Retirement Funds: Invest Or Avoid?

Retirement funds are an important part of financial planning, but there are some potential pitfalls to be aware of. While it's critical to start saving for retirement as early as possible, it's also important to avoid common mistakes such as not taking advantage of tax breaks, not getting a full employer match, and forgetting about inflation. Other mistakes to avoid include investing too conservatively, getting hit with high fees, and staying too risky as you near retirement. It's crucial to strike a balance between risk and reward, and to consider a variety of investment options such as stocks, bonds, savings accounts, and real estate. Seeking advice from a financial advisor can help individuals navigate the complex world of retirement planning and avoid costly mistakes.

Not taking full advantage of tax breaks

Tax breaks for retirement savings disproportionately benefit upper-income households, with 60% of the benefits of income tax breaks going to the highest-income 20% of households in 2019. However, you can take advantage of tax breaks to maximise your retirement savings.

Firstly, you can lower your tax bill by making the maximum contributions to your tax-deferred accounts, such as traditional IRAs and employer-sponsored plans like 401(k)s. This is because, with tax-deferred accounts, your contributions are typically deductible now, and you'll only pay applicable taxes on the money you withdraw in retirement. The higher your tax bracket, the more you will save.

Secondly, tax-deferred accounts allow you to raise the potential for compounding. Compounding is a basic principle of investing where any earnings you receive can produce earnings of their own, and the cycle continues over time.

Thirdly, you can save on taxes over the long term. Many people expect to earn less in retirement than they did in their working years, so if your income drops, your tax bracket may drop too. In that case, you could wind up paying less in taxes over time since your withdrawals in retirement would be taxed at a lower rate than when you were working.

Fourthly, tax-deferred accounts eliminate current taxes on investment gains. Usually, when you sell stocks or other assets that have grown in value since you bought them, you realise a capital gain, which triggers a related tax. But within a tax-deferred account, you can buy and sell assets without triggering any tax at all.

Finally, tax-deferred accounts can support your savings discipline. Except in special cases, withdrawing money from a traditional IRA or employer-sponsored plan before the age of 59 1/2 will come with a 10% early withdrawal penalty. Keeping the money in your tax-deferred account can be a powerful incentive for avoiding early withdrawals.

Not getting your full employer match

One of the main benefits of a 401(k) is that companies usually match a portion of the money you put into your account. This is essentially free money that you can use to build your retirement savings. However, in order to take full advantage of this benefit, you need to contribute enough to qualify for the entire match from your employer.

The amount that employers contribute varies from company to company. Some may match 50% for each dollar put in by the employee, while others may contribute a lower or higher percentage. It's important to find out what your company's policy is and make sure you are contributing enough to get the full match.

If you are just starting out in your career, it may be difficult to contribute enough to maximize your employer's match. In this case, you should aim to contribute at least enough to get the minimum match. As your salary increases over time, you can then increase your contributions to take full advantage of the employer match.

It's also important to keep in mind that your employer's match is tax-deferred money. This means that you don't have to pay taxes on it now, but you will have to pay taxes on the withdrawals when you retire. This can help you maximize your retirement savings while also managing your tax burden.

By not getting your full employer match, you are essentially leaving money on the table. This can add up to a significant amount over time, so it's important to make sure you are contributing enough to take full advantage of this benefit.

Not saving enough or at all

Not saving enough for retirement can have serious consequences. While it may not always be disastrous, it can kill dreams and force you to make serious adjustments to your lifestyle. For example, you may have to continue working until you die, or well into your "golden years", as one source puts it.

Indeed, the reality of not having enough money for retirement will be a reality for many. As of late last year, roughly 45% of working-age households had no retirement savings at all. This figure does not include social security or defined-benefit pensions.

Even those who are saving may not have enough. A 2016 survey showed that 50% of baby boomers had less than $100,000 saved for retirement. Unfortunately, their time to save and invest is running out.

• You need to keep working until you die.
• You drown in debt instead of planning for the future.
• You leave your family with financial and emotional stress.
• You reach retirement age with very little money in the bank.
• You throw your financial future away.
• Your children support you in old age.
• You need to sell your home and move somewhere cheaper.
• You have to make serious adjustments to your lifestyle.

So, what can you do to avoid these outcomes? Well, the simple answer is to save more.

• Save at least 15% of your annual income.
• Take advantage of the full range of accounts available for retirement savings.
• Take advantage of compound interest by starting to save as early as possible.
• Automate your contributions so that you save more over time.
• Take advantage of contribution limits for retirement accounts.
• Consider saving in a Roth account, where withdrawals are tax-free in retirement.
• Focus on the growth potential of stocks.
• Review your retirement savings progress regularly.
• Diversify your investments to mitigate risk.
• Maximize your contribution to your company's retirement program and get all of the matching dollars available.
• Save in addition to your retirement program, as much as 15% of your salary.
• Collect Social Security and other benefits later to save thousands.
• Seek professional financial advice.

Forgetting about inflation

Inflation can have a significant impact on your retirement savings and income, and it's important to consider its effects when planning for the future. Here are some ways that forgetting about inflation can affect your retirement funds:

• Purchasing Power: Inflation erodes your purchasing power over time, as prices rise and your money doesn't go as far. This can affect your ability to save for retirement and maintain your standard of living during retirement.
• Savings and Investments: The value of cash and savings accounts decreases with inflation. If the interest or return on your savings is lower than the inflation rate, your purchasing power will be reduced in the future. It's important to consider investing in assets that can keep up with or exceed inflation, such as stocks, bonds, or other investments.
• Retirement Accounts: Retirement savings accounts like IRAs and 401(k)s can be affected by inflation if the money isn't invested in assets that match or beat the inflation rate. This can result in a lower balance and reduced income during retirement.
• Pension and Social Security: Pensions may or may not be adjusted for inflation, and even with adjustments, they may not keep up with the rising cost of living. Social Security benefits are typically adjusted for inflation annually, but these adjustments may not fully reflect the inflation rate or the specific needs of retirees.
• Income Sources: Passive income sources like interest, dividends, and rental income tend to move with inflation but may not always keep up. It's important to diversify your income streams and consider sources that adjust with inflation, such as growth stocks or dividend-paying stocks.
• Retirement Plans: Forgetting about inflation can impact your retirement plans. You may need to work longer, save more, or make adjustments to your investment portfolio to account for the reduced purchasing power of your savings and income.

To protect against the effects of inflation on your retirement funds, it's crucial to start saving early, invest in a diverse range of assets, and regularly review and adjust your retirement plans to ensure they keep pace with inflation.

Investing too conservatively

While it is important to be mindful of risks, it is also crucial to remember that investing too conservatively can be detrimental to your retirement savings goals. Here are some reasons why you should avoid being overly conservative in your investment strategy:

Stocks can help beat inflation and grow your purchasing power

Historically, the stock market has provided higher returns than more conservative investments. For example, the S&P 500 has delivered average annual returns of about 10%. By investing in stocks, you can stay ahead of inflation and increase your purchasing power over time.

A balanced approach combines higher-return assets with lower-risk investments

You don't have to invest solely in stocks. A balanced portfolio includes a mix of higher-return assets, such as stocks or index funds, and lower-risk investments, such as bonds or certificates of deposit (CDs). This allows you to strike a balance between potential growth and capital preservation.

A long investment horizon justifies taking on more risk

If you have several decades until retirement, you have a long investment horizon. This means you can afford to take on more risk because you have time to recover from any short-term losses. As you get closer to retirement, you can gradually shift your investments towards more conservative options.

Not investing in stocks may lead to lower returns and the risk of outliving your money

By avoiding stocks or other higher-return investments, you may sacrifice the potential for higher returns. Additionally, your retirement funds may not last as long as you need them to. It is important to consider the potential impact of lower returns on your retirement plans.

Diversification is key

Diversifying your investments across different asset classes, sectors, and geographical areas is crucial. While it may be tempting to play it safe, putting all your eggs in one basket can create unnecessary risk. Diversification helps maximize expected returns while minimizing risk.

Frequently asked questions