retirement actually put too much in their 401(k) or 403(b) plans. Pouring as much money as you can into a tax-deferred savings plan may not always be the best idea. Your company-sponsored plan may not have the best investment choices. Tax deferral today is great when you’re filing this year’s tax return, but it may not be in your best interest in the long run. Tax rates have been increasing the past couple of years from historic lows, and are likely to rise in the future, as the government searches for ways to reduce deficits.
No one knows what will happen to tax rates in the future, which is why smart retirement savers diversify how they save. Start by contributing enough to your employer-sponsored plan to maximize any matched contributions that are offered. Then, do a tax projection to see if the deferral has already pushed you below the 25% tax bracket ($36,900 singles, $73,800 married filing jointly for 2014). Switch to a Roth IRA to maximize the annual contribution if you are in the 15% bracket. Once the Roth IRA has reached the maximum contribution, additional savings should be invested in a taxable account using growth-oriented investments. Long-term capital gains and qualified dividends are taxed at a zero rate in the 15% tax bracket.
Directly tied to what we believe is the biggest mistake is the problem of controlling spending. Learn to save systematically from every paycheck you earn. This is the concept commonly referred to as “paying yourself first.” Some people find it difficult to save without a little help. Check with your employer to see if they will direct part of your paycheck to an investment account for savings. You can set up an automatic bank draft from your checking account if your employer doesn’t offer this option. Have a fixed amount of money automatically sent to an investment account each month to force yourself to save.
Not everyone moves their employer-sponsored accounts to an IRA or to their new company’s plan when changing jobs, which can turn into another retirement planning mistake. Consolidating retirement accounts simplifies investment management and financial planning. It’s not uncommon for employers to lose track of former employees when they move. This can also happen when a former employer merges with a new company, or worse, if they go out of business. Your old 401(k) account is your money, but it needs the plan administrator to authorize distributions. You may reach retirement but not be able to access your old 401(k) account because you don’t know who the plan administrator is today. We recommend that you move your employer-sponsored retirement accounts with you when changing jobs.
Retirement planning can seem overwhelming and it is a big challenge. However, starting early and saving systematically can put you on a track for retirement success. A self-funded retirement will become more important in this age of declining pensions and an uncertain Social Security.
- Procrastination is the biggest retirement planning mistake.
- Retirement savings should be diversified between tax-deferred accounts, Roth IRA accounts, and taxable accounts.
- Controlling spending in order to save consistently is one of the most important keys to long-term financial success.