The transition into financial adulthood hasn’t been easy for millennials. They graduated with student loans into a terrible job market. So, it’s no wonder that retirement took a back burner for many of them while they were underemployed and living in their parents’ basements.
Half of millennials don’t have a 401(k) and only three in ten are actively planning for retirement, according to a recent study. At the same time, a whopping 60 percent of millennials believe Social Security—a key retirement component—will go bankrupt before they retire, another study found.
As the employment picture brightens, millennials have a second chance to bolster their finances, including putting together a basic plan to meet their retirement goals. Here are seven common mistakes that millennials are making while planning for the future.
- They don’t have a rainy day fund.
An emergency fund doesn’t seem like part of retirement planning. But having one will keep you from dipping into your retirement funds to cover an unexpected event like a car breakdown or big medical bill.
Only one in five millennials have at least five months’ worth of expenses saved up, according to a recent Bankrate survey, even though the rule of thumb is six. “I know it seems ridiculous to have money sitting around in the bank earning nothing,” says Lynn Ballou, a managing partner with Ballou Plum Wealth Advisors “But an emergency fund is your best friend.”
It also helps you avoid costly penalties that come with early retirement withdrawals and saves you from losing years of earned interest. Think about it: a $5,000 withdrawal that would have earned 5 percent equals a loss of $35,200 after 40 years, or when you’re closing in on retirement. That’s not chump change.
- They’re underestimating their costs.
Seven in 10 millennials think they’ll spend less than $36,000 a year in retirement, or 30 percent less than what average retirees are spending now ($46,757), according to a recent survey by Generational Kinetics. That average will increase considerably with inflation over the next thirty years.
“Millennials are unrealistic about retirement,” says Wayne Copelin, founder and president of Copelin Financial Advisors in Sugar Land, Texas. “They’ll say, ‘No, I can live on less than that.’”
- They’re not saving enough.
At a minimum, millennials should be saving enough in their 401(k)s to get the full employer match if one is offered, but two in five are leaving some or all of this extra benefit on the table, according to a July report by T. Rowe Price. That’s free money and a 100 percent return on investment.
Overall, millennials should be aiming to set aside at least 10 percent to 15 percent of their salary for retirement, instead of the current 6 percent median for this group.
Consider this: A 23-year-old who saves 10 percent per year can retire comfortably at 70, or five years earlier than those saving only 6 percent. Saving 15 percent would bring the retirement age down to 65, according to a recent analysis by NerdWallet.
In 2015 and 2016, millennials can save up to $18,000 in a 401(k) account.
- They’re missing out on an opportunity to invest in a Roth.
Unlike a 401(k) or a traditional IRA, a Roth IRA or Roth 401(k) allows after-tax savings that can be withdrawn tax-free in retirement. Those are great vehicles for young savers who are likely in a lower tax bracket than they will be in retirement.
“The beauty of being younger is that generally your income won’t disqualify you from any retirement savings tool,” says Craig LeMoine, a professor of financial planning at The American College in Bryn Mawr, Pa.
Roth accounts also offer some tax flexibility for withdrawals when paired with more traditional retirement accounts. For example, if withdrawing from a traditional IRA or 401(k) would push you into higher income bracket, then you could withdraw the money from a Roth account instead.
This year, millennials can put a total of $5,500 in a Roth IRA, a traditional IRA or a combination of the two.
- Their investment mix is too conservative.
Perhaps because they witnessed the carnage in the stock market during the financial crisis of 2008, millennials are risk-averse investors, to the detriment of their retirement savings. While 85 percent of millennials are saving for retirement, only a quarter of them own stocks, a Bankrate survey this spring found.
“Staying out of stocks is a mistake,” says Joshua DeJohn a financial advisor with Waterstone Financial Services in Pittsford, N.Y. “You need to have long-term exposure to equities in order to grow your assets.” That’s because stocks offer bigger returns over time, so the growth in your savings can outpace inflation.
Use an online asset allocation calculator to determine an appropriate blend of stocks and bonds for your risk tolerance, or select a target-date fund that will automatically rebalance investments to become less risky as you approach retirement.
- They’re putting too much money toward their kids’ education.
Since many millennials are still paying off student loans, they know first-hand the burden that college debt can be in the early years of adulthood. To shield their children from this strain, millennials are increasingly over-investing in their children’s 529 college accounts at the expense of their own retirement.
Millennial parents want to cover on average three-quarters of their children’s college costs, and half want to pay the entire bill, according to
a Fidelity report in September.
Fund your retirement first, because you can’t borrow to pay for your golden years. Then help your children select an affordable college and a major that provides a decent return on investment to pay back any student loans.
- They’re betting on an inheritance.
Some millennials may be too optimistic about a potential inheritance. One in ten millennials expect to be gifted their retirement, according to a September study from Insured Retirement Institute and the Center for Generational Kinetics. But a quarter of their Baby Boomers parents believe it’s better to spend all your money and let the next generation create its own wealth, according to an HSBC report released last year.
Even Boomers who want to leave money to their millennial kids may have trouble doing so, given their own retirement planning shortfalls. “
“Boomers are spending more money because they’re living longer and they’re healthier,” says Lauren Locker, head of Locker Financial Services in Little Falls, N.J. “They’re still trekking around and traveling in their 80s. I’m not sure there will be anything left for the millennials.”