Todd R. Tresidder’s Financial Mentor blog is a great source of information on how to financially prepare for the later years of your life. We asked him for his thoughts on how to intelligently prepare for retirement. This is what he had to say.
Other than not saving at all, what are some of the common mistakes people make when saving for retirement?
I wrote a comprehensive article titled The Dirty Dozen Retirement Planning Mistakes To Avoid to answer that exact question. The most common and serious mistake from the list is the first item – failing to plan. Having a flawed or incomplete plan is the root cause of most other mistakes on the list. When you get the planning part right it usually cures the remaining issues.
A thematically similar article is 12 Retirement Planning Myths That Can Convert Your Golden Years Into Lead. The primary difference in this article is that it focuses on the flawed assumptions and thinking processes that result in retirement planning mistakes (rather than the actual mistakes themselves like the previous article). You can think of this article as the “excuses” or reasons why somebody doesn’t make a good retirement plan in the first place.
What Are Some Of The Advantages IRAs have that give them an edge over a 401(k)?
Two advantages – lower cost and greater investment flexibility.
There are many articles written on the high costs of 401(k)s once you factor everything in. I won’t rehash that material here (Google can guide you), but it is very important. Suffice it to say these higher costs have a huge impact on long-term compound return.
This issue is not well understood by the average investor but a 1% increase in expenses can cut your retirement savings in half (depending on other assumptions). Because of the compounded effect, small changes in annual expenses can grow into dramatic differences in ending account value. It can be a very big deal and is worth paying attention to.
Additionally, 401(k)s usually offer limited investment choices; whereas, IRA’s can be self-directed with virtually unlimited investment flexibility (depending on the choice of custodian).
The combination of lower costs and greater investment flexibility provides a potential one-two punch to increase net investment return that can dramatically impact the growth of your retirement savings. When compounded over many years the affect can be truly astounding.
What else can people do to prepare for retirement other than fund their 401(k)s and IRAs?
Get a life!
People think retirement is all about the money when it is really about life happiness. They mistakenly assume it is about getting away from a job they dislike when it is really about going toward the balanced and fulfilling life they always wanted.
Don’t make the all-too-common mistake of retiring from your career to a life of permanent leisure thinking it will just be a long-term vacation. It’s not! Vacations are satisfying because they are a break from work. When the vacation becomes your lifestyle then boredom can set in as it shifts from a fun break to a daily routine. Many people need something deeper, more challenging, and fulfilling than the “pro-leisure circuit” to enjoy retirement. Make sure you have interests that motivate you to wake up in the morning and fill your days with passion.
Beyond getting a life, the other half of the answer to your question is a long checklist of all the detailed things a person must do to prepare for retirement besides just saving. In the Retirement Planning Checklist I provide specific, detailed answers describing all the tasks that must be accomplished to prepare for retirement in a simple-to-use checklist format. It answers the other half of your question.
Are there any tax implications that people should take into consideration when saving for retirement?
Yes, there are two issues.
1) Saving and Spending: When saving for retirement, always max out your contributions to the most tax advantaged plans first. When spending in retirement, always use the most tax advantaged plans last. It’s a first in – last out system.
For example, when spending you would spend post-tax money (regular savings) first, tax-deferred savings second (IRA, 401(k)), and tax-free savings last (Roth IRA). You should prioritize your savings strategy in the exact opposite order.
The overall goal is to maximize tax advantages so that the government pays for part of your retirement through tax incentives.
2) Tax Rates: Also, you should question the all-too-common assumption that your tax rate will decline in retirement. There are two reasons that may not be true:
1: If you plan to spend roughly similar in retirement (80% rule) to what you spent before retirement it will require roughly the same amount of income. For that reason, there is a very good chance you will be in a similar tax situation. Think about it. Many of the tax deferred savings accounts become ordinary taxable income when withdrawn. Where is the reduced tax rate?
2. Additionally, governments around the world are strapped for income and running deficits. Logic and historical precedent provide good reason to believe we will face higher marginal tax rates in future years as governments attempt to balance their budgets.
Thanks, Todd! Lots of great thoughts as always.
What do you think of Todd’s advice? Is there anything he said that particularly stuck with you?