They say that hindsight is 20/20, and while you may not be too worried about the future just yet, there are certain financial decisions in life that you may come to deeply regret when you're older. Here are a few moves that could ruin your retirement if you're not careful.
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1. Putting off retirement savings
Many people don't start saving for retirement until later on in their careers, but holding off on funding that IRA or 401(k) is a move you might really come to bemoan as a senior. The sooner you start saving for retirement, the more time you'll have to take advantage of compounding. Throw in the fact that IRAs and 401(k)s offer tax-deferred (or, in the case of a Roth account, tax-free) growth, and you're looking at a real opportunity to turn a series of relatively small contributions into a pretty large sum over time.
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The following table shows how much of a nest egg you stand to amass depending on when you first start funding your IRA or 401(k):
TABLE AND CALCULATIONS BY AUTHOR.
It's pretty obvious that starting early can make a real difference in how much retirement cash you accumulate, but to further illustrate this point, let's dive into some numbers for a minute. If you start saving $300 a month at age 25 and do so consistently for 40 years, at the end of the day, you'll have put $144,000 of your own money into your IRA or 401(k). But thanks to the power of compounding, you'll wind up with $932,000 -- more than six times that amount -- by the time you're ready to retire. Or, to think of it another way, you'll have access to an additional $788,000 of retirement income, all because you started early.
2. Not opening a Roth
Some people avoid Roth IRAs because they don't offer tax-free contributions like traditional IRAs. But saving for retirement with a Roth offers a number of key advantages that traditional IRAs just can't mirror.
For one thing, Roth IRA distributions are taken tax-free in retirement. Traditional IRA withdrawals, by contrast, are taxable. So if, for example, you retire with enough of a nest egg to withdraw $6,000 a month in retirement, you won't actually get access to all of that cash with a traditional IRA. If your tax bracket at the time is 25%, you'll lose up to $1,500 a month to the IRS and only get to keep $4,500 for yourself.
Now let's talk about tax brackets for a minute. Many people assume that they'll be in a lower tax bracket once they retire, but this isn't always the case. If you have enough money coming in from investments, savings, and work (keeping in mind that many retirees choose to work in some capacity), you could actually wind up in a higher tax bracket down the line. Furthermore, while we know what tax brackets look like today, there's no telling how they'll play out in the future. By opening a Roth, you'll eliminate the risk of the unknown.
Finally, unlike traditional IRAs, Roth IRAs don't impose required minimum distributions (RMDs), which means that if you don't need your money right away and your portfolio is doing well, you can leave your cash in place to keep generating tax-free revenue. With a traditional IRA, you'll need to start taking RMDs upon turning 70-1/2 -- and pay taxes on them to boot.
3. Tapping your retirement account early
Generally speaking, you can't withdraw funds from a traditional IRA or 401(k) before age 59-1/2 without incurring a 10% early withdrawal penalty. But if you have an IRA, there are a few exceptions to this rule, such as taking money out to pay for college or purchase a first-time home.
If you're trying to buy a house or cover college tuition bills, it can be tempting to take the money out of your IRA -- after all, it's yours, and it's sitting right there. But doing so could constitute a major setback as far as retirement goes. Any time you withdraw funds prematurely from a retirement account, you're not just losing out on the sum you remove; you're also losing out on whatever growth that money could've achieved. So if you have a portfolio earning 8% a year and you remove $10,000 at age 40 to purchase a home, you won't just be $10,000 short 25 years down the line. Rather, you'll have $68,000 less, because you'll have missed out on two and a half decades of compounding.
Remember, you can always borrow money for college or take out a slightly higher mortgage and pay it off during your working years. But once you retire, you'll have fewer options for generating cash and paying the bills.
The decisions you make today could have a lasting impact on your financial future. Steer clear of these mistakes, and you won't end up kicking yourself later on.
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