While working, a lot of people don’t put a ton of time or attention toward the investment strategy inside their 401k retirement plan, but as soon as they retire the gravity of the decisions is ratcheted up considerably.
Suddenly you go from working, making money, and saving money to being retired and living off of the savings. It can be a scary and confusing financial transition. So today I am here to help you not make five of the most common mistakes people make with their 401k when they retire.
Mistake #1 You use a large portion of the 401k to pay off your mortgage.
Whenever you withdraw money from a 401k or IRA, you have to pay federal income taxes on the distribution. If you retire with $500,000 and use $200,000 to pay off your mortgage, you have to pay taxes on that money, which puts you in at least a 33% tax bracket. Don’t do that.
If you really want to pay off your house using your 401k account, do it over 3 or 4 years so you can spread out the tax ramifications.
Watch: Using Your 401k or IRA to Pay Off Your Mortgage
Mistake #2 You suddenly become ultra-conservative with your 401k retirement plan.
Most people have their money invested in a diversified portfolio of stocks and bonds throughout their work career. Then, when they retire they start having thoughts like: “I can’t afford to lose any money. What if the stock market crashes? What if I run out of money?!” This kind of thinking generally leads to poor, emotionally-charged decisions.
Once you retire and you are no longer working and making money, your money needs to continue to work for you. You need to continue to invest your money in a diversified portfolio of stocks and bonds (with at least half of the money in stocks). Putting all of your money in cash, or all of your money in conservative government bond funds, will just not give you the kind of returns necessary to support your income needs in retirement.
Read: Saving in Retirement: When Good Financial Habits Go Bad
Mistake #3. You keep your investments in aggressive growth vehicles.
Once you retire, it is generally advisable to have a portion of your money in bonds and other more conservative vehicles. I know it sounds like I am going against Mistake #2, but remember — life is all about BALANCE.
I know, I know. Your aggressive investments have done incredibly well over the past couple of years, but when you retire you need to have an income oriented portfolio as opposed to a pure growth strategy. If you have the pedal to the medal and the markets have a couple bad years, it could adversely affect your retirement finances. Remember, since 1970, stocks and bonds have never both gone down in the same year.
Mistake #4. You don’t roll over your 401k into an IRA.
There are a few reasons why rolling over your 401k account into an IRA makes sense for most people.
Your 401k may have limited investment options. If you rollover the money into an IRA, you now have access to basically every investment vehicle out there.
You need more control over your investments. If your old employer changes 401k providers, they have the ability to change your investments. If the new 401k provider does not offer similar investments to the old one, you might find your money moved entirely to cash or to investments that are not as suitable for your situation.
You may be subject to a 401k blackout. If your employer changes their 401k provider you may be subject to blackouts. A blackout is a period of time ranging from days to weeks whereby you cannot access your 401k, make changes, or withdraw money. A blackout period is necessary for the 401k to smoothly transition from one provider to another.
You should have the option of consulting a financial advisor. Generally speaking, you do not have access to professional investment management inside of a 401k account. If you feel like you need the services of a financial advisor/fiduciary, a 401k is not a good option for you.
Many people end up with a few different 401k retirement accounts from previous employers. It is essential to have a cohesive, consolidated plan within your retirement portfolio. Combining your old 401k accounts into a single IRA simplifies reporting and ensures all of your money is working in a coordinated fashion.
Mistake #5. You wait too long to start spending money from your 401k/retirement accounts.
The thesis behind the Retirement Revolution is that many Boomers in their 60s and 70s are not spending enough money from their savings. Statistical data proves that, for the most part, retirees die with nearly twice as much money as the day they retired.
I know that doesn’t sound like a bad thing, but think about your quality of life during retirement. If you have 30 or 40 years (or more!) to live retired, and you know you don’t have to worry about money, doesn’t it make sense to spend that money on LIVING?
Read: Are You Ready to Join the 5% Club?
As soon as you retire, I recommend that most people should start spending 5% of their retirement savings per year. For more information, subscribe to my weekly newsletter.