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8 Critical Mistakes People Make When Planning for an Early Retirement

Want to retire early and not have to worry about running out of money or being forced to sacrifice your lifestyle later on? Check out this guide to avoiding the top mistakes that can ultimately derail your dreams of early financial independence.

Mistake 1:  Saving The Wrong Amounts In The Wrong Types Of Accounts

If you have access to contribute to an employer-sponsored retirement plan, you should always contribute enough to that account in order to receive the full company match. That's a no-brainer. But if you want to retire early, you need to be strategic in allocating the rest of your savings.

Too many people don't fully understand the eligibility rules and contribution limits for 401ks, 403bs, 457bs, Traditional IRAs, Roth IRAs ,HSAs, FSAs, and if you have self-employment income, SEP IRAs, Solo 401ks, and Cash Balance Pension Plans. Not getting this right could mean you are missing out on contributing to an account that could play a vital role in your retirement. Or it could mean you are making ineligble contributions to an account which could lead to you paying the IRS penalties. 

Not enough people are aware that even if their income is too high to make direct contributions to a Roth IRA, they have other options for funding a Roth bucket of money for retirement via a Backdoor Roth IRA, or if your 401k or 403b  allows, the Mega Backdoor Roth. This Roth money can be especially helpful for early retirees as the contributions (not the earnings) can be accessed at any age without taxes or penalties. And when RMD's kick in later in life, you will be glad to know those don't apply to Roth IRAs for the orginal account owner.

So should you prioritize pre-tax or Roth Savings first? It depends. I know. That's not extremely helpful. But each situation is different based on the current and future income tax rates you may be subject to, and your targeted retirement age. Generally speaking, if your top marginal tax rate now, is higher than what you expect your effective tax rate to be in retirement, it may be beneficial to focus on saving enough in pre-tax accounts now, to bring your current top marginal tax rate down to or lower than what your effective rate will be in retirement. 

Brokerage accounts should also not be ignored. This is because of they way they are taxed. Unlike a pre-tax 401k or IRA, when you take money out of a brokerage account, you pay capital gains taxes. But the IRS lets you take out a somewhat shockingly high amount while paying 0% in taxes. For example, in 2022, if you factor in the standard deduction, all of your income comes from brokerage account withdrawals, and you file married jointly, you can take out $109,250 and still be in a 0% tax bracket. That's over $9k a month in income tax free! So many people targeting early retirement will use their brokerage account assets as a bridge until they are over 59.5 can withdraw from other retirement accounts without penalty.

Mistake 2: Not Having A Written Set of Goals and Priorities:

Before you can ask what you should do with your money, you should be asking yourself what you ultimately want your money to do for you. Unfortunately, most of us don't have unlimited financial resources, which means tradeoffs must be made.  If you don't have enough in your retirement accounts by the time you want to stop working, that's a problem. On the flip side, if you are blindly throwing every dollar you have into saving for retirement, and ignoring other priorities such as travel, home updates or buying a new house, funding your children's college expenses,  etc, you may not feel fulfilled in the present. 

Real financial life planning is about figuring out how to allocate your financial resources so that you are fullfilled in the present, without risking your ability to retire early and stay retired in the future. It's extremley difficult to to do this without literally sitting down, and writing out a list of any goals you have that require money, and then ranking them. If you plan with a significant other, this can be an especially helpful exercise. You may find that you may have some differences of opinon , and thats quite alright. The idea is to come up with a plan that balances both of your priorities. Once you know which goals are most important to you, you can then determine where to prioritize your savings.

Mistake 3: Making The Wrong Decisions With Inactive 401(k)s and 403(b)s:

You can read a much more in depth article about this here, but the following is a brief summary. Too many people just assume that when they leave an employer, they should just roll it over to a personal IRA. Or worse, they get sold on this idea by a financial advisor who may not have their best interests at hear. It's important to be aware that unlike HCP Wealth Planning, most financial planners get compensated based on how much money you invest with them. This usually menas that if you keep it in your 401k, they don't get paid.  So they have a very real financial motivation to convince you to rollover your account to an IRA through them. 

But in many cases it makes sense to leave your investments in your old employer plan, or roll it to your new employer plan. You need to compare the overall costs, investment choices, and resources available in your employer plans and IRAs when deciding what to do. I have literally seen over a thousand 401ks and 403bs in my career. Some are fantastic and have funds with very low fees, ower than if you held those same funds in an IRA. Others are crappy and expensive. Taking the time to understand which category your 401k falls under could save you literally thousands or tens of thousands of dollars in fees over your lifetime. 

Keep in mind that your 401(k) or 403(b) may provide better protection against lawsuits (although in many states you either have unlimited protection in an IRA also, or up to $1 Million in protection).  There are some other factors you may need to consider as well when deciding if you should rollover such as the Age 55 rule, NUA opportunities, having access to stable value funds, etc. 

If your new plan has lower costs, and a lot of  tools and resources to help you manage the portfolio, it may make sense to roll your old plan into that.  If the opposite is true, there shouldn't be any reason why you can't keep your investments in your old plan, while at the same time start contributing to your new plan (you can't keep making contributions to an employer's plan once you stop working for them).  

If you really are self directed and prefer having access to the universe of investments instead of being limited to your employer's menu, then that could be a reason to rollover to a personal IRA.

Mistake 4: Not Properly Taking Advantage of an HSA:

One of the best ways to help prepare for healthcare costs in retirement is to take advantage of an HSA. They come with a triple tax advantage meaning you get a tax deduction when you contribute to them, the money grows tax deferred, and when you withdraw from them for qualified medical expenses, those withdrawals are tax free.  Oh yeah, and unlike an FSA, they aren't a "use it or lose it" account. You can continue to rollover the account balance year after year. Since you can actually invest in the stock market with them, the earlier you start, the better, so that you can let the power of compounding do it's thing. 

One of the biggest mistakes people make with HSAs, is they don't actually invest their contributions. They let the money sit in a cash position not really working for them. But to get the biggest benefit out of them, you need to invest them in the stock market for the long term. The second mistake I see is people spending their HSA money while they are still working. To truly take advantage of the triple tax benefit, you should treat them like a 401kor IRA and assume you won't touch them until retirement.

Mistake 5: Not Taking Advantage of Roth Conversions When Your Situation Calls For It:

Mistake 6: Not Knowing Exactly What Your Current and Future Cash Flow Looks Like:

Mistake 7: Not Planning For Worst Case Scenarios:

Mistake 8: Hiring The Wrong Financial Advisor: