You’re heading to the finish line – retirement is approaching, or maybe you’ve already retired. You’ll want to steer clear of mistakes that can derail your plans to live comfortably in retirement.
Here are the most common pitfalls to avoid:
#1: Not having a financial plan
The biggest mistake is not having a formal plan at retirement. You should meet with a comprehensive financial planner to ensure you are making informed decisions. This plan should address your cash needs in retirement based on current or expected spending. It should address social security and pension collection strategies. This includes how you will fund any cash shortfall during the year or replace income at retirement, and how to do so in a tax-efficient manner. The plan will make sure you are considering all options, even those you might not be aware of.
Since social security benefits comprise a major revenue source for most retirees, deciding when to collect is a critical part of the overall plan. You are eligible to collect social security retirement benefits at your full retirement age, which is 66 for those born in 1954 and prior. You have the ability to collect a reduced benefit prior to this – equivalent to 6.25% per year – starting at age 62. You can also delay the collection of benefits to age 70, with the benefit increasing 8% per year from age 67 through age 70. Whether to collect early or not is not a simple decision. You need to consider your health, longevity and financial need. The break-even point is age 76 for determining whether to collect early (at age 62), and age 80 for determining whether to delay collection until age 70. An ill-informed decision at age 62 could have a significant negative long-term impact on your financial plan.
#2: Underestimating expenses and the impact of inflation
Another common mistake is assuming that expenses decrease in retirement. Typically, expenses increase early in retirement as individuals enjoy their freedom. They travel more, as they need to entertain themselves during the time they used to spend at work. Medical expenses tend to increase more as we age. Out-of-pocket costs average $5,000 per year at age 65 and increase to approximately $23,000 by age 85. This excludes the cost of long-term care and does not reflect above-average prescription costs. We recommend talking to retired friends who live a similar lifestyle to see what type additional expenses they incurred.
Inflation impact on a retiree’s expenses can also be significant, as certain expenses for older persons have a higher than normal inflation rate. This includes health care and housing maintenance costs, which increase at a greater rate as you age. The average inflation rate for health care costs is 6%, which is more than double the current Consumer Price Index.
#3: No long-term care plan
This does not necessarily refer to insurance, although it too can be a big part of your long-term care plan. The cost of long-term care can be one of the biggest threats to your financial independence. The estimate is that more than 70% of people over age 65 will need some sort of long-term care in the future. To see costs in your area, look at the Genworth 2018 Cost of Care Survey online. You should have a plan that states how you want to be cared for should the need arise. Remember, long-term care is custodial care – not medical care. You should address the following questions:
- Where do I want to be cared for (i.e., at home or in a facility)?
- What type of facility will it be?
- How will I pay for care?
- Who will be in-charge of my care?
A long-term care policy helps to address some of the concern about how you will pay for care, but it does not address the other questions.
#4: No estate plan
An estate plan ensures your wishes are met at your incapacity or death. The plan consists of three documents:
- A Will states how you would like your assets to pass at your death and who will act on behalf of your estate (executor role). Remember to ensure the beneficiary designations on all life insurance policies and retirement accounts match the disposition wishes as stated in your Will.
- A Power of Attorney declares who can act on your behalf on financial matters if you become incapacitated. This can be as simple as writing your monthly checks, or as strategic as meeting with financial advisors.
- Your living will (or Advance Medical Directive) names the person who can speak to your medical professionals if you are unable to act on your own volition. It also states how you want to be treated in life-ending situations.
Not having these documents in place can be costly to you, as well as your estate and heirs.
#5: Underestimating your life expectancy
If you underestimate how long your assets will need to last, you may outlive your money. A person currently age 65 has a 25% chance of living past age 90. A couple who are age 65 have an over 50% chance of one of the spouses living past age 90. If you retire in your early 60s, you may live in retirement as many years as you were working. If you make a spending assumption in retirement that you will live to age 85, you may not have sufficient funds to meet your ongoing needs after age 85. If you underestimate your life expectancy, you might make a hasty social security decision or have an investment portfolio that is too conservative to meet your long-term needs.
#6: Forgetting to take your Required Minimum Distributions from qualified retirement plans
If you own an IRA, 401(k) or 403(b) you are required to start taking distributions from the account in the year you turn age 70 ½. If you forget to take the distribution, the penalty is 50% of the amount you were supposed to withdraw.
#7: Single stock exposure
Overexposure to one stock – whether it was an inheritance or stock accumulated through hard work at a company – can add significant risk to your investment portfolio. Consider the latter. If you have retiree medical benefits or a company pension, you are already relying heavily on that company during your retirement years. If your investment portfolio also relies on the company’s success, and something negative happens, your entire retirement plan could be impacted significantly. Also, if you are relying on your investment portfolio to provide for your lifetime needs, having the added risk of a concentration of any one stock could impact your retirement plan’s success. To reduce volatility, it is best to have a well-diversified portfolio invested in different asset classes, consisting of both equity and fixed-income investments.
#8: Not adjusting your investment approach or being too conservative (or too aggressive)
You should always update your investment portfolio to reflect where you are in life. Unfortunately, not everyone adjusts their investment approach or asset allocation as they near retirement. Since this phase of life can last 20 years or more, we do not recommend getting to conservative if you anticipate a long retirement. Despite a common emotional reaction to want to be conservative, you’ll need to be invested in the equity markets to keep pace with inflation. It is also important not to react emotionally to market fluctuations. We recommend you do the following: Determine an asset allocation that you are comfortable with, provide for your cash needs for three years, and rebalance your investments back to the original allocation goal on an annual basis (at least). You may want to consider a bond ladder which will provide you with cash flow for a set number of years, reducing the stress of market volatility.
#9: Not updating your financial plan
Your financial plan should be viewed as a living document. It should not be written and forgotten. Life changes and so should your plan.
Avoiding these mistakes can greatly improve your chances for having a long and successful retirement.