No matter how bright you are, you aren’t immune to financial mistakes.
It’s not always easy to apply financial information to your unique situation. Even the best and brightest can’t possibly know everything.
The four common financial mistake that even smart people make are never planning to retire, ignoring year-end tax planning, waiting too long to withdraw from their IRAs and 401(k)s, and not updating their estate plans.
Here are details on these mistakes, and how to correct or completely avoid them.
1. Planning Not To Retire
“I’ll never retire” is a phrase often heared from professionals and business owners who love what they do for a living and can’t imagine doing something else.
In fact, research by Pew Charitable Trusts pegs one in five Americans as “never planning to retire.” The problem with this is sometimes things outside of our control get in the way. You may be forced to retire for health, personal, or economic reasons. For example, a business owner I know recently developed an illness that requires treatment that saps his energy. He never thought he’d get sick at age 62, but he did. He has changed his mind about his long-term plans and would love to sell his business and retire so he can focus on his health, his family, and his hobbies.
Unfortunately, he has painted himself into a corner. The buy/sell agreement he has in place with his two partners only addresses the death of a partner, not disability or simply “wanting out.” Even though they are receiving offers to sell, the timing isn’t ideal for his other partners, so they aren’t interested. So he is still working.
Even if you love your job and can’t see yourself doing anything else, work with a financial planner to determine when and if you can retire, so you have the option. If you are a business owner, consult with your attorney to review your succession plan and buy/sell agreement. Make adjustments as needed.
2. Ignoring Year-End Tax Planning
According to IRS data, over 12 million taxpayers asked for an extension to file their taxes last year. This extension simply gives the taxpayer more time — six more months — to complete his or her return.
While you may put off filing your taxes in a given year, don’t put off thinking about tax strategies in the current year. Once the tax year has ended, it’s often too late. Instead, start now and at minimum, review your potential tax liability in the last quarter of the year, when you might still have time to do something about it.
For example, a man has not filed extensions but instead has blown past the deadlines and is still working on taxes from prior years. Since he doesn’t pay attention to tax planning for the current year, he might have missed out on opportunities such as:
- Harvesting Tax Losses
- Bunching up itemized deductions
- Converting IRAs to Roth IRAs in years when his income is lower or he has business losses
- Strategically planning his charitable giving
Develop a comprehensive tax strategy by meeting with your CPA and financial planner throughout the year, not just at tax time.
3. Waiting Until They Are 70½ To Withdraw From Their IRAs And 401(k)s
The IRS has been waiting patiently for you to withdraw funds from your tax-deferred savings, since that money will then be taxable. When you turn 70½, the IRS requires you to start withdrawing your funds — not all at once, but over your life expectancy. (Here is a relevant worksheet from the IRS website.)
They mean business, though, and levy a 50% penalty on what you fail to withdraw after that deadline. That’s a pretty hefty fine, if you ask me. The question is, why wait until 70½ to take out the funds?
It might be a good time to withdraw from a qualified plan when your tax liability is lower, even if you don’t need the money right then. Funds from a traditional IRA or a 401(k) are taxed at withdrawal. You can withdraw money without a penalty at age 59½ for an IRA or age 55 (under some circumstances) for a 401(k).
Eventually, you or your beneficiary will pay taxes on those qualified funds, so in years when your income is lower or you happen to have a lot of tax deductions, why not take withdrawals then? You don’t have to spend the money right away, since you can always reinvest it.
When planning retirement income withdrawals, work with your qualified tax advisor, CPA, and financial planner to determine the optimal withdrawal strategy based on your needs and goals. Don’t just wait until the IRS requires you to withdraw the money.
4. Not Updating Their Estate Plans
What were you doing five years ago? Have there been any changes in your life? I’ve seen quite a few changes in mine in the past five years. Since August of 2010, I’ve moved to a different state, took a new job, sold a home, built a home, and welcomed another grandchild. Need I say more?
We all have changes in our lives even if we are still living in the same community. Yet many of the smartest people I know haven’t reviewed and updated their estate documents in many years.
If you’ve had a meaningful change in your life, or it’s simply been a few years, consider reviewing your estate plan and making any necessary changes. Just like no matter how rich you are, there is always someone richer (unless, of course, you are Bill Gates), no matter how smart you are, there’s always going to be someone smarter.
So when planning your finances, it’s probably best to assume that even if you are pretty darn smart, you might have missed something. The smartest people I know ask for a second set of eyes on their well-laid plans.