I sat down recently with Christine Benz, Morningstar's director of personal finance, to discuss five common pitfalls that can trip up retirement savers.
Christine, although it can be tempting when unexpected expenses come up, pitfall number one is raiding your company retirement account.
Taking premature withdrawals from a company retirement plan can be very costly. You'll have to pay ordinary income taxes on that withdrawal, and you'll also have to pay a penalty if you're prior to retirement age.
Some plans have the option for participants to take a loan from their retirement account. Is that a better option than taking the money out directly?
It is a better option, but it's still not perfect.
The reason it's better is that you will have to pay that money back to yourself, and you'll have to pay interest on the amount that you've withdrawn.
The key reason that it's not a great idea, though, is that if you do lose your job prematurely, you'll have to pay that money back almost right away; you usually have 90 days to get the money back into the account. If you've lost your job, that could be very difficult to do.
Read more: 4 Key Questions to Ask When Considering a 401(k) Loan
Early withdrawals or loans from 401(k)s often happen during times of emergency. Pitfall number two is not having an emergency account that would essentially prevent you from having to do that.
You'll want to have some safe money set aside outside of your company retirement plan to meet those emergency expenses as they occur. Whether it's a leaky roof or some car repair that you've got to pay for, you'll have that money set aside in your checking or savings account. It will be there in your time of need, and you won't be forced to raid your retirement fund.
This money should essentially be invested or saved in something very safe.
Very safe--money market accounts, checking accounts, CDs. It's money that will not ever be at low ebb when you need to withdraw it.
How much should you have in an emergency account?
The standard rule of thumb is that you want to hold three to six months' worth of living expenses in your emergency fund. I think that's a good starting point. But certainly people who have more volatile earning streams, those in careers where there is a high probability of disruption in their job, or higher earners would want to have more like a year's worth of living expenses in their emergency fund.
Read more: 5 Tips for Your Emergency Fund
A lot of retirement savers don't just have retirement to save for; they have other things such as college education for their children. Pitfall number three is not prioritizing those savings correctly.
We're all multitasking for most of our earnings years. It's important to make sure that we have our priorities straight.
Certainly there is a strong emotional motivation to fund higher education for children, but you'll want to step back and think about the fact that retirement is a very big-ticket item. Retirement needs to be at the top of your priority list.
Also when it comes to weighing college funding versus retirement funding, think about the levers that your child will have if he or she gets to college age and maybe you haven't saved enough. There are loans that he or she could take. But you won't be able to take a loan to pay for your own retirement.
Read more: Investors' Tips for Juggling Multiple Investing Goals
Pitfall number four involves not bumping up your retirement savings contributions when you get a raise.
This is one of the most painless ways to increase your savings rate. If you do bump up your contributions along with your earnings, you will be putting money into the account without ever having seen it. So it's a very nice and painless way to increase your savings rate.
Also, if you don't bump up your contributions as your salary increases, your level of consumption, your standard of living, will be going up and up, and when you get to retirement you'll expect to continue with that standard of living. However, you won't necessarily be funding that retirement at an appropriate level if you don't step up your contributions along the way.
Read more: Will Your Income Needs Trend Down as You Age?
Most folks have the message now that retirement can be an expensive proposition. Pitfall number five is not considering some of the other retirement savings vehicles that may be available to you.
It's hard to beat a company retirement plan for painless savings; your money automatically goes into that plan month in and month out. That's a great way to build the bulwark for your retirement savings plan.
But it is important to think about supplementing it with a vehicle such as an IRA or even a taxable savings account. The key reason is that you are setting aside additional funds for retirement, and you may also be able to invest in investment types that aren't available inside the confines or your 401(k) or company retirement plan.
Read more: When Should You Save in a Taxable Account?