Let’s explore four common pitfalls that can throw your retirement plans off track. The most significant piece of advice financial advisors give is that once you establish your retirement account, you should not touch it. That is good advice, but sometimes, life’s circumstances can make it tempting to withdraw from your retirement. Of course, this is always with the promise that you will catch up later, but that can be more difficult than you think.
1. Inadequate Emergency Fund
If you do not have an adequate emergency fund, this can be a big risk for your retirement savings. There are many theories on how many months you should have saved up to cover an emergency. It is generally agreed that three to six months is a minimum. When an emergency happens, like a car repair, medical expense, or house repair, dipping into your retirement might be the first thing you consider.
If dipping into your retirement savings is the first thing you think of when an emergency occurs, then it is a sign that you do not have a sufficient emergency fund saved. A good thing to do is to imagine yourself having an emergency and ask yourself if your first reaction would be to dip into retirement. If you would be quick to withdraw from your retirement account, then you need to fortify your emergency fund.
2. Make Sure Medical Expenses Are Covered
Medical expenses can be a big temptation when it comes to dipping into your retirement savings. After all, people come first and when a loved one needs medical care, then withdrawing from your retirement savings is an easy decision. But unfortunately, the closer you are to retirement, the more enormous the impact this will have on your future.
Unplanned medical expenses are something that can happen at any time. The first thing you should do is to do an audit and make sure your health insurance meets your needs now. If it has been some time since you did an insurance review, then your coverage might no longer meet your needs. Also, start a health savings plan for deductibles and expenses that are not covered.
3. Save for Goals
Saving for short-term goals is rewarding. For example, if you anticipate that you will need to replace a car soon, you want to do some home renovations, or plan for a trip, starting a separate savings account for them will keep your retirement growing on schedule. When planning for a short-term savings goal, you can use this compound interest calculator to find out how much you will have to save to meet your goals.
Saving for short-term goals requires a different set of instruments than saving for longer ones. Therefore, you will need to think about liquidity and risk when making your decision.
One of the keys to choosing the right short-term instrument is the ability to access it if needed. Savings and short-term bond funds are an excellent choice for liquidity, but they often grow more slowly. So, depending on the time frame required, these might not allow you to reach your goal.
Other instruments, like CDs, have a more attractive interest rate and are suitable for goals that have a hard deadline, but they are not liquid. You cannot access them early without penalty. The next option is peer-to-peer loans. These have a low investment minimum, are lower liquidity, and they carry a higher risk. The advantage is that they often have better interest rates.
4. Beware of Fraud
In today’s society, another threat to your retirement savings is fraudsters and identity thieves. They can wipe out everything you have worked for in a few seconds. Protecting what you have worked hard for means creating secure passwords for all online accounts. You should also have antivirus software installed on all your devices. Also, it would be best if you never share your passwords with anyone.
Another thing to be cautious about is opening any emails that ask you to input any personal information. If you are not sure if an email is legitimate, then you can call the company that it appears to be from and verify that it was them who sent it. Many email scams can be very convincing when it comes to looking like a legitimate email from a company.
The same goes for anyone who calls you on the phone and asks you for information like your account number, credit card, or banking information. The best thing to do if the person on the other end of the line asks for this information is to hang up and call the company to see if it was them. You can never be too cautious when it comes to avoiding scams and preventing identity theft.
Common Pitfalls of Spending Your Retirement
Now, you know four common pitfalls that can throw your retirement off track. If you do fall for one of them, it can cost you more than the amount you withdrew. First, there are probably fees for withdrawing from your retirement plan early. Sometimes a hardship withdrawal can be made without penalties, but you have to have a good reason. Some examples of hardship circumstances are medical bills, buying a house, and college tuition. You can also withdraw to avoid an eviction, for funeral expenses, and to repair home damage.
Some retirement accounts allow for hardship withdrawals, but you should always consider another option first. The IRS can charge up to a 10% penalty on withdrawals. Also, you will owe regular income taxes on the amount you withdrew.
The best reason to avoid withdrawing from your retirement account is that you will lose out on what the money would have earned. If you start with $10,000 and contribute $500 per month in the stock market, you can expect an average return of 7%. This adds up to approximately $100,000 if compounded monthly over ten years. If you withdraw $10,000 to cover an expense but continue to make these contributions, you will have $80,000 in ten years.
As you can see, using your retirement funds to cover unexpected expenses costs you in many ways. However, life happens, and it is always good to make sure you have enough set aside for unexpected expenses. Doing a review and avoiding these pitfalls is the best way to ensure that you have enough in retirement.