Investing

5 Common Retirement Planning Mistakes — And How To Avoid Them

More than half of Americans need to take action quickly if they’re going to reach their retirement savings goals, according to the most recent Retirement Preparedness Measure (RPM) calculated by Fidelity.

The average RPM is 74, but 41% of Americans have an RPM of 65 or lower, placing them in the “poor” category when it comes to retirement preparedness. Another 14% of Americans have an RPM between 65 and 80, which places them in the “fair” category with action still needed to ensure a financially comfortable retirement. Only 33% of Americans are in the comfortable, or “very good,” category with an RPM of 95 or higher.

Here are five common retirement planning mistakes many people make that can lead to a low RPM, along with steps you can take to improve your retirement readiness.

1. Not having a plan

“If you fail to plan, you’ve planned to fail,” the old saying goes. Nowhere is this more true than in the area of retirement savings.

The good news is that most Americans understand the importance of retirement planning. According to the 2021 Retirement Confidence Survey conducted by the Employee Benefits Research Institute (EBRI), 58% of workers disagree with the statement, “Retirement savings is not a priority relative to the current needs of my family.” Unfortunately, four out of 10 workers say that saving for college or excessive debt is negatively impacting their ability to plan for retirement.

The key here is to make retirement planning and saving a financial priority. For example, it’s usually best to prioritize retirement savings over college savings. There are other potential ways to pay for college, such as scholarships, loans, grants and children working in order to help pay for their education. But options like these don’t exist for retirement.

2. Spending instead of rolling over retirement accounts.

When changing jobs, employees must make important decisions about what to do with the balances in their workplace retirement accounts. The main options are to take the money in a lump sum, leave the money in the plan or rollover the money into an IRA or a new employer’s retirement plan.

The worst option from a retirement planning perspective is to take the money in a lump sum and spend it. For starters, you could end up receiving only 70% of the money after taxes and penalties (if you’re under age 59½) are withheld. Even worse, spending the money will severely dampen your financial prospects in retirement.

Usually, the best option is to rollover the funds into an IRA or your new employer’s 401(k). When conducting an IRA rollover, make sure that your retirement plan assets are rolled directly into the IRA instead of sent to you and then you depositing them into the IRA. This will avoid an automatic 20% withholding for taxes.

3. Not taking advantage of tax-deferred retirement savings plans.

The federal government makes tax-deferred retirement savings plans available to encourage Americans to plan and save for retirement. These include traditional IRAs and 401(k)s, which are sponsored by employers and available through the workplace.

Traditional IRAs may offer a current tax deduction while funds grow on a tax-deferred basis, with taxes assessed at ordinary income tax rates when funds are withdrawn in retirement. With 401(k)s, contributions reduce current income, which may lower current taxes — these funds also grow tax-deferred.

In 2021, you can contribute up to $6,000 to a traditional IRA, or $7,000 if you’re 50 years of age or over. The 2021 contribution limit for 401(k)s is $19,500, or $26,000 if you’re 50 years of age or over.

4. Failing to diversify their retirement portfolio.

Diversification is one of the biggest keys to a financially successful retirement. This means spreading out the investments in your retirement portfolio among the main asset categories of stocks, bonds and cash equivalents, based on your investing objectives, time horizon and risk tolerance.

Another way of looking at diversification is: Don’t put all of your retirement eggs in one basket. Asset categories often tend to not correlate with each other — for example, when stocks are rising, bonds may be falling, and vice-versa. Having the right mix of assets across all three categories can help smooth out investment returns over the long term.

5. Not taking charge of their retirement investments.

When investing for retirement, you shouldn’t just “set it and forget it.” Successful retirement investing requires attention and diligence on your part in order to choose the right securities and ensure that your portfolio remains properly diversified.

One of the best ways to take charge of your retirement investments is to use a self-directed IRA (SDIRA). This specialized type of IRA can give you access to more investment options for your retirement funds, which can help you achieve greater diversification.

Self-directed IRA investment options include a wide range non-traditional assets other than stocks, bonds and cash equivalents. These include real estate, precious metals, private equity, promissory notes, cryptocurrencies, limited partnerships and tax liens, among others. SDIRAs are available as both traditional and Roth IRAs.

The information provided in this article is educational content and not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

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