Retirement planning is possibly the most difficult part of financial planning because it is extremely difficult to predict the exact years of employment, the exact amount of money that you will accumulate during the years of employment and the expenses that will occur in retirement. As retirement planning is basically an effort to anticipate uncertainty during the years that you won’t be able to work anymore, you should focus on building a secure financial future by using all the available resources you have while you still work. This also means to avoid common retirement planning mistakes in order to be able to reach you financial goals during the golden years.
The following are common retirement planning mistakes to avoid.
1. Start saving late
Start saving late for retirement can be really costly. Although retirement is typically 40 to 45 years away from the day you start working, it takes time to accumulate the amount of money that could guarantee a secure financial future.
Each dollar you save in your 20s or 25s can earn considerably more compound interest for a period of 40/45 years. This allows you to accumulate more money during the years of employment, while maintaining your current standard of living, and save more money for retirement. On the contrary, each dollar you save in your 40s earns significantly less compound interest because it has less time to mature until retirement. This means that, if you start saving after you have bought your first house or sent your kids to college, not only you have lost valuable time during which you could have accumulated money, but most importantly you have considerably less time until retirement to make up for the years that you didn’t save any money. So, the earlier you start saving for retirement, the better.
How much you should save? It’s up to you, but financial advisors suggest that saving 10 percent of your income annually is sufficient to anticipate potential financial emergencies.
2. Not thoroughly exploring retirement plans
Retirement is not a theoretical situation, it’s a real situation. When you retire you need to make sure that you will have money to cover your financial needs. As retirement should be a period of relaxation, leisure and good quality of life, you should be aware of all retirement options that can earn you a secure financial future during the golden years.
Most people do not explore retirement plans thoroughly and are not aware of their options. This can lead to higher taxes or less earnings during retirement. By setting a retirement goal, you can plan ahead and choose the best retirement plan that can serve your goals and provide you with your savings target.
Typically, the best option is a Roth IRA because you pay income tax in the beginning, your principal grows with your post-tax dollar contributions and you are not required to pay further taxes on your investment earnings upon withdrawal. Assuming that you get a job in your 22s and you start saving immediately $2,500 annually at an average annual return of 7% your Roth IRA Fund Balance at 65 will be 619,441.24 and you won’t owe a penny to the government. With a Roth IRA you allow yourself tax free investment earnings upon withdrawal and a lot of time to accumulate money for retirement. So, basically, it’s a win-win situation.
3. Underestimating investment risk
Investment risk is a key factor that can make or break your retirement planning strategy. In your 20s, you can make aggressive investments and increase your capital over a longer period because there is more time until maturity, allowing the compounding more time to build. However, if you accept a higher level of risk than the level of risk you are willing to accept for a given level of returns, the mix of assets in your portfolio may incur losses that you wouldn’t experience, had you accepted the proper level of portfolio risk.
When you are young, you have time to recover from potential losses until retirement. But exposure to higher risk as retirement approaches may be detrimental. The rule of thumb is that the percentage of stocks that you should keep in your portfolio is 100 minus your age. So, if you are 20, you keep 80% stocks in your portfolio. If you are 70, you keep 30% of stocks in your portfolio. However, as life expectancy for the U.S. population is increasing, financial advisors suggest that the percentage of stocks that you should keep in your portfolio is 120 minus your age.
4. Failing to consider future health care expenses
Failing to consider future health costs can have a catastrophic effect on your retirement planning. This happens because heath care expenses increase as you approach retirement and are a major part of the expenses that occur in retirement. Even if you have accumulated a lot of money and you are financially ready to retire, health care expenses can considerably reduce your income and diminish your quality of life.
5. Failing to change your lifestyle
Retirement planning is not static, it’s dynamic. This means that you have to adjust your lifestyle according to changes in your financial situation such as increase or loss of income or changes in the economy that directly or indirectly affect you household in order to maximize your retirement savings.
For instance, some people are reluctant to move to less expensive areas, although they fail to keep up with the rising housing prices in high-cost areas. In order to protect your retirement savings, consider relocating. By relocating to a lower-cost area, you can save money from home equity that can be reinvested. With this money you can cover basic expenses, including home insurance, property taxes, maintenance, but also health insurance, without touching your retirement savings.
All in all, retirement planning should be based on realistic goals. Although it is impossible to accurately predict how much money you will have accumulated after 40 or 45 years, you should set a realistic goal that represents the ideal retirement for you. Based on this goal, start saving early and as much as possible, but be disciplined. Finally, if you recognize any of the above retirement planning mistakes, make sure to avoid it today in order to be able to look forward to your future without the slightest doubt of running out of money in retirement.