Jane Young, CFP, EA
Managing your finances is a balancing act between spending for today and saving for the future. It’s important to plan and save for retirement but the demands of everyday life frequently get in the way. Here are some common pitfalls to avoid when planning for your retirement.
Living Beyond Your Means – Spending more than you earn, failing to save and going into debt can be huge threats to your financial security and retirement plans. Develop a spending plan that allows for an emergency fund and annual savings of 10-15% of your gross income. Make a conscious decision to spend less money, buy a less expensive house and buy less expensive cars to keep your expenses below your income. This can help you save for the future with a buffer for financial emergencies.
Failure to Participate – Participate in tax advantaged retirement plans for which you may be eligible. Contribute to your employers 401k or 403b to take advantage of any employer match and deduct the contributions from your current income. Additionally, if you are eligible, consider contributing to a Roth IRA. Generally, an after tax Roth IRA contribution can grow tax free, with no tax due upon distribution.
Failure to Diversify – Maximize the potential for growing your retirement nest egg by maintaining a well-diversified portfolio designed to meet your unique risk tolerance and investment timeframe. A common pitfall is the failure to monitor and rebalance your portfolio on an annual basis. A portfolio that is too conservative can be as detrimental to your retirement plan as an overly aggressive portfolio. Upon retirement, investors frequently make the mistake of changing their portfolio allocation to be extremely conservative, when they may live for another 30 to 40 years.
Market Timing and Trading on Emotion – Moving in and out of the stock market based on short term market fluctuations generally results in lower long term returns. There is a natural inclination to buy when the economy is booming and sell when the economy is in the doldrums. This usually results in buying high and selling low, which can be very detrimental to your portfolio. To maximize your retirement portfolio avoid the emotional temptation to react to short term events and fluctuations in the market.
Funding College and Living Expenses for Grown Children at the Expense of Retirement – Avoid the pitfall of sacrificing your retirement to fund college education for your children or to make significant contributions toward an adult child’s living expenses. Students have many options to finance or minimize college expenses but you can’t take out a loan to finance your retirement.
Cashing Out or Taking an Early Withdrawal – When you change jobs, transfer the money from your employer’s plan to another tax deferred plan such as a Rollover IRA. This allows you to avoid paying significant income tax and a 10% early distribution penalty, if you are under 59 ½.
Jane Young, CFP, EA
One of the biggest decisions associated with saving for retirement is choosing between a Roth IRA and a Traditional IRA. The primary difference between the two IRAs is when you pay income tax. A traditional IRA is usually funded with pre-tax dollars providing you with a current tax deduction. Your money grows tax deferred, but you have to pay regular income tax upon distribution. A Roth IRA is funded with after tax dollars, and does not provide a current tax deduction. Generally, a Roth IRA grows tax free and you don’t have to pay taxes on distributions. In 2013 you can contribute up to a total of $5,500 per year plus a $1,000 catch-up contribution if you are over 50. You can make a contribution into a combination of a Roth and a Traditional IRA as long as you don’t exceed the limit. You also have until your filing date, usually April 15th, to make a contribution for the previous year. New contributions must come from earned income.
There are some income restrictions on IRA contributions. In 2013, your eligibility to contribute to a Roth IRA begins to phase-out at a modified adjusted gross income of $112,000 if you file single and $178,000 if you file married filing jointly. With a traditional IRA, there are no limits on contributions based on income. However, if you are eligible for a retirement plan through your employer, there are restrictions on the amount you can earn and still be eligible for a tax deductible IRA. In 2013 your eligibility for a deductible IRA begins to phase out at $59,000 if you are single and at $95,000 if you file married filing jointly.
Generally, you cannot take distributions from a traditional IRA before age 59 ½ without a 10% penalty. Contributions to a Roth IRA can be withdrawn anytime, tax free. Earnings may be withdrawn tax free after you reach age 59 ½ and your money has been invested for at least five years. There are some exceptions to the early withdrawal penalties. You must start taking required minimum distributions on Traditional IRAs upon reaching 70 ½. Roth IRAs are not subject to required minimum distributions.
The decision on the type of IRA is based largely on your current tax rate, your anticipated tax rate in retirement, your investment timeframe, and your investment goals. A Roth IRA may be your best choice if you are currently in a low income tax bracket and anticipate being in a higher bracket in retirement. A Roth IRA may also be a good option if you already have a lot of money in a traditional IRA or 401k, and you are looking for some tax diversification. A Roth IRA can be a good option if you are not eligible for a deductible IRA but your income is low enough to qualify for a Roth IRA.
Jane Young, CFP, EA
Are you concerned that you don’t have the financial means to fully retire anytime soon? That may not be such a bad thing. There is much more to retirement than reaching some magic number where you will be able to cover your living expenses. Your personal identity may be closely aligned with your career. Personal identity plays a huge role in your self-esteem and happiness. Your sense of accomplishment and purpose can also be tied to your work. The structure, responsibility and expectations from your job give you a sense of purpose and help you feel appreciated. Retirement may have a dramatic impact on your personal identity and sense of relevance. Make a plan to transition into your retirement adventure with a new sense of direction and purpose.
Many of your relationships are connected to your career. Relationships with colleagues, clients, co-workers and suppliers account for a lot of your social interactions. These are people with whom you have a common understanding and intertwined social connections. Think about the impact retirement may have on these connections. How will you replace this sense of community and nurture these relationships after retirement?
Another consideration in retirement is keeping your mind stimulated. At work our minds are fully engaged as we juggle several different tasks at once. This may be exhausting, but it keeps our minds stimulated and energized. A study conducted by the Rand Center for the Study of Aging and the University of Michigan found that early retirement can have a significant negative impact on the cognitive ability of people in their early 60’s. The study concluded that people need to stay active to preserve their memories and reasoning abilities. As you transition into retirement, be sure stay mentally active and engaged.
You may be looking forward to retirement in anticipation of doing all the fun things you currently have no time for. Retirees frequently enter retirement with tremendous enthusiasm and fill their first few years with exciting trips and activities. However, after a while you tire of these activities, the activities lack the substance to make you feel truly fulfilled. You start missing the sense of affirmation, self- identity and purpose you found in your job. You have time to engage in fun activities every day, but it’s just not enough, you aren’t fully satisfied.
It doesn’t have to be this way. Before you jump into retirement, give some serious thought about what you will do in retirement. How will you stay socially and emotionally engaged in a way that is truly meaningful and rewarding? Engage in activities that will feed your self-esteem. Consider a new, part-time career, set some fitness goals, engage in volunteer activities, or take up a meaningful hobby. Decide how you will develop new social networks. Once you are retired, what will you say and how will you feel when someone asks – What do you do?