Preparing for retirement is an interesting process. It involves making countless decisions for the future without entirely knowing what that future will entail:
What will the stock market be doing the year you finally decide to retire? Will you still have the same goals you do now? Or will you have unexpectedly developed an unbridled passion for deep-sea diving? Only time will tell.
While some amount of uncertainty is unavoidable, there are things you can do to support best possible outcomes now. Over the years, we've noticed a few common mistakes made among individuals planning for retirement. Some of these you've probably heard about in the media. Others may be more surprising. But ALL can, and should, be avoided!
In this article, we'll help you do exactly that by revealing the 8 most common mistakes that can diminish retirement lifestyle. Let's get started:
Mistake 1: Not Maximizing Savings
According to a 2016 Time Magazine article, an astounding 1 in 3 Americans have saved $0 for retirement. And a surprising 56 percent have saved less than $10,000.
Credit card debt, student loans, low wages and the need to save for college are all commonly listed grievances. While most of our clients don't fall into that 56 percent, many are surprised to learn they still aren't fully maximizing savings. Here are some common culprits:
Not Taking Advantage of 401(k)s
If your employer provides a matching 401(k) you should ideally be withholding the maximum contribution value from each paycheck. Who doesn't like free money, right?
Additionally, for higher-income households, a 401(k) may be your only option for deducting contributions from taxes. If you are eligible for a work retirement plan, the ability to deduct contributions to a traditional IRA begins to phase out for single workers once they reach $61,000 or more in annual income. For couples, that phase-out begins at $98,000.
Another benefit? The generous contribution cap. Workers can invest up to $18,000 per year in their plan in 2016. Those older than age 50 can put in an additional $6,000 per year. Conversely, traditional IRAs, limit annual contributions to $5,500 for workers under age 49 and $6,500 for those age 50 or older.
Withdrawing Savings Too Early
According to one recent survey, three in four respondents didn't know how much they could safely withdraw from their savings accounts annually. While experts have long advised withdrawing at a rate of 4 percent or less per year, recent low-interest periods have made many reconsider.
If you are withdrawing at a rate of 6 percent per year, and you risk depleting your next egg within a decade or two. At RSWA, we've seen our best results by taking a cautious approach, lowering return expectations for bonds in such a low yield environment so we take a cautious approach on return expectations. Working with a capable advisor can help you determine a safe withdrawal rate.
Ignoring Business Ownership Savings
Business owners have many special savings opportunities that aren't available to regular employees. One less frequently explored opportunity is cash-balance pension plans. These plans have high limits that allow large amounts of cash to be stockpiled each year. Depending on the structure of your company, you may be able to fund your cash-balance pension plan with up to $245,000 in one year.
Another noteworthy option are defined benefit plans where the contributions are defined instead of the benefits. The benefit is usually a monthly benefit defined by a formula based on the employee's length of service, salary, age at retirement and other factors. Potentially large amounts can be contributed on behalf of the employee but benefit amounts are subject to limits.
Finally, business owners should explore SEP-IRA or Simplified Employee Pensions (SEP). Not only does the plan allow higher contribution limits than Individual IRAs, but it does so with less complexity and costs compared to its defined benefit counterparts. Of course, a qualified financial advisor can help you determine which plan would be best for you.
Mistake 2: Not Setting Clear Retirement Goals
While most people desire a mix of relaxation, purpose and play within their golden years, few can describe what that actually looks like.
Though you needn't map out every trip, hobby and event – you do want a general idea of where you're heading. For most individuals, setting retirement goals falls into two categories: mental preparation and financial preparation. Though the majority of this article focuses on the latter, the former is equally important.
If work has been a large part of your identity, determining what you'll focus on next will be all the more important. Will you continue to work on the side for personal enjoyment? Or will you devote yourself to latent hobbies? Suddenly having a ton of free time may sound like a dream come true, but the reality of such a large change is often different than expected. Check out AARP's Life Reimagined for free online tutorials on goal setting and career planning
Other important questions to ask:
When do you want to retire?
Where do you want to retire?
What will you do in your free time?
How much will the answers to each of these questions cost?
Finally, don't forget to factor in estimated healthcare and living expenses. A simple Google search will deliver a variety of retirement expense calculators online. These are a great starting point, but keep in mind their capabilities are limited: Large out of pocket costs for coinsurance, private nursing and experimental procedures are not always factored. Additionally, many calculators integrate Long-Term Care insurance, whether you have it or not.
Mistake 3: Making Bad Investments (Trying to "Beat the Market")
No matter how much data discourages the chasing of hot returns, there always seem to be people who want to do it. Whether it's the thrill of the hunt, or the possibility of getting lucky, many investors waste significant time and finances trying to beat the market.
In our 20 years of experience, it's never a good idea. And that's because it's nearly impossible for an investor to consistently "beat" an market over long periods of time. Taxes, trading costs and various fees add up quickly – causing most investors to simply hope they break even.
According to Dalbar's annual Quantitative Analysis Of Investor Behavior study, despite “guessing right” 67 percent of the time, the average mutual fund investor was not able to come close to beating the market based on the actual volume of buying and selling at the right times. Translation: Work with the market; not against it.
Mistake 4: Avoiding The Markets Altogether
Many of our clients are surprised when they learn NOT investing is just as risky as investing itself. That's because decades of data indicate certain predictability factors when it comes to certain investment decisions. While nothing is ever "a sure thing," leaving money in the bank is a sure way NOT to grow your nest egg.
If we assume 3 percent inflation per year and cash-earning zero interest, that translates to a 3 percent loss in purchasing power per year. Multiply that over the next 25-30 years and you're looking at a wad of cash that is potentially 50 percent less valuable than it is today.
Mistake 5: Underestimating Post-Retirement Expenses
Most retirees underestimate how much they will spend within the first 5 years of retirement. This is often due to a mixture of meeting the unknown and excitedly trying to do many things at once. Exotic vacations, traveling to see grandkids, purchasing sports cars – it's especially easy to overspend when you believe you're "well set-up." To prevent over-confidence in funds, you'll want to accurately estimate expenses in the following categories:
General Living: How much does it cost for you to live? Which of your current expenses will continue into your retirement? Food, utilities, and other basic expenses must all be carefully considered.
Healthcare Expenses: How will your healthcare costs change post-retirement? Will your company health care plan still cover you in retirement? Will Medicare be enough or will you need to supplement it? Are your prescriptions covered by Medicare? Will you invest in long-term care insurance?
Familial Expenses: Do you have children? If so, you may want to factor them into your post-retirement expenses. Job loss, career changes and additional educational requirements may all contribute to a desire to financially support your family post-retirement.
Aspirational Expenses: How much will those fun, lifestyle activities really cost you? If you're planning on doing a lot of traveling, factor in ALL of the associated costs. If you're planning on starting a business, also factor in ALL of the associated costs. Again, an experienced advisor can help.
Mistake 6: Not Considering Location in Your Retirement Strategy
Always wanted to live in Florida? Or maybe the mountains are more your style? Moving to another state during retirement requires careful planning. Costs of living can vary dramatically – even from one city to the next. Everything from the cost of mortgages to groceries to plane tickets (for visiting family) should be considered.
Tax differences in different locations should also factor into your decision making process. Income taxes in particular vary dramatically by state. Additionally, property taxes on the type of home you purchase can also ramp up taxes. For example, may towns charge a higher tax rate for waterfront homes.
Overlook these calculations and at best, you'll run the risk of surprise – What? It's going to cost how much to live there? – at worst, you'll run the risk of having to stay home.
Mistake 7: Improperly Handling Illiquid Investments
Many future-retirees underestimate the complexity of preparing illiquid investments for retirement. An illiquid investment is anything of ownership that is NOT immediately spendable. The most common of these are secondary homes and familial businesses (though overlooked life insurance policies are also common). Obviously, each of these will ultimately need to be sold to obtain liquid value. And selling valuable illiquid investments takes time!
Additionally, you may assume your home will sell for X amount, but when was the last time you had it appraised? Overestimating the value of our prized processions is common for all of us. So, it's important to partner with a non-biased, third-party when handling illiquid investments.
Mistake 8: Not Having a Qualified, Trusted Financial Advisor
Finally, the most unfortunate mistake of them all – not having a qualified financial advisor whom you can trust. Notice, we said trust. Finding an advisor who has your best interest in mind, clearly communicates without industry jargon and holds similar values is imperative. Not just to your peace of mind, but to your bank account.
Many of our clients come to us after having worked with other, larger firms. As cliche as the saying goes – I felt like just another number – that's exactly how our clients have described their previous advisory experiences. Beyond reviewing credentials, understanding legal standards and conducting background checks, many future-retirees forget to ask one simple question: How are you compensated?
Little known fact: Not all advisors are required by law to place your interests above their own. Understanding if a financial advisor expects to be compensated directly by their clients or by the products they sell is important. Additional questions to ask include: Are you an employee? Can you only sell or present "approved" products and investments from your firm? Or can you act independently? Does the firm expect them to sell certain products?
Good advisors exist in many different business structures, but working with one who can't independently make recommendations on your behalf is perhaps, the biggest mistake of them all.
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