When it comes to early retirement, sabotaging your retirement plans unintentionally can be distressingly easy. Many people who try to retire early end up making some critical errors that can cost them dearly in retirement.
Sometimes, the best way to avoid making a costly mistake in your retirement planning is simply to have a few examples of the worst possible things you could do.
To this end, here’s a list of some of the fastest ways to sabotage your early retirement:
#1: Spending Like You’re Still Working
In retirement, most people make less money than they did while working. However, some people don’t significantly change their spending habits after retiring.
One of the biggest ways that you can sabotage your own retirement, early or otherwise, is by not coming up with a monthly budget and adjusting it based on your new income level. If you’re only making $80,000 a year in retirement, but spend $12,000 a month, then you’ll probably burn through your retirement funds quickly.
#2: Not Knowing Where Your Retirement Income Will Be Coming From
Speaking of retirement income, what income sources do you have for retirement? All too often, I’ll ask a client this question, only to hear a response along the lines of “Umm… I don’t know.”
It’s important to know where your retirement income is going to be coming from, and how much you’re going to be getting, if you’re to have an effective money management strategy in place.
#3: Using Only Low to No-Growth Savings Accounts
Sometimes, a client will have a significant amount of money sitting in a savings account just sitting idle. While having an emergency fund is a good idea for covering sudden, large expenses such as a hospital stay, past a certain point, having too much money in the bank is a waste.
Right now, a savings deposit account simply doesn’t pay enough interest to make it worthwhile as a wealth-building vehicle. As cited by CNN Money, “the average savings account has a measly 0.06% APY (annual percentage yield, or interest), and many of the nation’s biggest banks pay rates as low as 0.01%.” If you had $10 million in the bank, you’d only get $1,000 - $6,000 in interest a year.
In fact, the actual total value of the money in the bank would shrink after inflation. According to inflationdata.com, the “average annual inflation rate is 3.22%.” So, that $10 million would have lost about $322,000 in value per year!
Relying on almost zero-growth savings accounts to store money for retirement is a sure-fire way to shrink your retirement nest egg rather than grow it.
#4: Investing Only in High-Risk, High-Reward Accounts
On the opposite end of the spectrum, far too many prospective early retirees have lost their shirts investing in high-risk funds.
The temptation to choose accounts that promise fast growth is understandable, especially when you have a goal of retiring early. However, the chances that you’ll lose the principle invested is typically much higher with a high-risk, potentially fast-growth investment than it is with a broadly allocated portfolio.
This is part of the reason why many financial advisors recommend that their clients diversify their investments. By doing this, if one stock goes under or a fund drops dramatically, you won’t suffer major losses in account value .
#5: Tapping Retirement Accounts Early
If you retire early, you may be tempted to tap into certain retirement-specific accounts, such as an IRA or your old company 401k. However, doing so can be incredibly costly.
For example, according to the IRS, if you withdraw money from an IRA account before turning 59½, you’ll be subjected to an extra 10% tax on that income. While there are exemptions for events such as death or disability, you’ll want to discuss the issue with an experienced money management specialist or tax advisor before trying to take such early deductions to see if it’s worthwhile to do so. This is a very large chunk of money to lose, making it harder to fund your retirement.
Another costly mistake would be to withdraw funds from your IRA or 401K too early, meaning in your early 60s, since your retirement account will not have enough time to grow large enough in value to last until the end of your retirement.
#6: Supporting Adult Children
When you’re trying to retire, it’s important to eliminate any and all forms of debt first. Taking debt into retirement can really put a strain on a fixed income.
Despite this fact, many potential retirees take on extra debt trying to financially support an adult child. For example, they’ll try to help said children buy a house or fund their college education.
While it can be hard to say no to your child, it may be necessary for your own financial stability in retirement. As pointed out in a Forbes.com article, “the problem is that retirees cannot replace their money, while their adult children can earn money to cover these expenses.”
#7: Not Including Your Spouse in Your Retirement Planning
If you’re married and retiring early, it’s absolutely vital that your spouse is aware of how your early retirement affects the household finances. It doesn’t do you any good to be frugal with your discretionary expenses if your spouse is out on the town spending half your monthly income in a single weekend.
When you start planning for retirement, you should make sure that you include your spouse in the planning process and make sure that they know what the plan is and why you need to stick to it. Failing to do so can not only drain your finances in retirement, it can lead to some severe marital disputes.
Hopefully, knowing a few of the major ways that you can end up sabotaging your own early retirement plans will help you avoid these pitfalls.
If you’re considering early retirement, check with an experienced retirement planning advisor for some basic money management tips to help you prepare for the transition from working to being retired.