By Daniel Cohen
There are many variables to consider when planning your retirement. It is best to start planning for retirement years if not decades ahead of time. Considering that life expectancy today exceeds 79 years, it is important to plan things right because mistakes, especially early on, can have a material effect on your quality of life for many years in the future. A 65 year old today can expect to live another 19 years to age 84. There are many possible mistakes one can make in planning for retirement. Following are some of the mistakes that can be avoided by planning and being properly educated.
Retiring Too Early
Retiring too early is a mistake some make. Unfortunately, some leave the labor market out of no choice of their own and remain unemployed or underemployed for the remainder of their working years. However, some choose to take an early retirement and pursue other interests. It is often tempting to take an early retirement payout from an employer, but often it is better to let retirement benefits continue to compound while earning additional income. After accumulating a large amount in a retirement account, some leave the workforce thinking that balance will sustain them for the rest of their lives. What they often miscalculate is a safe withdrawal rate that would ensure they don’t outlive their money. Others sell their business, settling for an amount they think will allow for a comfortable retirement without first confirming what amount is enough to sustain them in the lifestyle they want in their older years.
Timing of Social Security
While many people look forward to receiving monthly Social Security checks at age 62, it is often far more prudent to wait until full retirement age which is age 66 or 67 depending on the year you were born. At age 62 you receive at least 25% less than if you waited until full retirement age. If you postpone collecting retirement benefits beyond your full retirement age, you will increase your benefit by 8% each year you wait up until age 70. The decrease for filing early or the increase from filing later is permanent, so it will affect you for rest of your life. There are many online calculators to help you decide when to file. For two person households, there are many strategies to consider to maximize the income from social security and whether one spouse should claim early and the other late. There are other more complicated strategies. Some retirees are encouraged to delay collecting social security until age 70 even if they are not working, particularly when they have investment funds to cover their living expenses until they reach that age.
Failing to Consider Inflation
According to government statistics, inflation is relatively low. However, government statistics may not seem to apply to your household. The inflation in the cost of milk for my three kids is off the charts. When planning for retirement, the risk of not planning for inflation may be your biggest mistake. You may be comfortable with the income you are able to earn after retiring, but will your income grow so that 10, 20, or even 30 years later you are able to maintain the same standard of living. Fewer people retire each year with a pension from their employer, and, unfortunately, many of those pensions that still exist do not have an annual adjustment for inflation. Investments need to be made that have a history of protecting against inflation.
Too Much Fixed Income.
For prior generations, retirement was a time to invest one’s money in conservative investments that produced a fixed rate of income. Most people retiring today cannot live comfortably off the income being offered by government bonds and certificates of deposit. However, many planners and online planning tools still recommend large allocations to fixed income as the investor ages. These recommendations seem to ignore the negative effect of rising rates on the value of a portfolio, and rates are likely to rise in the coming years if not decades. Rules of thumb exist to subtract one’s age from 100 or 110 to figure the amount to invest in equity investments. Rules like these are likely to create portfolios that will under-perform and not provide for the income needed by retirees.
We would all like to believe that, like fine wine, we all get better with age. This is not necessarily true when it comes to investing. There is an old Swiss proverb that says, “Money is harder to hold on to that it is to earn.” Many people accumulate much of their wealth in 401(k) accounts and usually the only choice while employed is to invest in the mutual funds that their employer chose for the plan. In retirement, there is no limit to how that money can be invested, and some choose to invest on their own by trading stocks and often end up losing by not following proper strategies to protect their money. They forget that the mutual funds in the 401(k) were broadly diversified and professionally managed. Also, once a retiree has full access to their money, they may decide to invest in a business opportunity or real estate venture without fully understanding the risk and how to limit their exposure to loss. Warren Buffett has two rules for investing; #1 is “Don’t lose any money” and #2 is “Don’t forget rule #1.” Once again, financial planners are there to help retirees avoid making mistakes. Risking money, especially as we get older, is not something to take lightly.
High Cost of Guarantees
The sales pitch is appealing to many retirees. You can buy a variable annuity, index annuity, or some other financial product that guarantees a certain return with little or no downside risk. The problem with many of these products is that they can be very expensive or the upside potential is so limited that the owner will not realize the long-term potential of investing in the markets. Also, the appeal of investing in certificate of deposits with the FDIC guarantee is attractive but is the rate earned enough to justify the lower long-term return expected by staying in a guaranteed investment? The guaranteed rates on most financial products do not adjust for inflation which is another factor to consider. Once again, it is very important to consult with a professional in order to make an informed decision on any long-term investment, and that professional should not only be able to offer insurance products to their clients.
Underestimating Healthcare and Long Term Care Costs.
A significant risk to your financial wellbeing is unexpected medical and long-term care expenses. There is a high cost for healthcare once you leave the workforce and no longer receive benefits under your employer’s policy. Medicare starts at age 65 so consider that when deciding on the timing of retirement. Also, the annual cost of care in an assisted living center can easily pass $100,000. If one spouse needs long-term care for an extended period of time, the surviving spouse can be left with a significantly reduced retirement fund. With proper planning, these factors can be considered well ahead of time so that a financial burden isn’t created. We all hope to live long healthy lives. Unfortunately, most of us will need increasing medical attention as we age. Suffice it to say, proper health insurance and even long term care insurance should be fully explored in any well thought out retirement plan.
Comprehensive financial planning is needed at all stages of life and especially for the planning associated with retirement. Proper planning well in advance of retirement will allow for a smooth transition from your working years to your retirement years.