When it comes to retirement planning, knowing what not to do can be just as important as knowing what you should be doing. Even if you’re diligently putting money away in a 401(k) plan every month, certain basic retirement planning mistakes can, unfortunately, wipe out all your careful preparation and seriously impact what your life will look like after you stop working.
To help improve your chances of a secure and comfortable retirement, here are some of the most common retirement planning mistakes you’ll need to avoid.
1. Not having a plan
The biggest retirement planning mistake that you can make is not having a retirement plan at all. Unfortunately, this is a mistake that many Americans end up making. According to recent survey data from the Employee Benefits Research Institute, for example, nearly half (48 percent) of workers haven’t figured out how much money they need for retirement or how they’re going to save that amount.
But with retirement planning, as with so many other things, failing to plan means planning to fail. In other words, a financially secure retirement doesn’t just happen—it’s the culmination of a process that involves setting specific, measurable financial objectives and creating a step-by-step plan to achieve them.
2. Underestimating your needs
When you retire, you might stop working but you don’t stop living. While some of your regular expenses might go down (for example, you might decide to sell your car because you used it only for commuting to work) many of your other routine living costs will stay the same. You might even find your spending going up if you’ve made any big-budget plans for your retirement, like an extended vacation or a major home improvement project. This is all to say that it’s important not to underestimate your financial needs during your retirement—many experts recommend that you plan to replace as much as 80 percent to 90 percent of your pre-retirement income.
3. Overestimating how long you’ll work
If you feel like your retirement savings won’t be quite enough to retire when you want to, it’s easy to assume that you’ll be able to work for an extra year or two to make up the difference. However, you mustn’t overlook the fact that the question of when you retire isn’t always within your control.
If you’re in good health and enjoying your job, working a little longer might not be a big deal, but you could have no choice but to retire early if you’re faced with things like health issues, layoffs, or the need to provide care for a parent or spouse. Indeed, the 2016 Retirement Confidence Survey revealed that 46 percent of retirees stopped working earlier than planned.
4. Forgetting about inflation
Inflation is easy to forget about, but its effects on your retirement savings can be dramatic. For example, imagine that you’ve calculated that you’ll need to save $875,000 over the next 20 years to fund your retirement. When you add inflation into the mix (which, historically, has averaged about 3 percent per year over long periods), the purchasing power of that $875,000 will be reduced to just $484,000 in today’s dollars. If you want to end up with a purchasing power of $875,000 in today’s dollars by the time you retire, the actual amount you’ll need to save is closer to $1.6 million.
5. Borrowing from your 401(k)
If you need to deal with a financial emergency, it can be tempting to see your 401(k) plan as a handy source for a quick loan. In fact, many 401(k) plans make provision for such situations by offering so-called “hardship withdrawals,” which allow you to take money out for things like medical expenses, home purchase costs, or tuition fees.
This practice is not uncommon. Data from J. P. Morgan Asset Management shows that 1 in 5 plan participants borrows an average of 15 percent of their retirement plan balance—but it’s not a great idea. Not only do you have to pay tax, and in many cases a 10 percent penalty, on a hardship withdrawal, but borrowing money from your retirement plan means that you lose valuable interest and destroy the compound return effects that are so important when it comes to long-term savings. It’s better to follow this simple rule: once you’ve put money into a retirement plan, don’t take it out again until you’re retired.
6. Not planning your Social Security strategy
While you can opt to start claiming Social Security benefits as early as age 62, that doesn’t mean you should. Not everyone realizes that it’s important to be strategic about Social Security, and that doing so can help you maximize your benefits. For example, you might know that you can increase your benefits by choosing to collect Social Security later than your full retirement age, but you might not know that there are ways to coordinate benefit-taking with your spouse that can allow you to make the most of both sets of benefits. Take the time to learn more about Social Security before you start collecting—it could make a significant difference to your monthly payments.