Money Education: Retirement Planning Mistakes to Avoid

Retirement planning is a journey that can start with your first-ever paycheck and continues until you retire. Making the right decisions during this journey is crucial, as it determines the comfort and financial security you can expect in your golden years.

Despite the wealth of information available, numerous retirement planning mistakes plague investors, potentially jeopardizing their financial futures. That can make navigating the complex world of retirement planning can feel understandably overwhelming.

However, by being aware of common mistakes and seeking guidance from a knowledgeable financial advisor, you can avoid pitfalls and optimize your retirement savings. Remember, the sooner you start saving and planning for retirement, the more comfortable and secure your retirement years can be!

The Top 3 Retirement Planning Mistakes

Here are three of the biggest mistakes I’ve seen people make while planning their retirement:

The “Red Zone” Mistake

One of the biggest retirement planning mistakes someone can make is being too risky with their retirement investment allocation within five years of retirement. We call this period the “red zone” of retirement planning—the five years before and after retirement. During this time, investment losses or poor returns can have devastating impacts. This can increase the fear of outliving one’s savings among retirees.

A real-world example of this occurred in 1999, during the height of the dot-com craze. I met a man we’ll call Tom. Tom was then three years from retirement. He had amassed $1.8 million in his 401(k). It was a comfortable nest egg that gave him a 95% chance his retirement savings would last until age 105. Unfortunately, he did not reduce the risk within his investment allocation when his 401(k) was at this level. The dot-com bubble burst, and the stock market plummeted. Tom’s 401K dropped from $1.8 million to $800,000. Suddenly, the likelihood of his savings lasting to age 90 fell to just 45%. A small allocation change from riskier stock assets to a stable value fund could have spared Tom this agony.

To sidestep a similar fate, performing regular financial checkups and reviewing your retirement investment allocation quarterly is imperative. Adjusting your allocation based on larger market cycles and leaning towards a more conservative approach when markets are at high levels or when you’re nearing retirement is advisable. There’s an old Wall Street saying: “Bears make money, Bulls make money, Pigs get slaughtered.” Tom’s story underlines the importance of avoiding excessive risk at inopportune times.

Ignoring Employer Matching

Another common retirement planning mistake is not taking full advantage of one of the most lucrative benefits of an employer-sponsored 401(k) plan: employer matching.

Employer matching is essentially “free money” that can significantly boost your retirement savings. With such a plan, your employer contributes their own money to your 401(k) plan. It’s called an “employer match” because your employer’s contribution typically matches your contributions up to a pre-determined limit.

If your employer matches your 401(k) contributions, ensure you contribute enough to maximize this benefit!

The Tax Trap

Retirement accounts, such as traditional 401(k) accounts and IRAs, offer tax-deferred growth, which means you don’t pay taxes on your contributions until you withdraw the funds at retirement.

But there’s always a trade-off. If you make pre-tax contributions, such as with a 401(k), then your retirement distributions are considered taxable income. However, you can receive tax-free distributions if you make post-tax contributions, such as with a Roth IRA.

So the question is: when can you most benefit from tax deductions? Now, or later? If you make pre-tax contributions, you can reduce your tax burden immediately. However, you might have higher taxes in retirement. Alternatively, the opposite happens if you make post-tax contributions: you’ll have higher taxes now and potentially lower taxes in retirement.

If you plan to be in a higher tax bracket when you retire, any tax reduction could be beneficial for maximizing your retirement income. Moreover, paying those taxes now (while you’re in a lower tax bracket) could increase your lifetime tax savings!

It’s a personal choice and depends entirely on your plans for your career and retirement.

Other Common Retirement Planning Mistakes

Here are some other common mistakes retirement planners make that can reduce their retirement income:

Overlooking Catch-Up Contributions

If you’re over 50, you can make “catch-up contributions” to your retirement accounts, allowing you to save more as you approach retirement. Ignoring these can mean missing out on thousands of dollars in additional savings.

Neglecting the Impact of Social Security

Social Security benefits play a critical role in most people’s retirement income. Understanding how the full retirement age impacts your benefits and when to start taking these benefits can significantly affect your overall retirement income.

Deferring the Start of Your Saving

One common mistake people make is delaying retirement savings, often believing they have plenty of time. However, the power of compound interest means that the earlier you start saving (even if it’s only small amounts), the more you can accumulate by the time you retire. Don’t put off until tomorrow what can be started today. Your future self will thank you!

Misunderstanding the Impact of Inflation

Many people forget to factor in inflation when planning for retirement. Inflation can erode the purchasing power of your money over time. If your retirement savings aren’t growing at a rate that keeps pace with inflation, your money may not stretch as far as you hoped when you retire. To mitigate this, consider investments with real returns that outpace inflation.

Forgetting about Healthcare Costs

Healthcare is a significant expense for most retirees. Yet, many people overlook these costs when planning for retirement. Creating a budget that factors in the latest estimates for healthcare costs can help you prepare for a more accurate retirement income.

Relying Solely on Social Security

Many people assume Social Security will provide enough income for their retirement years. However, after retiring, Social Security benefits only replace about 40% of an average wage earner’s income. Remember that Social Security is often at the center of governmental budget disagreements, and its future is constantly in flux. Therefore, it’s important not to rely solely on Social Security but to have other sources of retirement income as well.