As you move through your working years and get closer to retirement, there are a lot of things to consider to be sure you’re prepared. Have you created a financial plan to determine if you can reach your retirement goals? Are you saving enough? Are you taking advantage of the retirement benefits you are offered? Will you have sufficient savings to maintain your lifestyle and live comfortably? Having a financial plan can help answer these questions and ensure you take advantage of your employer's benefits. In this article, we will discuss some common retirement planning mistakes that you can avoid with proper planning.
Many people make the mistake of starting to save for retirement too late in life. The longer you wait to start saving, the less time you will have to benefit from compounding interest. A delay of even a few years can cost thousands of dollars in growth.
As you can see from the above example, waiting even ten years from ages 25 to 35 can result in a loss of nearly $600,000 due to missed compounding growth. Therefore, starting to save as soon as you are able can have a massive benefit to the growth of your retirement plan. Moreover, taking advantage of the automatic contributions to your retirement plans through work and auto transfers to savings accounts has also been shown to help people save more.
When you delay saving to your company 401(k), as seen in the example above, you lose compounding growth, plus you could also miss out on your company 401(k) match. Most employers offer a match to your 401(k) contributions, which is essentially free money contributed to your plan. The matching formula is different for every 401(k) plan. Still, companies can offer anywhere from 50 – 100% of employee contributions up to 3 – 6% of employees pay. Take advantage of your 401(k) match and adjust your contribution limit to reach the full match so you are not leaving any money on the table. Review your benefits with your financial advisor to make sure that you are taking advantage of all the benefits your employer is offering.
You’ve started saving for retirement and are taking advantage of your company match. Where should you invest the funds? When should you review those investments? Retirement investment mistakes are easy to make if you don’t understand a few important details. The first step in this process is to determine the level of risk you are comfortable taking on while still being able to fund your retirement goals. Once you know your risk tolerance, you can set up a portfolio that aligns with your risk tolerance.
Many 401(k) companies offer lower-cost mutual funds, index funds, and ETFs. They are required to send you annual disclosures outlining the fees and the impact on the return, so be sure to read through those. If you are self-directing another retirement plan, following trends or hot tips you find online can be enticing to bolster your return. However, you might not understand what is driving the current trend or buy it at a high price and sell it at a low price out of panic. In the long run, it can cause you to fall short of your goals or even cost you money. Ensure you understand what you are investing in and not taking on risks you do not fully understand.
With your risk tolerance established, where should you invest the funds? An important concept to understand when setting up a portfolio is diversification. Specifically, diversification of financial risk. Diversification is investing in different asset classes to reduce your exposure to any particular asset or risk. For example, real estate can be used in a portfolio as a hedge against inflation. It also has a low correlation between stocks and bonds, protecting you from market downturns. Creating a diversified portfolio aligned with your investment risk is the ultimate goal.
Once your portfolio is set up, the investments should be periodically reviewed and rebalanced if necessary. This will return your portfolio to the appropriate mix of assets to better manage market risk. Working with a financial advisor can give you peace of mind that your investments align with your risk tolerance and your diversified portfolio. A financial advisor can answer any questions you have about the market trends you are seeing, calm any panic or uncertainty, and discourage rash decisions regarding how your assets are invested in the market.
Retirement plans were created to protect your money until you reach retirement age. Still, you can take early withdrawals from the plan. However, taking distributions before retirement age will leave you with a lower balance, and you will lose the benefits of the funds growing and compounding for retirement. Be cautious about taking money from your retirement plans and only take it if necessary.
With a 401(k) or IRA, if you are under age 59 ½, there is an additional tax penalty for taking distributions from the plans. You will pay income tax on the distribution plus a 10% early withdrawal penalty. If you are over age 59 ½, the 10% early withdrawal penalty does not apply, but you must pay tax on the distribution amount. Working with an accountant can help determine the amount of retirement funds you can withdraw each year while controlling your taxes.
One critical decision in retirement is when to take Social Security benefits. Benefits for Social Security can start as soon as age 62, but the benefit will be lower. Full retirement age is the following for people born:
|1955||66 and 2 months|
|1956||66 and 4 months|
|1957||66 and 6 months|
|1958||66 and 8 months|
|1959||66 and 10 months|
|1960 and later||67|
If you were to take your Social Security benefits at age 62, the benefit would be about 30% lower than if you waited until your full retirement age. If you start your Social Security benefit at age 62, the benefit will not increase when you reach full retirement age; the benefit you receive will stay the same throughout retirement. Contacting the Social Security office and setting up an appointment to review your benefits can help determine when to start your benefits.
If you do not need your benefit at age 62 or even your full retirement age, you can delay your benefits. Each year you wait past your full retirement age, your benefit will increase by 8% until you reach age 70. You could receive 124% of your full retirement age benefit if you delay taking your benefits until 70. Depending on your income needs, this can be a great addition to your monthly income.
You know your current expenses, but what will they look like in retirement? Failing to account for additional costs in retirement is another common retirement blunder to avoid. Healthcare and long-term care can be the most significant costs when you retire. When you reach age 65, you will qualify for Medicare, covering some of your health expenses. Medicare will not, however, cover any costs associated with long-term care in your home or a nursing home. The duration and level of long-term care will vary from person to person and often change over time. Here are some statistics you should consider (all are "on average"):
Costs for long-term care can vary depending on the type of care you prefer. Care can range from a homemaker service to a private room in a nursing home. According to AARP, “Long-term care is expensive. Genworth puts the national median monthly 2021 costs at $9,034 for a private nursing home room and $4,500 for a one-bedroom unit in assisted living. A home health aide costs $5,148 per month.” Planning is very important so that you are comfortable with the care and can cover future costs. If you need long-term care, your options include applying for Medicaid, paying out of pocket, or long-term care insurance.
Long-term care insurance can be a great benefit, but the coverage has a cost. Working with an advisor can help determine if you can self-insure, meaning having enough savings to cover any costs associated with long-term care. If there is a shortfall, your advisor can recommend a plan based on your wants and needs to cover some or all the expenses associated with long-term care. They will also be able to weigh the coverage costs against the benefits it provides so you know you will be taken care of if you need long-term care.
Retirement is the last thought on your mind when you start on your career path, but planning for it as soon as possible can help immensely. Working with a financial advisor can help give you peace of mind that you are on track to meet your retirement goals. With your age, life span, and lifestyle in mind, they can help determine when to take Social Security benefits and retirement distributions to make your retirement enjoyable.
Together, you can determine how much to save to your 401(k) and when to start saving. A financial advisor can help with the diversification and allocation of your 401(k) and will continue to monitor the portfolio and recommend any allocation changes. Plus, a financial advisor can help calm any fears about market events and discourage rash investment decisions that could keep you from reaching your retirement goals. Creating a financial plan can give you the peace of mind that you are on track and doing all you can to reach your goals.
It is never too early to start planning for your retirement. Review the benefits you are offered through work and take advantage of savings inside your work plan. Take advantage of any additional savings as you get closer to your retirement goals. Creating a plan and updating it as your goals change can give you peace of mind that you are on track to have the type of retirement you want.
Author: Matt Jaspert, CFP® | Financial Planning Team Lead | Allegheny Financial Group | October 2023
The information included herein was obtained from sources which we believe reliable. This report is being provided for informational purposes only. It does not represent any specific investment and is not intended to be an offer of sale of any kind. Past performance is not a guarantee of future results.
Allegheny Financial Group is a Registered Investment Advisor. Securities offered through Allegheny Investments, LTD, a registered Broker/Dealer. Member FINRA/SIPC.