We’ve all heard the dismal retirement statics for the millions of baby boomers now hitting their mid-60s. By one measure, nearly half the boomers are “at-risk” of not having enough income in retirement.
The Employee Benefit Research Institute reports that 47.2% of the oldest boomers are in danger of running short, while for younger near-retirees, it’s 43.7%.
Unsurprisingly, more than 70$ of lower-income households are projected to have retirement shortfalls, but even 41.6% of middle-income households are “at-risk.”
Retirement income is a tough problem, one beset by many unknowns: your longevity, your health, the performance of investments, and the economy. Unless you have several million dollars free and clear today (very few people do), the question of retirement income is a serious one.
Here are the biggest retirement planning disasters most people make and how to avoid them.
Disaster No. 1: Aiming for a Number Without Understanding Reality
A lot of the focus on retirement saving in the past few years has been on reaching the “number” you need to retire. However, that can be a trap, says Kris Carroll, a chartered financial analyst at Carroll Financial Associates in Charlotte, North Carolina.
“A lot of retirees and near-retirees look at their investments too frequently and get focused on the total amount, sometimes on a daily basis. That’s a lot of emotional capital tied up in the daily random moves that investment markets tend to make,” Carroll says. “You’ll be a happier person if you look less often.”
Yet the real trouble is focusing on a single number that you need to hit or have hit in order to retire in the first place. For example, many people think that $1 million is enough to retire comfortably and enjoy your lifestyle.
But what happens if you hit that goal, then the market drops for a few years? You make start thinking about going back to work.
“It is easier to delay retirement by one year than to go back to work three years later. Give yourself some room for error,” Carroll says.
Disaster No. 2: Far Too Rosy Projections
If you plan conservatively and careful, you can enjoy a long and prosperous retirement - even if the market is down, says Elle Kaplan founding partner of LexION Capital Management in New York.
The key is not to make big assumptions about your investing returns.
You’d never get in a car without an idea of your endpoint and think “I hope I just end up in the right place,” Kapan explains. You would, of course, carefully choose your destination and the best route to get there. Your financial life is no different, Kaplan says: You need a retirement road map that is customized to fit your individual situation and goals.
“Every assumption you make should be extremely conservative,” Kaplan says. “Plan like you’ll live to be 100, and make contingency plans for everything.”
Your plan should take into account all the factors that might affect you in retirement, like each and every one of your anticipated expenses, what you’ll be receiving in Social Security, what if your health deteriorates significantly, etc.
“Your savings become your paycheck and must last the rest of your life,” she adds. “It’s easy to find ways to spend extra money but much more difficult to deal with a shortfall.”
Disaster No. 3: Confusing Your Future With Your Parents’ Past
Boomers need to know this is not their parents’ retirement, says Tom Scanlon, a certified financial planner in Manchester, Connecticut.
“Many of our parents had a pension plan when they retired. Now pensions are mostly limited to federal, state, and municipal workers. Boomers that want a fully funded retirement need to know they are on their own,” he says.
That means having planned, saved, and invested to have that fully funded retirement by taking advantage of a 401(k) Plan and both traditional and Roth individual retirement accounts.
Along with Social Security, private retirement funds will provide a basis for retirement income, Scanlon says.
If the plan is funded correctly, many retirees are better off waiting until full retirement age before collecting Social Security, Scanlon advises.
Additionally, people who are about to retire should consider downsizing their large homes sooner rather than later because it will cut down on monthly living expenses.
You should also consider working part-time during retirement. “The extra income will be nice to have, but staying active and engaged is a huge benefit,” Scanlon says.
Disaster No. 4: Putting All Your Retirement Plan Eggs in One Tax Basket
Americans play a lot of taxes during their workings years - Social Security and Medicare taxes, income taxes at the state and federal levels, real estate and investment taxes, and so on. Some of those taxes can be deferred and some not, so the key to a strong retirement income is being able to control those tax rates.
Retirement savers thus should seriously consider opening a Roth IRA, says Michel Clarke, a certified financial planner in Orlando, Florida. Have some money in a tax-deferred account such as an IRA or 401(k), Clarke says, and some in a Roth.
You can withdraw money from the Roth IRA without paying taxes on it, because you made the original contribution with already-taxed income.
“We have all heard we should diversify our investments. Believe it or not, it’s the exact same thing with your future tax liability,” Clark explains. “When you use both Roth and pre-tax accounts, you are diversifying the taxes that you are going to have to pay in the future. You are going to have some taxable accounts, and you are going to have some tax-free accounts. This will give you options in retirement.”
If tax rates are high in a given year, Clark continues, then you take tax-free distributions from your Roth instead. If halfway through retirement your tax rates drop (say you move to a state with no income tax), you can take taxable distributions from your tax-deferred accounts.
“Having both accounts will allow you to play around with your tax bracket,” he explains.
Disaster No. 5: Assuming a Rule of Thumb Applies to You
A lot of financial advisers assume that a retiree’s spending will go up by the rate of inflation, yet a J.P. Morgan study found that man costs such as clothing and meals go down and really on medical spending consistently rose, says Neil Brown, a certified financial planner in West Columbia, South Carolina.
“Their spending did not go up as much as people assumed. Your health-care is going to rise, and your other spending is going to fall,” Brown says. “If you don’t spend as much, the amount you need to save will be lower.”
The longstanding rule of thumb was to spend no more than 4% of your portfolio annually if you wanted the money to last. But in today’s near-zero-interest-rate world, that is now more realistically 3%. There are other things you can do to manage spending, like moving to a tax-friendly state for retirees and delaying Social Security.
“You can add 10% to 20% to Social Security with planning. It can add two or three years to your retirement planning,” Brown says. “If you have other assets, it’s usually a good decision to delay Social Security.”
Asset allocation matters, too. “If you don’t need a lot of risk to meet your goal, you don’t need a lot of equities,” he says. “Don’t under-save and retire early and then take on a risky portfolio because you didn’t have the discipline to reach your goals during your working years.”
Nevertheless, as you get older, equities can play a growing role, Brown says. “Be conservative in the first year you retire, but add 1% or 2% in equities as you age. If you have a big loss early, it hurts more than having a big loss later,” he says.
Disaster No. 6: Ignoring What May Be Your Single Greatest Asset, Your Home
Most people have heard of a home equity conversion mortgage, often called a reverse. But a few realise how powerful it can be as a standing credit line, says Bill Parker, a CPA and reverse mortgage specialist at Wallick and Volk mortgage bankers in Scottsdale, Arizona.
“One of my favourite uses is when one spouse has taken out a single-person pension payment, set up a home equity conversion mortgage early, let it grow at government-guaranteed rates, and then we use it to supplement the income fo the surviving spouse when the pension receiver passes away,” Parker says.
The key is that, by federal law, the unused portion of the credit line grows at the same interest rate as the loan. You could compound interest over several years until you really need the cash flow to live on down the road.
“Over 15 years, a $200,000 line of credit can grow to $400,00, and it’s guaranteed by the government,” Parker says.
Unlike a home equity line of credit, the value of your house has nothing to do with it.
“I think over time, more financial planners are going to start using it as a planning tool,” Parker says. “Imagine if you could avoid taking out Social Security and instead use the line of credit, then at age 70 get full Social Security Benefits. This will help millions.”
Disaster No. 7: Making Too Many Decisions in a Short Period of Time
One of the problems facing near-retirees is “decision fatigue,” says Douglas Goldstein, a certified financial planner and co-author of Rich as a King: How the Wisdom of Chess Can Make You a Grandmaster of Investing.
In short, they put off retirement planning, then try to make too many decisions in a short period of time - even in a single day. The end result is that they wind up making poor choices.
You run into this tactic in everyday lids, Goldstein points out. “Car salesmen are trained to walk you through a series of decisions in which you are likely to choose the default option, like worthless anti-rust coating.”
Eventually, the brain simply turns off as fatigue builds.
The same thing can happen with investment and retirement planning, Goldstein warns. When people have to make too many decisions late in the day, for instance, they tend to be too conservative.
In the case of investors, they will invest for income when they should be investing for growth. A good financial planner will not force too many decisions too quickly on people who are planning for retirement for precisely this reason.
“A retirement plan is a great tool, but make your investment decisions when you’re fresh the next day,” he says.
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