Avoid These Mistakes When Saving for Retirement as a Low-Income Earner

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If you don't earn a lot of money, it can be hard to keep on top of your bills, never mind save for retirement. Sadly, that's the situation a lot of Americans find themselves in. Sky-high living costs have made it harder than ever for earners at the lower end of the scale to save for their old age.

The number of low-income households who manage to invest is shrinking. Back in 2007, about 1 in 5 low-income households had money in a retirement account. Fast forward to 2019 and that figure had halved, according to research from the Government Accountability Office. Just 1 in 10 low-income households had retirement savings in 2019.

If you aren't sure how to save for your retirement, here are some mistakes to avoid.

1. Ignoring the future

If you are juggling bills just to keep your head above water, the idea of carving out extra money for your old age can feel overwhelming. Unfortunately, Social Security benefits may be even less by the time you retire. And ignoring the problem won't make it go away. On the flip side, even small contributions today can make a difference.

What you can do.

Sit down and make a realistic plan. For example, see if you can contribute 1% of your income to a retirement account. The magic of compound interest means even small amounts can build up over time. Plus, once you have an account and are in the habit of putting money into it, you can gradually increase your contributions.

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Compound interest is essentially earning interest on your interest. To give you a very rough idea, let's say you invested $500 today and left it alone. There are no guarantees, but it isn't unreasonable to think it might earn annual average returns of 8%. In 20 years, you might have over $2,300. In 30 years, you could have over $5,000.

2. Not claiming tax breaks

Many low-income families miss out on tax credits, which is money that could go toward retirement. For example, the IRS says about 24% of people did not claim the Earned Income Tax Credit they were entitled to in 2020. It's a refundable tax credit, so if it takes your balance below $0, you could actually claim a refund. Plus, it's only one of several credits out there.

In addition to tax credits, the government offers tax breaks to certain types of retirement contributions. Tax advantaged accounts can translate into more money for your golden years.

What you can do

Find out if you're eligible for the IRS's Volunteer Income Tax Assistance. It's free for low income and other groups and will give you expert help in how to file, as well as what tax credits you might qualify for.

In terms of getting tax breaks on your retirement savings, find out if your employer offers a 401(k) and how it works. In addition to tax advantages, if your company will match your contributions, this could be a big boost for your fund.

That said, many people don't have access to a 401(k). If you're one of them, consider opening an individual retirement account (IRA). IRA contributions can either reduce your taxes now or give you tax-free withdrawals in your old age. Whichever route you go, it's also worth looking into the Saver's Credit. It's another tax credit that rewards lower earners who contribute to their retirement accounts.

Finally, if you receive SNAP benefits, know that money in an IRA or 401(k) account does not count toward your total assets. So you can save for retirement and still qualify for food assistance.

3. Thinking short term

Making short-term investment decisions is a common mistake, no matter how much you earn. This might involve panic selling when the market is falling, rather than waiting for it to recover. Or buying into an investment based on a fear of missing out, without fully understanding the pros and cons of that asset.

What you can do

Broadly speaking, the idea behind long-term investing is that you buy assets that you think will do well over the coming decades. It's important to have a plan, which includes some idea of when you might retire. It's also good to have an emergency fund. If you lose your job or face another financial emergency, that fund will mean you don't have to dip into your investment money.

You don't need to have a lot of knowledge about the stock market to invest for the long term. If you don't have a lot of cash to spare, avoid high-risk assets such as crypto. Sure, they might go to the moon. But you might also lose everything.

Instead look for relatively low-risk investments. That might take the shape of an exchange-traded fund (ETF), which tracks an index such as the S&P 500. This gives you exposure to the biggest 500 publicly traded companies in the U.S. and historically has produced decent returns. It also means you don't have to spend time researching individual stocks.

Bottom line

If you are a low-income earner who's trying to save for retirement, congratulations. It isn't easy to prioritize your future self over the financial demands of today. Research tax credits and other assistance that might boost your retirement savings and try to keep a long-term perspective on your investments.

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