Two Common Retirement Saving Pitfalls

In your twenties or thirties you know that you’ve got a number of years left in the workforce. How long do you want to work before traveling, learning to sail, or playing golf as a full-time job? How much would you like to save for retirement at age 50, 60, or 70? What would you do if you had the means to retire at 40? These are important questions that could seem beyond your reach.

In reality, the age of forty isn’t that far off. As you approach middle age, consider how to grow your money at a rate that matches your financial goals. Retirement is just one goal. You might also want to acquire property, send your children to private school or college, and many other things. For many of these ideas, good investments come in handy.

Do You Have Goals?

Some millennials are diligently socking away a fixed percentage of their annual income (i.e. 5-10 percent). You might use your employer’s retirement plan or an IRA. You know you want to grow your money, but maybe you haven’t mapped out concrete financial goals. Some may lack direction, and they aren’t sure which retirement options suit them. That’s where getting professional advice helps.

A Bit of Background

Before you create a plan, think about your life in general. Your spending and saving habits now will affect your retirement. First of all, decide how many years you want to keep working and how much you want to save per year. Think about how to get out of debt and how to increase your annual earnings. You could also invest more aggressively in a variety of retirement savings instruments. As your annual income increases, you could keep your living costs stable and save more for retirement.

As an academic, I think diversity in investments is important for millennials just like you. I always urge my students and friends to consider the most cost-effective way they can accumulate and diversify their savings.

Once I have helped someone create a plan, two things often trap them and mess up their road to long-term financial well-being.

Pitfall #1: Cashing Out

If you are with a company for any length of time and get laid off or decide to change employers, you may get the option to cash out of the 401k. Doing this before you are 59.5 years old could mean that you will pay a higher marginal tax rate because the distribution may put you into a higher income bracket (at least one time.)

Another possibility is that you will pay a hefty 10 percent penalty tax for cashing out. Both of these are something that you could withstand once, but people who frequently change jobs or careers could end up cashing out several times over their working life. Instead, you could roll over a retirement account into another plan. It is usually pretty easy to roll retirement plans into an IRA. Another downside of cashing out is that it means you are start back over. Each time you do you are depriving yourself of the benefit of exponential growth, further delaying your retirement and reducing your retirement income.

Pitfall #2: Overextending Yourself into Long-Term Debt

Another big mistake is that young people increase their incomes over time and begin to build more expensive lifestyles. They give up their starter homes for larger homes. They add a pool and purchase pricier vehicles. They take fancier vacations, add more amenities for their home and family, and buy better clothes. This all occurs in a way that inflates their monthly household budget, and, without warning, they may have to cut back on their retirement investments or general savings in order to pay their recurring debts. Young people may also not consider how much the interest on various loans cost them over the years.

Balancing the amount you save for retirement and diversifying your investments will help you prepare for the future. Keep your recurring debts down and do not allow your monthly budget eliminate any flexibility for discretionary spending or extra savings. You might not retire at 40, but you can keep your finances stable while your retirement nest egg builds interest over time.

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