A recent report by PwC found that nearly 1 in 4 Americans have no retirement savings. Additionally, only 36% of US adults feel that their retirement planning is on track. While saving for retirement is an important first step, there are other mistakes that could have a dramatic effect on your retirement savings. Below are 4 of the biggest mistakes that we see too often when people are saving for retirement.
1. Withdrawing From Your Retirement Account Too Early
A misconception about retirement accounts such as 401(k)s, IRAs, etc. is that it is available to take out when you wish. While it is true that you can take that money out at any point, the federal government will penalize you if you take the money too soon. For IRAs, 401(k)s, 403(b)s, and other tax-deferred savings accounts, distributions taken before turning 59 ½ will result in a penalty. Most often, this mistake gets made when an individual leaves one job, and cashes out their 401(k) and fails to properly roll it into another qualified account.
One major exception to this rule is for public service employees with a 457(b) retirement account. Employees with 457(b) accounts can take funds from these accounts without penalty at any point after that there is a separation of service.
2. Delaying Saving for Retirement
Referring back to the PwC retirement survey, 64% of adults are concerned that their retirement savings are not on track to meet their retirement goals. One of the easiest ways to build up your retirement savings is to begin saving as soon as possible.
For example, use the assumption that at age 65, a taxpayer would like to have $1,000,000 in savings for retirement. The age that they begin saving for retirement will have a large impact on how much they need to contribute personally. Assuming annual account growth of 6%, a 25 year-old will need to invest $505 every month until the age of 65 to have $1,000,000. This accounts to an annual contribution of $6,060, and a lifetime contribution of $248,460. The remaining $751,540 all comes from compounding growth in the account. If the starting date were delayed just 5 years, that same individual would need to save $700/month until their 65th birthday to have the same $1,000,000 in retirement savings. By delaying for 5 years, they would need to contribute an additional $53,940 of their own money. Pushing it back 5 more years and beginning contributions at 35 would require $983/month, which would equate to $365,300 of their own money being contributed.
Age to Begin Contributions
Savings at 65
Total Amount Contributed
3. Not Using All the Retirement Accounts Available to You
One trap that many people fall into thinking is that they cannot save more than the limits allowed on their 401(k)s. As we discussed in a previous article, a Health Savings Account can actually be one of the most effective retirement savings tools. In addition to an immediate tax deduction when you contribute to the HSA, you also receive tax-free growth and tax-free distributions if the distributions are used for qualified medical expenses.
Making additional IRA contributions may be possible depending on a variety of situations. This ranges from older employees, self-employed individuals, spouses that don't work, etc. All of these situations should be discussed with a tax and financial planning professional to determine your best course of action.
4. Paying Taxes at the Wrong Time from Retirement Accounts
One of the most important mistakes to avoid when saving for retirement is to avoid paying too much in tax.
The two certainties in life are death and taxes. While we cannot control the first, we have significant control over our lifetime tax bill. Most often, taxpayers contribute all their money to their traditional 401(k) or traditional IRA to reduce their current tax liability. The problem with that strategy is that it may create a greater lifetime tax liability. The decision whether to contribute to a traditional tax-deferred or a Roth account comes down to tax bracket management. If you are married and make $250,000, you are currently in the 24% tax bracket, meaning that every $1,000 you put into your 401(k) would save you $240. The problem with that view is the short-sightedness of that tax deduction. Although you saved yourself $240 when you contributed, you could end up paying more should tax rates change. If we just go back to the 2017 income tax brackets, that same married couple would be in the 33% bracket. Depending on your income and the tax brackets in retirement, you may end up paying more tax to take out the same $1,000 than the $240 benefit you captured when making the contribution.
When preparing for retirement, there is no one-size-fits-all solution. While you are working, it is imperative to sit down with a tax advisor to make sure that not only your short-term, but also your lifetime tax bill is being reduced. To schedule a call to see what that would look like yourself, click the button below.
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