Retirement is a huge adjustment for most people, mentally and socially. Your day-to-day routine changes without a job to report to, and you and your spouse have to learn to adapt to being around each other full time.
Your financial strategy also must shift when you leave work, or there can be huge consequences for your nest egg and standard of living. Here are eight retirement mistakes you should avoid making:
1. Taking Social Security Too Early
According to certified financial planner Eric McClain of McClain Lovejoy, “Don’t start Social Security as soon as you are eligible. It may make sense to delay, perhaps even draw on your other assets first.”
McClain is right. While you might be eligible to start taking your benefit at age 62, waiting until your full retirement age (FRA) which is 66 (67 if you were born in 1960 or later) results in a monthly payment that is about 30 percent higher than you would receive at age 62. If you can wait until age 70, your benefit will max out and be another 32 percent higher than at your FRA.
Also worth noting is that any cost-of-living adjustments will be based off of these higher benefit amounts as well.
Additionally, if you take Social Security before your FRA, any income earned above $15,720 (for 2015) will result in a reduction of $1 of your benefit for every $2 of income above that limit.
Also, be sure to check out some of the filing strategies available to married couples if applicable to your situation.
2. Not Investing Aggressively Enough
Retirement is not the end of your financial journey; in many ways it is only the beginning. According to the Society of Actuaries (via Vanguard Investments):
“A 65-year-old man has a 41% chance of living to age 85 and a 20% chance of living to age 90. A 65-year-old woman has a 53% chance of living to age 85 and a 32% chance of living to age 90. If the man and woman are married, the chance that at least one of them will live to any given age is increased. There’s a 72% chance that one of them will live to age 85 and a 45% chance that one will live to age 90. There’s even an 18% chance that one of them will live to age 95 …”
What this means is that you still need to invest at least a portion of your retirement nest egg for growth. What percentage and how your overall portfolio should be allocated will vary based on a number of factors unique to each retiree’s situation. However, being too conservative can result in outliving your money in retirement given today’s longer life expectancies.
3. Ignoring the Impact of Inflation
At a somewhat normal rate of 3 percent inflation, your purchasing power will be cut in half in 24 years. Given the statistics above and the fact that we are living longer, inflation is every retiree’s worst enemy.
What can you do to mitigate the impact of inflation on your retirement finances?
- Invest aggressively enough to stay ahead of inflation.
- Plan conservatively for inflation. Inflation for retirees is higher in part due to higher health care costs.
- Be prepared to adjust spending and retirement account withdrawals if needed.
4. Not Meeting With a Financial Planner for Retirement Planning Help
Engaging the help of a qualified, fee-only financial advisor for retirement advice can help both pre-retirees and those already retired ensure that they are on-track.
A financial advisor can use their experience to provide you with a detached third-party view of your situation. He or she can help you design a retirement income strategy based on your anticipated resources, including Social Security, any pensions you might have, your various tax-deferred retirement accounts and other resources.
You only get one shot at retirement, so don’t let your pride or a reluctance to spend the money deter you from getting the help you need.
5. Not Planning for Health Care Costs
A couple retiring in 2014 would need $220,000 to cover health care costs in retirement, according to a study by Fidelity Investments. This is a significant amount of money even for someone with a $1 million plus nest egg. For 2016, it is expected that there will be no cost-of-living adjustment for Social Security, yet for many retirees Medicare premiums will increase.
For those still working and who have access to one, putting money away in a health savings account (HSA) can be a great way to supplement your retirement savings and build up a portion of your nest egg with pre-tax money that can be tapped tax-free in retirement for qualified medical expenses.
6. Not Creating a Retirement Budget
A great first step for everyone approaching retirement is to establish a budget for his or her desired retirement lifestyle. Where will you live? What will you do? How much will it take to fund your lifestyle each month? Do you have the financial resources to support this lifestyle? If not, you will need to rethink your retirement. Perhaps you need to go back to work or scale back your activities a bit. A budget helps you get a handle on where you are and if you will be okay financially in retirement.
It is far better to know that you need to make adjustments than to go blissfully into retirement and spend at a rate that you can’t sustain and run out of money.
7. Failing to Have a Retirement Income Strategy
One of the most complex aspects of managing your finances in retirement is managing distributions from your various retirement accounts along with other sources, like a pension or Social Security.
Which accounts should you tap and in what order? What are the tax ramifications? How will your income affect Medicare and other benefits? The ramifications of not having a retirement income strategy can be catastrophic.
8. Not Factoring in the Impact of Taxes in Retirement
Taxes can be a huge factor in retirement. Withdrawals from retirement accounts, such as IRAs and 401ks, are usually subject to full taxation at ordinary income rates. Further, these withdrawals are added into any other income you might earn. For example, if you have $50,000 in income from other sources and withdraw $50,000 from an IRA, you will be taxed on $100,000 in income.
Looking at this another way: If you have $1 million in your 401k account, you really only have $600,000 to $700,000 in spendable cash flow after taxes.
A Roth IRA is not subject to taxes if all rules are followed, and a Roth 401k can be rolled into a Roth IRA to receive similar treatment. Pension payments are usually taxable. However, some state pensions might be exempt from state income taxes in that state. Social Security also can be taxable depending upon your income.
Annuities are taxable as well. Distributions from non-qualified annuities (purchased outside of an IRA or retirement account) will be taxed to the extent that the money being distributed is not the principal amount that you contributed. If you annuitize, there is a ratio between the amount of your premiums and the amount that is due to gains on the account. The amount pertaining to gains will be subject to ordinary income taxes each month.
If you take a partial lump sum from the annuity account, the assumption is that the distribution is from the gain portion of the account and all partial distributions will be fully taxed until the gains are used up. In a qualified annuity that is inside a retirement account, the same tax rules apply. As with any IRA, the full amount of any distribution would be subject to ordinary income taxes.
The bottom line is that retirees must take taxes into account. In some cases, there will be options as to where to take money from, and it is important that tax considerations be taken into account with all such decisions.