Retirees Be Warned: Saving Too Much For Retirement Could Cost You

Baby boomers, who are in or rapidly approaching their retirement years, are the first generation to be part of a job market where retirement savings largely fell on their own shoulders. In the 1980s, employer-provided pensions began to shift to 401(k)s, a retirement savings account that mainly relies on employee contributions. And by the 1990s, the amount of employers offering pensions dwindled even further. This change in retirement funding brought a shift in how the working class viewed saving and spending habits. Baby boomers began to place a larger emphasis on saving for the future while they were in the workforce. Now, this saving habit is ingrained in the American working culture, and moving away from it is a challenge for retirees even after they leave the workforce.

For many baby boomers and subsequent generations, it may be hard to believe that there is such a thing as saving too much, especially if you've heard that nearly half of all people who retire at 65 will run out of money. However, saving too much for retirement could cost you more than you think. Those who oversave may wind up paying more in taxes, missing out on major experiences, and even lacking the necessary cash on hand to deal with unexpected expenses as they arise.

Once retirees stop working, they must live off their income from retirement savings and Social Security. While many retirees rely heavily on Social Security, some have amassed large retirement savings accounts in the form of 401(k)s and various IRAs. Unfortunately, hefty stockpiles of cash in these accounts aren't always as helpful as they might seem, especially when it comes to taxes. Retirees must pay income tax on the money they withdraw from their 401(k)s and IRAs, and there comes a point when making those withdrawals is no longer optional. Currently, after someone turns 73, the IRS requires them to start taking money out of their retirement accounts. Missing just one required minimum distribution (RMD) can trigger a 25% penalty, but this can be reduced to 10% if the RMD is withdrawn within two years, according to the IRS.

How much you must withdraw from your retirement savings account depends on what you have in the account at the end of the calendar year before your 73rd birthday and your IRS-determined life expectancy. This means the more money you have in retirement savings, the more you must withdraw each year. This factor could seriously impact your annual income, possibly putting you in a higher tax bracket. The IRS lists the 2026 tax rate for single filers making over $105,700 as 24%, while those making over $201,775 will pay 32%. The highest tax rate is 37%, and that's applied to single filers making more than $640,600.

Money that's stocked away into a retirement account can come with steep penalties for early withdrawals. However, a recent Vanguard study found that people without sufficient emergency funds are still more likely to cash out their 401(k) accounts early despite the penalty. But the study also found that those with at least a $2,000 emergency fund contribute 2.2% more to their 401(k) and are more than 17% less likely to take a hardship withdrawal. When retirees focus solely on contributing to retirement savings accounts and forgo putting money away for emergencies, it can create a serious financial burden if something unexpected arises. These emergencies can be anything from a simple car repair to a medical emergency that drains funds over time, and many retirees are susceptible to making the emergency fund mistake of not effectively planning for these financially disruptive events.

According to Federal Reserve data, only 55% of American adults have three months' worth of emergency savings, which is a small increase from the 47% who had this amount in 2015. Keeping all your money locked away in a retirement savings account limits your access, and this can have dire and unexpected consequences for your finances because that money isn't liquid. While some retirees may opt to take out a personal loan instead of incurring early withdrawal penalties, doing that brings another added expense into the equation in the form of interest.

An excellent way to take advantage of the "pay yourself first" wealth-building strategy, which financial experts heartily endorse, is to have your employer put a portion of your pay directly into a 401(k), IRA, or other investment account. The downside to this approach, though, is that if you're setting too much aside for retirement, it could force you to take on debt to make purchases for things you need. And if you have credit card debt, which typically comes with a high interest rate, you could be paying off that debt long after you retire. As of 2022, per the Federal Reserve, the percentage of households headed by someone 75 or older that has debt — 53.4% — was at its highest level since 1992. Meanwhile 64.8% of families headed by someone between the ages of 65 and 74 were also in debt.

Taking on too much bad debt, especially as you get closer to retirement, could cost you the financial freedom you were working toward by placing so much of your income into retirement savings. Retiring with debt could set yourself up for a financial struggle that can be hard to get out of on a fixed income. Fidelity recommends prioritizing paying off debt with an interest rate of 6% or higher before focusing on retirement savings, assuming you also already have emergency savings set aside. This isn't a hard and fast rule, as everyone's financial circumstances vary, but it's something to consider as you plan for your financial future.

Staying focused on your retirement savings goal is key to having the money you need when you stop working. But saving too much could mean you miss out on doing things now that you might regret later. In a GoBankingRates article, financial planner Taylor Kovar said, "When you focus so much on pinching pennies, it can lead to missed opportunities that make life richer — like spending quality time with your spouse and kids or investing in experiences that build stronger relationships." These days, some retirees are embracing a surprising retirement strategy that encourages spending money, and it can actually increase feelings of fulfillment.

Saving money beyond what you need for retirement can bring regrets of missed opportunities, such as not making vital home improvements that would make it a nicer place to enjoy your retirement years. A savings focus can also mean you didn't take advantage of travel experiences before declining health prevented you from doing so. Often, family becomes increasingly important as you age, and some people regret saving money they could have used to help their kids pay off debt that's burdening them or buy a house without having to take out a high-interest loan. Finding a balance between saving for retirement and not missing out on living can make your life more meaningful.