“Loose lips sink ships,” a saying popularized during World War II, is a reminder that making the wrong choice can lead to grave consequences. It’s just as applicable today when it comes to your retirement savings plan; a couple of missteps can potentially jeopardize your financial future.
As you prepare for retirement, ask yourself if the following three “leaks” are ones you’re working diligently to plug in order to stay afloat after leaving the workforce:
1. Spillover from your retirement accounts into your children’s (or grandchildren’s) education fund.
The rules governing both traditional Individual Retirement Accounts (IRAs) and Roth IRAs allow you to make withdrawals for qualified higher education expenses without the 10 percent penalty if you are under 59 ½—but that doesn’t mean that you should do it. Sometimes, the best support we can provide our children and grandchildren doesn’t come from writing a check but from allowing them to devise their own financial solutions.
Plug the leak: A general rule of thumb is to keep deferred investments deferred as long as possible to allow compound interest to work to your advantage.
2. Slow seepage out of your 401(k) and into your wallet.
I hear many reasons why people think it is OK to borrow from their qualified retirement plan, such as, “The interest rate is lower if I borrow against my 401(k) plan compared to a commercial loan,” or, “If I borrow from my 401(k), I will pay myself back.” Whatever reason you use to justify borrowing from your retirement account, think again . One of the golden rules of personal finance is to always pay yourself first. If you are taking loans against your retirement plan, you are violating that rule.
Plug the leak: If the money you are withdrawing is not to supplement your retirement, then it is best to continue letting your money work for you so you don’t have to work for your money for the rest of your life.
3. A flood of cash from your 401(k) or IRA after an emergency.
Would you use a plunger to hang a picture? Probably not. The same thinking applies to your savings. You should have a designated emergency fund vs. relying on your retirement account in an emergency. Emergency savings need to be safe, liquid, and readily available, such as in an FDIC-insured money market or savings account. If you have no short-term savings, you may find yourself in a position where you have no choice but to tap your retirement accounts to pay for something. You will likely incur taxes and penalties on the withdrawal, making that emergency much more expensive.
Plug the leak: Consider building your short-term savings now, even if it means putting less into your retirement accounts temporarily. Your long-term savings, such as your retirement accounts, should only be used to fund retirement expenses or supplement your Social Security.
Identifying the smallest (and worst) leaks
Just like any leak: Many spending leaks start small and grow over time such as daily coffee runs, paying for extra cable channels you never watch, or eating lunch out every day – all of these expenses could instead go toward a healthy retirement account.
Start tracking what you spend each month so that you can identify your unique spending leaks. Once you plug those leaks, you can start thinking about how prepared you are for retirement.
Steve Repak is a CERTIFIED FINANCIAL PLANNER™ professional, CFP® Board Ambassador, and financial literacy speaker. He is also an Army veteran and the author of Dollars & Uncommon Sense: Basic Training For Your Money. Follow him on Twitter: @Steve_Repak