6 Warning Signs You're Sabotaging Your Nest Egg

Depending on how old you are, retirement may seem like a vague, distant goal. Still, even if it's many years off, it's important to pay attention to your retirement savings because the decisions you make now — whether good or bad — will be magnified by the power of time. Review the list below to see if you're making any of these mistakes.

1. You Haven't Calculated How Much You Will Need

If you don't know how much you'll need to retire, you probably also don't know how much you'll need to invest right now. There are many simple-to-use, free online retirement planning calculators that can help you calculate these figures easily. Fidelity's myPlan Snapshot, for example, requires just five bits of information to generate a rough estimate of your retirement needs and the monthly contributions needed to achieve your goal.

2. You're Not Saving Enough

If you work for a company that matches some of your 401K plan contributions, you absolutely must take advantage of what basically amounts to free money. (In fact, it's likely the easiest money you'll ever make.) And yet, about 25% of workers who are eligible for a match do not take full advantage of the benefit.

Many of today's large employers also use various forms of automation with their retirement plans — automatic enrollment, automatic investment selection, and more. Having to opt-out if you don't want to participate has proven to generate higher participation levels than opt-in programs. The problem is, those programs tend to use relatively low contributions to start, and most workers never increase that amount.

Don't be lulled into a false sense of confidence by automated contributions. Base your contributions on what you feel capable of contributing — it's likely higher than the automatic contribution amount.

3. You're Not Investing Wisely

The most common investment choice in 401K and similar plans is a target-date retirement fund (TDF). Their popularity is understandable since TDFs take care of some of the most complicated investing decisions for you. Investors simply choose a fund with the year closest to their intended retirement date as part of its name (the Fidelity Freedom 2055 fund, for example, is designed for people who plan to retire between 2053 and 2057). The fund is invested in a way the mutual fund company believes is best for someone with that much time until retirement. Another benefit of target-date funds is that they automatically alter how they invest over time, becoming more conservative as the investor nears retirement age.

Still, not all TDFs intended for similar target retirement dates are the same. Some are more aggressive than others. During the financial crisis of 2008–2009, many people who were invested in 2010 target-date funds, those intended for people right on the cusp of retirement at the time, lost a lot of money. Allocating all of your retirement contributions to a single fund can be risky. At the very least, understand how the target date fund you're considering is designed and make sure you're comfortable with its assumptions.

4. You Haven't Chosen the Right Tax-Advantaged Plan

If you're eligible to participate in a 401K plan, you may have a choice between a traditional or a Roth 401K. If you don't have access to a workplace plan, you probably qualify for an IRA. Again, you'll have your choice between a traditional or a Roth IRA.

The key difference has to do with taxes. With a traditional 401K or IRA, the money you contribute is immediately tax-deductible. If you make $50,000 and contribute $5,000, your taxable income becomes $45,000. When you take money out of the account in retirement, you'll owe taxes.

With a Roth, it works the other way around. Money you contribute is not tax-deductible. If you make $50,000 and contribute $5,000, your taxable income remains $50,000. However, when you take the money out in retirement, no taxes are due.

Choosing the best approach comes down to trying to pay taxes when your income is lowest. So, if you're in the early stages of your career, your income is probably relatively low. Paying taxes on the contributions now by using a Roth would likely make the most sense. If you're at a stage in your career when you are earning a lot, gaining a tax deduction now may make the most sense, pointing you toward a traditional 401K or IRA.

5. You've Taken a Loan, Hardship Withdrawal, or Early Distribution

The main point of building a nest egg is to have to have enough money to live on when you're older. However, IRS rules make it surprisingly easy to take money out of retirement accounts well before retirement.

Participants in a 401K plan can typically borrow against their balance or may qualify for a hardship withdrawal. Those using a Roth IRA can withdraw their contributions at any time without penalty, and they can access their earnings if their account has been open for at least five years and the money is used for certain purposes, such as a first-time home purchase or education.

However, accessing retirement account money early can be harmful to your financial health. If you have a loan from your 401K and you leave your employer — whether by your choice or your employer's — you'll have to repay the full amount of the loan very quickly. And taking money out of any retirement account for any reason other than retirement means that's less money that can avail itself of the power of compound interest.

6. You Haven't Named Beneficiaries

Failing to name a beneficiary for your 401K account or IRA means that money will become part of your estate upon your death, costing your heirs needless time and money. Simply naming a beneficiary will get the proceeds where you want them to go without the need for probate. Name your beneficiaries properly and your heirs could even turn your account into a stretch IRA or 401K, which can greatly maximize the value of your account while minimizing taxes.

Even if you're young and retirement is set somewhere in the distant future, when that day comes, you will be glad to have taken care of these details way back when.

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