I am so pleased to share this post written by Money Done Right!
Logan Allec is a CPA, personal finance expert, and founder of the finance blog Money Done Right, which he launched in July 2017. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money.
3 Retirement Mistakes to Avoid
We all want to retire comfortably, but many of us don’t know exactly how to reach that goal. Different people offer completely different pieces of advice, and it’s difficult to determine the best ways to approach retirement savings.
This article will cover some of the most common errors people make when saving for retirement. We’ll also explain how you can improve your retirement plan to overcome these mistakes and get back on track. It’s never too late to start thinking about retirement—every dollar you contribute will make a real difference.
Starting Too Late
While you can always turn your retirement plan around, the truth is that starting early is one of the best things you can do for your financial future. The longer you wait, the more you’ll need to save each year to make up for that lost time.
The money you invest in a retirement account grows over time, so you’ll end up earning more returns by investing now rather than waiting until next year. When it comes to saving for retirement, time in the market is always better than timing the market. No matter how you choose to invest, the most important thing is to start contributing early.
If you’re having trouble making progress, start by contributing as much as you can each month—the size of the contribution is less important than getting in the habit of saving for retirement. Even as little as $5 per month can help you adjust your money mindset. It’s much easier to save money gradually than to completely change your budget overnight.
Tax-advantaged retirement accounts like 401(k)s and IRAs come with annual contribution limits, so you can’t always make up missed contributions by saving more in the future. With that in mind, you should start putting money in your retirement account as soon as possible, even if you feel too young to think about retiring.
You can find more ways to save and increase your monthly contribution by reviewing your bank and credit card statements at the end of each cycle. Some budgeting apps automatically categorize transactions and help you identify problematic spending habits more quickly. Eventually, your retirement account should be one of your top financial priorities rather than something you contribute to if you have any extra cash.
Missing 401(k) Employer Matches
You can only take advantage of this tip if your company offers a 401(k) match, but this is an incredibly lucrative opportunity that many people miss out on. It’s essentially free money, and it’s one of the most common financial mistakes.
If you have access to a 401(k) employer match, you can effectively double the portion of your income that’s eligible for the match. A common matching policy is for an employer to match fifty cents on the dollar for every dollar you contribute to your 401(k) up to a certain percentage of your salary. So instead of taking home $2,500 in cash, for example, you could turn that into $3,750 simply by putting it into a 401(k).
Matched contributions offer a higher return on investment than virtually anything else you could do with your income, so you should always contribute enough to receive the full match. You could be leaving a significant amount of money on the table every year you fail to reach the maximum.
If you’re not sure of your company’s 401(k) policy, talk to someone in HR or accounting to learn more about your options. They’ll help you get started and may even be able to set up automatic payments so that you don’t forget or miss monthly contributions.
Misunderstanding Tax Advantages
Most people are aware of common retirement accounts like 401(k)s and IRAs, but they may not know about the unique tax benefits that each option offers. Simply understanding the tax code will go a long way toward using your money more efficiently and prioritizing contributions for better returns.
401(k) plans are generally established by employers, and they come with substantially higher contribution limits than IRAs. In 2019, for example, individuals can contribute up to $19,500 to a 401(k) but only $6,000 to an IRA. Those limits are slightly higher for those age 50 or over.
In addition to 401(k)s and IRAs, you should also know the distinction between standard and Roth accounts. These affect the way in which your contributions are taxed and could potentially have a major impact on your retirement portfolio.
With a traditional 401(k) or traditional IRA, you can deduct all contributions from your taxable income in the year they were made. If you earned $50,000 and contributed $10,000, for example, you would have a taxable income of just $40,000.
Tax brackets are based on your taxable income, so deducting some of that income reduces your overall tax burden along with your effective tax rate. This is especially important for high earners who would lose a significant percentage of the last portion of their income to taxes.
While contributions to traditional retirement accounts are tax-free, your money will be taxed as normal income when you withdraw it after retiring. This is a very broad statement and not true for everyone, but traditional accounts are generally the better option the further away you are from retirement and the lower your tax bracket is now relative to what it will be in retirement.
On the other hand, the contributions you make to Roth 401(k)s or Roth IRAs are made with after-tax income, so you don’t get any tax advantages upfront. Instead, the money you contribute grows tax-free and isn’t subject to taxation upon withdrawal.
In contrast to traditional accounts which favor those who are currently earning more than they will in the future, Roth accounts could be a better option if you expect to be in a higher tax bracket during retirement. Of course, it isn’t always easy to predict your future income, nor what tax brackets will be when you retire.
Saving for retirement can be surprisingly simple, but a few common mistakes could end up costing you a lot of money. These tips will help you identify weaknesses in your current retirement plan and make the right adjustments. The sooner you start, the easier it will be to reach your retirement goals.