Even careful, dedicated savers don’t always have a strategy in place to meet financial needs during retirement.
“Many times, they’re just putting money aside and hoping it will work out,” said Jeff Photiades, wealth management advisor with Northwestern Mutual in Manchester, New Hampshire.
Professionals, like Photiades, frequently see people making the same mistakes with their retirement plans. The good news is these pitfalls are easily avoidable if you know to look for them. Here are five things every retirement saver should watch out for:
1. Withdrawing funds early. When planning a home improvement project, a grand vacation or how to pay for a child’s college tuition, you may be tempted to tap into your retirement account.
“We see this more often than you might think,” said Photiades. “A 40-year-old may think a $10,000 to $20,000 withdrawal will be easy to make up. The challenge is that it makes a huge difference [in how much money can be saved].”
Taking money from a tax-advantaged retirement account like an IRA or 401(k) before retirement age can be expensive. Funds withdrawn from these accounts are subject to ordinary income tax rates, and they are also assessed a 10 percent tax penalty if taken before age 59½. Then, there are the lost investment earnings to consider.
For example, when taking $20,000 from your 401(k) to pay for an emergency expense, you actually only net about $13,000 after taxes and penalties. Leaving that $20,000 in your retirement account, however, and assuming growth of 6 percent annually, in 25 years it will be worth over $85,000, Photiades pointed out.
This is why it’s a good idea to build an emergency fund for about 6 to 12 months’ worth of expenses. By building this financial buffer, you will be able to avoid the pricey temptation of tapping your retirement accounts and keep your long-term savings strategy on track.
2. Borrowing from a 401(k). Workers today stay at a job for an average of just under five years, according to the most recent data available from the Bureau of Labor Statistics. This trend makes a 401(k) loan tricky for many employees, Photiades explained.
“The good news is that employees are required to pay themselves back and re-fund their 401(k) plans,” said Photiades. Unfortunately, if you leave your job, “the balance can’t be rolled over or moved to a new employer until the loan is repaid.”
Most loans need to be repaid within five years, and sometimes sooner, he added, or the outstanding balance will be treated as a pre-retirement withdrawal and will be subject to ordinary income tax and the early withdrawal penalty. Plus, Photiades added, the stock market grows more often than it contracts. Borrowers who pull money out of a retirement account are likely to miss out on potential market increases.
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