Although retirement can be a rewarding time in people’s lives, it can also be a stressful time.
This is especially true if you fall victim to the following mistakes, so make sure to avoid them at all costs.
1. We rely heavily on Social Security
Millions of seniors collect Social Security in retirement, and these monthly payments play a key role in helping beneficiaries keep up with their expenses. But if you’re planning to live on Social Security alone once your career is over, you’re making a huge mistake.
Contrary to what you may have been led to believe, Social Security is not designed to replace your previous salary. If you were an average earner, these benefits would translate to about 40% of your previous income. If you had a higher income, they will replace an even smaller percentage.
Since most seniors need more than 80% of their previous earnings to live comfortably, you should take steps to secure income beyond what you receive from Social Security. For the most part, this means funding a retirement plan like an IRA or 401(k) during your working years, but it could also mean planning to work part-time in retirement, renting out your home as a senior or a host of other possibilities. The key, however, is to recognize that while Social Security will help pay the bills in retirement, it won’t be enough to fund your golden years by itself.
2. Assuming your cost of living will drop drastically
Many people assume that once they retire, their living expenses will magically shrink. But chances are your monthly bills won’t change that much when you’re no longer working.
Think about the things you spend money on today, such as housing, food, utilities, and clothing. These are all items that you will continue to need when you are older, and whether or not you are working at the time won’t really matter. You may even find that some of your expenses increase in retirement, such as health care and leisure.
In fact, the Employee Benefit Research Institute found last year that about 46 percent of households spend more money, not less, during the first two years of retirement, while 33 percent spend more for the first six years out of the workforce. To avoid financial struggles later in life, plan a retirement budget that accurately reflects the expenses you will face and make sure the income you expect is sufficient to support them. If not, you may want to consider delaying retirement until you are in a better position financially.
3. Non-utilization of coverage contributions
Many workers fall behind on retirement savings during the early stages of their careers, when student loan payments, housing costs and other expenses eat up most of their income. Fortunately, those 50 and older have an excellent opportunity to make up for lost years of savings in the form of catch-up contributions.
If you save in an IRA and are at least 50 years old, you can currently put in an extra $1,000 each year for an annual total of $6,500 (workers under 50 can contribute as little as $5,500). If you save in a 401(k), you can make an additional $6,000 contribution for an annual total of $24,500 (compared to $18,500 for younger workers).
Unfortunately, many people do not take advantage of coverage contributions, and as a result, end up falling short by the time their golden years arrive. In fact, only 14% of 401(k) participants age 50 and older made supplemental contributions in 2017, according to Vanguard data.
If you don’t have savings, it’s imperative that you take steps to fill your nest egg, either by cutting expenses to free up cash or by taking on a side job and using its income to fund your retirement plan. Otherwise, you may face a big disappointment when your golden years arrive and you realize that you don’t have enough money to do the things you’ve always dreamed of.
4. Forgetting about taxes
Between Social Security benefits and your nest egg, you may find yourself on the receiving end of a pretty healthy income stream in retirement, especially if you’ve saved well. But don’t assume that all that money will be yours to keep. Chances are the IRS will be entitled to its share as well, especially if your retirement income is substantial.
There are several ways you may be taxed in retirement. First, unless you have a Roth IRA or 401(k), withdrawals from your nest eggs will be taxed as ordinary income — meaning your highest possible rate. The same is true for many types of pensions. Additionally, if your income exceeds a certain threshold, you could be taxed up to 85% of your Social Security benefits. Finally, just as interest and investment income are taxed during your working years, they are also taxed in retirement.
The takeaway? Be sure to factor taxes into the mix when calculating your expected retirement income. If you plan to withdraw $30,000 a year from your 401(k) and expect your ordinary income tax rate to be 25%, know that you will end up with only $22,500 and plan your expenses accordingly.
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The more thought you put into retirement planning, the better off you’ll be when your golden years finally arrive. Avoid these mistakes and you’ll set yourself up for a more financially secure future.
CNNMoney (New York) First published September 21, 2018: 9:49 am ET
