Understand your options
Retirement may seem a long way off and far removed from your day-to-day concerns. And yet, this is actually the best time to start planning and saving—that is, when you still have time to accumulate the money you’ll need.
Here are some common mistakes that throw people off course in their retirement planning. Knowing these pitfalls should help you steer clear and save more.
Mistake #1: Not taking full advantage of retirement accounts
If you don't contribute enough to receive the full company match, you’re leaving money on the table.
Consider contributing up to the maximum allowable amount into your qualified employer-sponsored retirement plan (QRP), such as a 401(k), 403(b), or governmental 457(b) plan. This can help fund your retirement as well as reduce your taxable income.
If you are unable to contribute the maximum amount and your employer offers a matching contribution program, try to contribute at least as much as the match—otherwise, you are leaving free money on the table.
You may want to think about funding an IRA, which can help supplement QRP savings, and you may have access to a wider range of investment options. If your employer doesn’t offer a QRP or you’re self-employed, that’s all the more reason to look into opening an IRA.
Mistake #2: Getting out of the market after a downturn
When the market takes a big hit, you may be tempted to sell the investments in your retirement portfolio and hold the proceeds in cash. If you do, you’ll miss the gains if the market turns around. Consider keeping a good mix of asset classes in your portfolio: stocks, bonds, and cash alternatives.
Once a year, consider rebalancing by checking your accounts to see if market activity has shifted your investments away from your desired asset allocation. If it has, you may want to sell some investments and buy others to bring your accounts back into alignment.
Mistake #3: Buying too much of your company's stock
If your employer’s stock is an investment choice in your 401(k), you may want to consider keeping your allocation to no more than 10 percent. You’re not being disloyal; even the mightiest of companies—think Enron and WorldCom—can falter. With your salary already tied to your company’s fortunes, you may not want a sizable part of your retirement savings to be similarly dependent.
Mistake #4: Borrowing from your retirement plan
Many QRPs offer loans to participants. Unless you need the money for an emergency, try not to use this option. Borrowing can be an expensive choice in two ways:
- Smaller retirement savings: When you take out a loan, you are losing the benefits of potential investment growth and that could leave you with a smaller retirement savings. How much smaller? This depends on a number of factors, including the size of the loan, the repayment period, whether you continue contributions during this period and the earnings on your investments. Also, if you stop contributing while you are paying back your loan, you won’t receive any employer matching contributions.
- Repayment requirements: If you leave your employer, the plan may give a short period of time (e.g. 30 or 60 days) to repay that outstanding balance. However, if not repaid, the outstanding loan balance is generally subject to income tax and possibly a 10% IRS tax penalty for younger workers.
In addition, cashing out of your 401(k) when you move to a new employer might be costly as well. Know your distribution options when changing jobs.
Mistake #5: Underestimating the cost and length of retirement
Some crucial factors to take into account:
- Longevity: If you retire around age 65, you could spend a quarter century or more in retirement. As a result, you may need to save enough to last 25 to 30 years.
- Inflation and taxes: Even with relatively mild inflation over the past 25 years, the cost of living has more than doubled. Also consider what taxes you’ll be paying on the money you withdraw from your retirement account.
- Health care: Even with Medicare, you could have expenses for supplemental insurance, some prescription drugs, and nursing home care.
- Lifestyle sticker shock: A rule of thumb for retirees is to plan on needing approximately 80 percent of their pre-retirement income.
- Take advantage of your employer plan and match (if any).
- Open and contribute to an IRA, even if you participate in a plan at work.
- Don’t automatically jump out of the market after a downturn.
- Keep a balanced portfolio that doesn’t include too much of your employer’s stock.
- Be realistic about the probable length and cost of retirement.
This article has been prepared for informational purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Investing involves risk including the possible loss of principle. Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns. The accuracy and completeness of this information is not guaranteed and is subject to change. Since each investor's situation is unique you need to review your specific investment objectives, risk tolerance and liquidity needs with your financial professional(s) before a suitable investment strategy can be selected. Also, since Wells Fargo Advisors does not provide tax or legal advice, investors need to consult with their own tax and legal advisors before taking any action that may have tax or legal consequences.