Personal savings for retirement is no longer optional... it's necessary for retirement. Years ago, pensions and social security benefits used to be sufficient income in retirement. Life expectancy increases, fewer pension offerings and retirement lifestyles with more luxury have made planning for retirement more important than ever. While pensions and defined benefit plans are much less common today, the availability of company 401(k) plans has increased.
If a 401(k) plan is offered to you, it is important to understand how to make the most out of this benefit. Especially if you find yourself in a position where you are mentally ready and anxious to retire. Read below to find out 5 common 401(k) mistakes... and what you can do instead.
Mistake #1: Saving too Little
For some, a small amount of their paycheck is put away every pay period into their retirement plan. People convince themselves that because they are saving that's good enough.
Or, a company has an automatic enrollment into their 401(k) plan. The automatic elective deferral kicks in and the employee never bothers to adjust it.
All resulting in saving too little for retirement.
What To Do Instead:
“How much should I be putting into my 401(k) each year?” The answer to this question is different for everyone given their individual situation.
However, a common mistake is thinking you're saving enough when in reality... the majority of Americans are saving too little. The best way to figure this out is to sit down with your Financial Advisor. Map out what type of retirement lifestyle you envision, what lifestyle you live currently and determine the amount of expenses you anticipate for your retirement.
Doing this type of planning will help clarify how much you should be saving given your situation.
Mistake #2: Saving Too Late
It is not uncommon for someone approaching retirement to experience a sudden wave of fear. They start to worry, “Do I have enough to retire?... Will I even be able to retire?.. Can I fix this so I can retire?” This results in either a frantic attempt to make up for lost years of saving or even postponing retirement.
What To Do Instead:
It can be extremely difficult to ramp up retirement savings suddenly. Over the years people become comfortable with their spending habits and have recurring expenses that need to be paid. It can be hard to drastically change your lifestyle to save more. The solution? Start earlier.
If you're reading this and thinking “I have plenty of time... I'm 10, 20 or even 30 years away from retirement.” Consider this: It is much easier on you, your cash flow, and your lifestyle to consistently save throughout your working years. This gives your retirement nest egg more time to grow and the ability to adjust deferral amounts in the event that you budget is tight without losing momentum. The ability of your money to grow through the years is the critical benefit to starting earlier.
If you're reading this and are finding that you're starting later in your career, take advantage of what to do instead in Mistake #5.
Mistake #3: Borrowing From Your 401(k)
It is no secret that redoing a kitchen, buying a new house, paying for college education or taking a vacation can come with large price tags. When some people don't have the financial resources available in their personal savings, they decide to borrow from their 401(k) instead. This is a mistake for many reasons.
Remember why you put the money away in the first place. To save it, let it grow and accumulate it for retirement. Taking distributions out of your 401(k) before you are 59 ½ comes with some hefty tax penalties.
What To Do Instead:
Set a goal for yourself to save at least 6 months worth of expenses in a non-retirement account. Place this money into an investment account so it is accessible if needed. Accomplishing this will likely require strict budgeting and lifestyle adjustments.
Now should you decide to follow through with one of these big ticket items, you can instead take money from the savings you acquired. You won't incur any tax penalties doing this because it is not from a retirement account. It will make you more mindful of spending habits and remember to begin the process again to rebuild your savings.
This goal is also two-fold. Unfortunately, life doesn't always go as planned and things do happen. If a member of the household is temporarily unable to work or faces a medical emergency, it allows for 6 months worth of bills to be paid. This time may be crucial to figuring out next steps.
The only exception to this is in the event of severe financial hardship where it may be your only option. However, this should be a last resort.
Mistake #4: Assuming the Company Match is “Good Enough”
Some companies match a percentage of your salary if you contribute so much of your own money. In response to this, some people decide to just defer that same small percentage because it is the amount that the company will match.
For example, let's say you earn $60,000 per year and your company matches 3%. That means you are contributing $1,800 and they are matching $1,800. Sounds great, right?
In this example, you are only accumulating $3,600 per year. That is hardly enough to save every year for retirement. In retirement, you want to enjoy life and do more things... and that comes with a price tag.
What To Do Instead:
If you're offered a 401(k) company match, do not assume that is all you need or should contribute. In fact, most Americans need to go well beyond the company match but aren't.
How much should you elect to defer instead? A 401(k) has an annual deferral limit of $18,000 as of 2017. There is no one size-fits-all solution when it comes to how much to voluntarily contribute as a lot of it is based on savings, current expenditures, anticipated expenses in retirement and other factors. However, striving to max out at $18,000 any year that you can especially early in your career will be extremely beneficial. Your future self will thank you for doing so.
Mistake #5: Not Taking Advantages of Catch-Up Contributions
If you came to the 401(k) game late you may be worried you won't ever be able to retire. Some people just accept the “work until I die” mentality and don't bother changing anything.
What To Do Instead:
The IRS recognizes that not everyone is on top of their retirement savings game until later in life. This is why once you turn 50, you become eligible for “catch-up” contributions. The purpose is to allow individuals approaching retirement age to “catch-up” and save more for retirement. For 2017, the elective deferral limit is $18,000. The catch-up contribution is an additional $6,000. That is $24,000 a year you can be saving after age 50 until you retire. This may seem like a lot to you and it is. However, when you're approaching retirement age, the more you can save the better off you'll be. As a bonus it will also provide additional tax savings in years an individual is typically in their highest income tax bracket.
Understand your 401(k) plan. Your benefits department or retirement plan contact will be able to help you with any questions about the company match, vesting schedule, investment options available, etc. It's also a great idea to get your Financial Advisor involved. They can help make the entire retirement planning process easier on you by taking your total picture into account.
Remember, planning for retirement is a process that takes time. The sooner you begin the better off you'll be.
At SENIOR Financial & Tax Associates, we help individuals with common 401(k) and retirement questions find the clarity they need. It is our mission to have clients feel confident about their plans for retirement to avoid these common mistakes. All with the purpose of allowing you to enjoy a more simplified life without glaring questions and “what if” thoughts.
If you'd like to review your retirement plans, give us a call today to schedule an appointment at 716-662-4470. We are happy to help you find the answers you're looking for.
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