Until the 1980s, retirement planning was mostly centered around pension plans, which provided individuals with a steady source of income once they retired. When this changed and employers made defined contribution plans like the 401(k) more popular, it was up to individuals to take charge of the investing decisions which means that retirement mistakes can be much more costly.
5 mistakes to avoid before retirement
Retirement isn't just about spending time on the beach and living a life of leisure. It is also about organizing your finances to provide enough income to last through retirement while adjusting for market conditions and your needs as you age. The decisions made in the pre-retirement phase can have serious and lasting effects, here are some of the most common mistakes to avoid before retirement.
1. Not adjusting your portfolio for risk
Asset allocation is dividing your portfolio among different asset categories such as stocks, bonds, and cash. How your money is split between these categories should reflect your risk tolerance and time horizon.
"Asset allocation is extremely important to consider as you near retirement," says Rachael Camp, a certified financial planner with Camp Wealth Management in Mishawaka, IN. ”As you get closer to retirement, you'll want to shift more towards cash and bonds, and start shifting out of stocks." The degree to which you adjust your portfolio will depend on your stage in life and how much income you might need from the portfolio. "Cash is important to consider here as well because cash can be your defense in a down market. Many retirees prefer to keep one to three years in cash to ride out a bear market," says Camp.
Rebalancing realigns your portfolio back to your stated goals. It requires you to sell the portions of your portfolio that you're "overweight" in and buy more of the assets that you're "underweight" in compared to the recommendations of your financial planner or a risk tolerance questionnaire. For a more hands-off approach, a target date fund may be appropriate as the portfolio allocations are based on an expected retirement date and grows more conservative as you get closer to that target.
2. Not accurately calculating income in retirement
Your annual expenses in retirement will determine how long your nest egg will last; miscalculating this number can lead to serious consequences, including being forced back into work, running out of money, or taking Social Security sooner than intended.
The 4% rule is a common rule of thumb stating that a safe withdrawal rate is 4% yearly. While rules of thumb can be helpful, in practice, you may need to be more flexible to compensate for market fluctuations and your financial needs.
"A dynamic spending strategy is another option which helps investors to spend flexibly from their portfolios based on market performance and accounting for market fluctuations, without sacrificing one’s lifestyle throughout retirement," says Julie Virta, certified financial planner and Senior Financial Advisor at Vanguard.
When estimating income in retirement, consider all income sources, like pensions, Social Security, savings from a spouse or partner, or required minimum distributions if you are close to 73 years old. Within a few years of retirement, you should start to keep a detailed record of your expenses. Also, consider what you may no longer have to pay for in retirement such as savings and work-related expenses.
3. Taking Social Security at the wrong time
Social Security can play a major role in your retirement planning. This is because the amount you receive in social security income can help offset some of the need to withdraw from your portfolio. You can begin taking Social Security payments as early as age 62 but this will permanently reduce your Social Security income payments by as much as 30%.
"You should review your options in taking social security at full retirement age, versus planning to wait until age 70, based on your income needs and lifeline assumptions," says Virta. "There may also be planning around your and a spouses’ Social Security to consider in maximizing your payments." When you take Social Security may also have an impact on how much you withdraw from your portfolio. In the early years of retirement, your withdrawal rate could be higher as you delay Social Security and decrease in the later years.
4. Not accounting for health costs
The average retired couple age 65 may need about $315,000 to cover health care costs in retirement according to Fidelity. This number is expected to rise over time as health care inflation has typically increased faster than general inflation and people have been living longer.
"Try to think about your health care spending in retirement as part of your budget, versus a large lump sum," adds Virta.
If you plan on retiring before Medicare age, you may want to look into your employer's options to see if COBRA is an option and what the costs may be.
"Many people rely on a spouse to continue working and join their plan, but you can also look to the public marketplace," explains Camp. "The public marketplace can be very expensive, but with careful tax planning, you may be eligible for the premium tax credit, which will help reduce the cost." In addition, diversification among your investing accounts such as pre-tax, post-tax, and taxable can be one of the best ways to safeguard against the cost of health care. Doing so can give you more control around the taxable impact. Another planning option is a Health Savings Account, which can be a flexible and tax-efficient way to save for current and future health care expenses.
5. Carrying high debt into retirement
In an ideal scenario, all of your debts are paid as you go into retirement. However that isn't always the case. According to the U.S. Government Accountability Office, the share of older Americans with debt increased from 1989 to 2016. Their data showed that 58 percent of older households had debt in 1989 compared to 71% in 2016. The debt that older Americans have has also increased nearly threefold, from $18,900 in 1989 to $55,000 in 2016.
Carrying high-interest debt in retirement can be dangerous because it can chip away at the money that you need to maintain your lifestyle and potentially cut your retirement short by draining your portfolio. Before retirement, it could be advantageous to create a plan to pay down those debts or even adjust your retirement timeline to continue savings while simultaneously paying off the debt.
The takeaway
As you approach retirement, your decisions can have lasting effects on your retirement. Take the time to assess your tolerance for risk and make sure your portfolio reflects your needs, keeping in mind that it could shift over time. Carefully consider your options around health care expenses and pay close attention to detail to estimate your income needs. Lastly, meet with a financial planner to ensure you have all bases covered.
