A financial reporter recently asked me about the biggest mistakes that I see in retirement. That got me thinking because in the nearly 24 years I have been helping people with retirement planning, I have seen quite a few mistakes. Here are the ones I believe hurt people the most:
One of the biggest mistakes I have seen is people retiring too early because they assume they are going to spend less in retirement. They may base this misconception on some rule of thumb they read on the internet, yet these days almost every single retirement-planning rule of thumb is incorrect or misleading.
One of the most dangerous rules of thumb is that in retirement you are going to need only 70% of what you earned during your career. Why would you need so much less? Are you going to spend your retirement sitting in the rocking chair on the front porch? Absolutely not.
When people retire, what do they do? For one, they start crossing off their bucket list items—travel, a second home, cross country in the RV, heli-skiing, or whatever their dream may be. So, actually, many people spend more in their early years of retirement. Later in life, the frequency of travel and other retirement activities usually decline, so as retirees move into their 80s, they end up spending less than when they initially retired. However, in their mid-80s and onward, expenses start to increase once again because of health care costs.
So the spending is not linear, and you are probably not going to spend less over your entire retirement. You must adopt the idea that retirement spending is shaped more like a smiley face rather than a steady increase of a fixed amount tied to inflation.
Another big mistake is that most online calculators fail to include any tax assumptions or calculations. Most people don’t realize that 401(k)s, low-basis stocks, mutual funds, and exchange-traded funds (ETFs) come with a liability: a tax bill!
Every retiree’s situation is different based on the mix of account types. A person with 100% in a 401(k) has a much higher potential tax liability than a person with a mix of cash, stocks, Roth IRAs, and 401(k)s.
Because of these issues, we at NewFocus are working on releasing a better calculator. It will offer more realistic projections using critical but often overlooked factors such as taxes and inflation. Say you have $1 million in your 401(k) or IRA. A lot of online calculators will not show that with that $1 million comes a large liability because you have not paid taxes on the money. Or consider restricted stock unit shares that you have held over an extended period; you are going to pay taxes when you sell those.
Many people punch their portfolio values into online retirement calculators that do not account for taxation in general and definitely do not account for it on a state-by-state basis, like California, Oregon, or other states that have income taxes.
People often assume all their health care costs will be covered once they get on Medicare. They forget about the costs involved with Medicare Part B, supplemental insurance, copays, dental work, and prescription drugs. They also forget to factor in $600 a month—at minimum—per person in average health care costs growing at 5% inflation.
Retirees tend to invest in products with very high fees—products such as loaded variable annuities and private real estate investment trusts that may have up to 14% upfront fees.
The products sound great because the salesperson does a fantastic job in presenting the bells and whistles, guarantees, and options. They sound so good, in fact, that people do not read the giant prospectus that comes with the product.
Only after do they realize that they have invested 50, 60, 70, and even 80% of their retirement account in a product that has underlying fee structures of 3% a year, which is what some variable annuities that offer guaranteed income for life charge.
Keep in mind you can find no-load versions of these variable annuities that are OK for a portion of your portfolio—maybe 20 to 25%. But the problem is that people are rolling entire retirement plans into products loaded with high fees.
That is a mistake that has cost people five to 15 years of retirement income in some cases.
Another mistake is failing to plan for Social Security and taking it too soon. If you wait to receive Social Security benefits from your full retirement age to age 70, you effectively get an 8% rate of return on your money as long as you live to your mid- to late 80s.
For most people, the present lifetime value of their Social Security income is over $1 million. So it pays to make wise decisions when it comes to Social Security.
Perhaps the most significant mistake is not having a withdrawal strategy in retirement. A withdrawal strategy—which I call the 3-5-7 Plan—is centered on the idea that you carefully calculate your overall expenses, including taxes, health care costs, and inflation. Then you subtract dependable income, such as Social Security, pensions, and maybe real estate rental income from long-term-held properties.
The number you come up with is the amount that you draw from your portfolio each year, and this is the number of your annual withdrawal amount. I suggest retirees need three years’ worth of that amount in safe money (e.g., CDs, FDIC-insured money market). You also need a rebalancing strategy to constantly feed that safe money account and replace what you have spent when the market gives us positive returns.
This strategy helps you through one of the biggest risks of retirement: the order of stock market returns, meaning whether the good returns come first, second, or in the middle, or the bad returns come in the beginning or in the end of retirement.
Being aware of those common retirement mistakes is important. Make sure you have a financial plan, and get some professional advice. Consider going to a fiduciary, fee-only CERTIFIED FINANCIAL PLANNER™ professional who is not selling high-fee products.