When you’re starting out on any endeavor, it can be challenging to get everything correct. What helps though is knowing the pitfalls and common mistakes that other people have made, and how to avoid them.
The impact that taxes will have
Have you wondered why so many people choose a Roth IRA over a Traditional? That’s because we’re talking about the value of a dollar in a Roth IRA, compared to the value of a dollar in a traditional IRA. You would think a dollar is a dollar, right? Not when that dollar is being taxed.
When you keep your money in a Roth IRA, you are contributing after-tax dollars.
With a traditional IRA, your money is going in before it’s taxed, which means your cost is only the amount of the contribution, plus you may get a tax deduction, depending on your income. That makes it seem like the traditional IRA is a better deal, and in the short run, it is.
But when you pull $30,000 out of a traditional IRA in retirement, the IRS gets a little piece of that pie — how little depends on your future tax rate, but several thousand dollars, to be sure. When you pull that $30,000 out of a Roth IRA, you’re putting $30,000 into your pocket because you paid the taxes up front.
High fee investing
One major benefit of opening an IRA is the variety of investment choices you can access. But what many savers don’t realize is that high-fee investments can quickly eat away at overall returns. Remember, the goal of an IRA is to increase your savings via contributions and compounding, but if you opt for high-fee investments, then you’ll be giving up an ever-growing percentage of your assets as they gain value.
Making contributions too late in the year
An IRA contribution for a year can be made up to April 15th (when taxes are due) of the next year. So you have until April 15, 2018 to make a 2017 IRA contribution. But waiting until that following April 15 deprives you of the tax-sheltered growth for all those months. It’s best to make your IRA contribution as early as possible for the year. If possible, contribute to a 2017 IRA early in 2017 instead of waiting a year later to do that.
Not rolling over your 401K
Instead of rolling over their 401K’s, a majority of Americans, those with relatively small amounts of money saved in their company sponsored 401K, tend to just cash them out when they leave that company. Even if you only have $2,000-$3,000 in a 401K, sure, cashing that account out gets you money right away. The disadvantage that you’re doing to yourself is that you’re now not going to earn anything off of that money like you would if it was still in a retirement account. Keep in mind too that you’re also going to be penalized 10% for withdrawing your 401K early. The best thing you can do for yourself is roll it over into an IRA so it grows and works for you.