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Retirement planning mistakes young professionals make and how to avoid them

August 2, 2021 / 5 min read

Retirement may seem like a lifetime away, but the earlier you plan for it, the more financially comfortable and prepared you’ll be. Take the time now to invest in yourself and avoid these retirement planning mistakes.

Often, the popular retirement planning recommendation for young professionals is to simply “save as early and as often as you can.” While this concept is certainly prudent, it’s a bit vague. How much should you save? Where should you save? When should you save? Just as important as what you should be doing is what not to do. There are many common pitfalls young professionals make when working to achieve their retirement goals. Avoiding these can ensure they optimize success for their post-working years.

Budgeting for retirement as a young professional

One of the biggest mistakes young professionals make is failing to establish a budget. An important first step toward a comfortable retirement is to allocate after-tax income to specific buckets. A basic budgeting model of 50/30/20 is a common starting point. Allocate 50% of monthly income to fixed expenses, 30% to flexible spending, and 20% towards financial goals. While this split is not a hard-and-fast rule, building out a budgeting goal can be a great anchor.

When you don’t use a budget, you can easily lose track of where income is really going and can drift away from desired habits and tendencies. For example, a general rule of thumb is to not spend more than 30% of your after-tax income on housing. Doing so can leave one over-extended and unable to enjoy flexible spending or focus on prudent financial savings goals like paying off high-interest debt.

Don’t delay 401(k) contributions

Gone are the days of retirees relying on employer-funded pensions or government-managed programs like Social Security to primarily fund their retirement lifestyle. While some pension plans linger and Social Security benefits are still anticipated, having these income streams fund retirement in its entirety is unrealistic.

Instead, young professionals need to take action and consciously save towards their retirement. The key mistake many make is waiting to contribute. It’s all too common for new staff to defer electing a 401(k) contribution or allocating dollars to a brokerage account until they feel more financially stable. Even if it’s a small amount to start, getting an account funded and initiating the compounding effect is crucial. Additionally, most retirement plans offer an annual increase tool to bump savings on a consistent basis gradually.

Even if it’s a small amount to start, getting an account funded and initiating the compounding effect is crucial.

Choosing a traditional or Roth 401(k)

The Roth 401(k) option has become more popular within retirement plans over the past decade. The main difference between a Roth 401(k) and a traditional 401(k) is the tax treatment. In a traditional 401(k), pre-tax dollars fund the account, and ordinary income taxes are owed upon distribution. Roth 401(k)s are funded with post-tax dollars, but qualified distributions are tax-free under current laws.

Ask yourself, “Do I expect to be in a higher tax bracket now or when I plan to use these funds?” Many young individuals are likely in a lower tax bracket now, and the Roth option is a better choice. If the tax rate difference between the two time periods is significant, investors can miss out on impactful savings by ignoring the Roth 401(k) option.

What about individuals who don’t have access to an employer-sponsored retirement plan? Good news — they can always contribute to an individual retirement account (IRA) or explore other retirement plan options if they’re self-employed.

Don’t chase trends — stick with smart allocation

Many individuals’ main vehicle for investing is their retirement plan offered through their employer. Others use IRAs, brokerage accounts, or a combination of each to save for retirement. Regardless of the investment vehicle, one of the most contemplated decisions is, “What do I invest in?”  Before exploring this decision, investors first need to address the appropriate amount of risk (equity/stock exposure) to have in their portfolios.

The three pillars for purposes of the risk discussion are time horizon, risk tolerance, and needed rate of return. As a young professional, you have time on your side.  Taking some risk in the early years of savings is crucial.  Not everyone can stomach the volatility that accompanies an aggressive equity allocation, but some individuals need to take on a higher level of risk to meet their retirement goals. Being too aggressive can cause individuals to sell out of the market when volatility rears its ugly head. Being too conservative can cause individuals to fall short of their desired retirement asset base. Choosing the appropriate risk level within your portfolios is the first step toward managing retirement assets appropriately.

Once you determine the prudent investment allocation, you can address which investments make sense for you. It can be easy to get caught up in the appeal of a hot stock or speculative investment like cryptocurrency. While these investments are intriguing, they present significant downside risks for investors and can quickly diminish balances if negative volatility creeps in. For retirement plan investors with limited knowledge of the stock market, target date or allocation funds are easy to get exposure to the broad market while maintaining cost efficiencies. These funds rebalance quarterly to their allocation targets, decrease risk over time, and allow investors the luxury of low ongoing maintenance and monitoring.

Don’t ignore insurance

You may be young and healthy now, but it’s still a big mistake to disregard insurance. Insurance can be an afterthought when focusing on debt repayment, retirement contributions, and budgeting, but it shouldn’t be. If your employer has a strong benefit package, you may already be covered, but make sure you still understand your position. Understanding disability and life insurance options, coverage, and downside risks are vital when developing your “crisis plan.”

Understanding disability and life insurance options, coverage, and downside risks are vital when developing your crisis plan.

Having disability insurance, both short-term and long-term, is important to all young professionals. Quality of life and financial resources can significantly decrease if individuals are no longer able to perform their job. We prefer to see long-term disability insurance policies cover 50-60% of gross compensation. If the employee pays for these premiums with after-tax dollars, benefits are not taxable to the employee. As with any insurance, understanding the different types of coverage and potential risks is prudent in the overall retirement planning strategy.

Life insurance can be used strategically for several different planning reasons, but for a professional with a young family, the most important is income replacement. If you have a family that relies on you for income and retirement savings, you likely want to ensure they enjoy the same quality of life beyond your death. Group coverage through work is a great start, but additional coverage is likely needed to fund lifestyle goals for your beneficiaries. Term life insurance coverage is one cost-effective and flexible way to mitigate this risk. Having the appropriate coverage will help provide peace of mind that your family will be taken care of if something happens.

Get started

Spending a short amount of time early in one’s career becoming familiar with these planning areas will help provide a baseline for increased financial flexibility in the future. The sooner you start, the better position you’ll be in for a comfortable retirement. 

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