Early Career Retirement Choices Can Make a Difference
You may be reading this because you just got a new job or have a close friend or family member who did and you love to help others. There is a crucial decision impacting your financial future that needs to be made but most people mess up. Don’t be like most people!
Planning for retirement is one of the most important financial challenges you will be faced with in life. Creating the right plan for your situation will help keep you on track to achieving financial independence later on in life.
But if you make one of these “Big Three” mistakes when creating your initial retirement plan after starting a new job, you could face some major obstacles on the path to financial freedom.
Not Saving Enough or Waiting Too Long to Start
When you are in the early stages of your career retirement is probably nowhere near the top of your list of life challenges and concerns. When you are in your 20s and 30s you are more likely to be focused on paying off student loans and credit card bills or paying everyday living expenses. Other financial goals within your sights may be buying a home or just trying to build up that emergency fund you hear financial planners telling you that is needed.
All of these financial goals and challenges are fighting for the same hard earned dollars in your budget. That is why it’s so easy to make the mistake of assuming that you can simply save more tomorrow to make up for lost time or put off saving altogether.
Others rely too heavily on their employer to help them choose how much to contribute to a retirement plan through the default setting during auto-enrollment. The problem with this approach is your initial contribution rate may not be enough.
The best strategy to make sure you are saving enough is to run a basic retirement calculation when you initially set up your retirement account and then again at least once per year during an annual review.
This process will allow you to get a solid estimate of how much you will need to save to maintain your desired lifestyle during retirement and not rely on your friends and co-workers to guide this important decision.
It is often recommended to start with an initial goal to save at least 10-15% of your income per year throughout the course of your career. Try to at least contribute enough to get the full match from your retirement plan at work if an employer match is offered if saving 15% or more is unrealistic from the start. Regularly increasing future contributions each year automatically is another way to “save more tomorrow” if a contribution rate escalation feature is offered in your retirement plan. If this isn’t available, set a calendar reminder to increase contributions at least 1-2% each year. You may also want to apply future pay increases or bonuses to your retirement account. The bottom line is to automate savings and pay it forward to your retirement!
Not Having a Plan From the Beginning
If you have ever been to a restaurant that has over 200 menu items you know that feeling of indecision when forced to narrow down your options. Your financial future is by far more important than your next meal.
Some choices in life can seem overwhelming, especially when we know just how important they are.
Choosing your initial investment options in a retirement plan is a challenge for many of us because we do not all possess the financial confidence to make an informed decision. The reality is that tools and resources exist to help us make these decisions and even a novice investor needs a basic plan. If you don’t have a written game plan your future retirement savings may not be enough to help pay for important life goals.
A basic investment plan also helps us avoid emotional decisions that can throw our plans off track. When periods of extreme market volatility many investors tend to steer clear of stocks and invest too conservatively. Allow recent market ups and downs to scare you away from the stock market can be a huge mistake if you are in the earlier stages of your career.
That’s because only focusing on stock market risk can be shortsighted and expose you to a bigger risk and that is the risk of outliving your money.
For the hands-off investor, consider using a low-cost, passive investment strategy that focuses on asset allocation (or how you divide your account across asset classes like stocks, bonds, real assets, and cash). This will usually work better than just trying to pick the top performers from previous years. One hands-off approach to invest in a diversified portfolio that provides professional guidance include selecting an asset allocation mutual fund that fits your risk tolerance. As an alternative, a target date mutual fund that automatically adjusts to gradually become more conservatively invested as you approach retirement.
Not Making the Most of Tax-Advantaged Accounts
Many retirement savers make the mistake of not taking full advantage of the tax-favorable treatment of 401(k) plans and IRAs. Traditional retirement accounts such as 401(k) plans and deductible IRAs provide a nice head start because you get an immediate tax break and the ability to lower your taxable income. The IRS contribution limit for a 401(k) is $18,000 and the IRA contribution limit is $5,500 in 2016.
Another key benefit of taking full advantage of retirement accounts is that they enable your earnings to grow on a tax-deferred basis. When you pair this tax benefit with the power of compounding interest, the thought of retirement starts to appear a little less daunting. You can also use the concept of asset location to your advantage by contributing to a Roth 401(k) or Roth IRA to get the benefits of tax-free growth of earnings. Just be aware that Roth accounts are funded with after-tax dollars. As a result, this strategy generally works best when you do not need to lower your taxable income in the current year or if you expect to be in a higher tax bracket during retirement.
With the decline of pensions and concerns about the viability of Social Security, it is becoming increasingly clear the burden of funding retirement is on us as individuals. If you avoid these top 3 mistakes when creating your retirement plan, you will be able to balance enjoying life today with the peace of mind knowing you are preparing for true financial independence in retirement (no matter how far away this goal may seem or how you define your own “retirement”).