Transitioning to Retirement

Most of us look forward to retirement, but it can be a very stressful transition.  Carefully planning your financial future will increase the chance that your golden years will truly be enjoyable.  There are numerous retirement planning pitfalls that you can proactively avoid.  Below is a brief guide to avoiding costly mistakes in retirement planning.  A secure, happy retirement requires savvy planning, saving and investing. 

Not Putting a Plan in Writing with the Correct Updated Assumptions. While most people who are near retirement age have a sense of how much assets they have accumulated and how much they will need to spend in retirement, most people fail to have those numbers checked against different market condition scenarios. Potential retirees should consider testing and updating their plans using a wide range of market returns assumptions, including rate of inflation and other macro factors. This assumption-testing process can bring to light flaws in a retirement plan while there is still time to take action in advance of retirement.

According to the Transamerica Center for Retirement Studies, although 58% of retirees had a financial strategy for retirement during the coronavirus pandemic, only 18% had it in writing. A written financial plan is essential as it helps ensure that your savings will last. Facts that need to be considered include debt repayment, living expenses, investments and returns, taxes, as well as the need for long-term care.

As the world economy struggles and inflation continues to edge higher, one needs to challenge the conventional wisdom regarding expected annual rate of return, inflation rate, GDP growth, etc., because any one of these factors can easily derail a carefully crafted retirement plan. 

Not Using a Retirement Projections Calculator.  It’s important to consider how your income and expenses will change in retirement. Every person who plans to retire should use a retirement calculator in order to determine just how much money they will need in order to retire while maintaining a comfortable standard of living. Some expenses like health care and travel are likely to increase, but many pre-retirement recurring expenditures could go be reduced or eliminated. 

According to the Employee Benefits Research Institute, while median household expenses decline with age, housing-related expenses remain the single largest spending category. Healthcare expenses are the second largest component, and these steadily increase with age.

The 4% rule is a guideline stating that you should take out only about 4% of your retirement savings annually. Each person’s situation is unique but having some guidelines can help you prepare.

Not Choosing the Optimal Retirement Age or Retiring Too Early. Staying on the job a few additional years can boost your income in retirement by one-third or more. Social Security defines age 66 as the typical retirement age for most people, but many Americans don’t wait that long. You can avoid the early filing benefit reductions imposed by Social Security by working until your full retirement age (as defined by the IRS). At the same time, you can keep contributing to your retirement-savings plan, building additional balances that can be invested in the market.

For many people, retirement means transitioning from the full-time career or job they’ve held for many years. But there are many other possibilities, including: part-time work in your current job or career, a new job or career, either part time or full time, a bridge job for a few years until full-time retirement, self-employment or business ownership, or a volunteer position for a cause you believe in.

Taking Social Security Too Early.  The majority of retirees choose to begin receiving Social Security payouts within a few months after turning age 62 or immediately after they stop working, even though it is almost always beneficial to delay the benefits. A National Bureau of Economic Research working paper, written by Stanford economist John B. Shoven, concludes that most retirees are leaving money on the table.  There are “spikes” in the retirement age data at ages 62 and 65. Some psychologists argue that early Social Security eligibility at age 62 and perception of “normal” retirement age at 65 serve as reference points that influence peoples’ decisions to retire at these ages.

Underestimating Health Care Costs. Health care costs pose one of the most serious risks to retirement security, so it’s important to understand how to plan for this major expense and navigate the system. A study from the Employee Benefit Research Institute estimates that a couple with drug costs at the 90th percentile throughout retirement would need savings of about $325,000 by age 65 to have a chance of covering their health care expenses during retirement.  Even for those on Medicare, health care costs can still erode spending power. Out-of-pocket expenses for people in retirement have risen over 50 percent since 2002. Long-term care costs can be even less predictable than out-of-pocket costs.  About half of people 65 and over won’t incur any long-term care expenses, and an additional quarter will pay less than $100,000. Fifteen percent, however, will pay $250,000 or more.

Underestimating How Long You’ll Live.  Evidence suggests a prevailing tendency for people to underestimate their longevity.  There are gender, socio-economic and health differences in longevity estimates but in general people do not appear to understand the true extent of the risk.  In order to have enough money for your retirement, many retirement experts suggest that you plan to live into your late eighties, or even your nineties. Planning to live only into your seventies could mean that you will run out of money early as you outlive your expectations.

Choosing the Wrong Investment Strategy.  There are many investment strategies available, from aggressive to conservative. Generally those who are younger are advised to invest more aggressively, tapering to more secure investments as they grow older. 

When you retire, you’ll have to rely on your accumulated assets for income. To ensure a consistent and reliable flow of income for the rest of your lifetime, you must provide some safety for your principal. It’s common for individuals approaching retirement to shift a portion of their investment portfolio to more secure income-producing investments, like bonds.

Unfortunately, safety comes at the price of reduced growth potential and the risk of erosion of value due to inflation. Safety at the expense of growth can be a critical mistake for those trying to build an adequate retirement funding strategy. On the other hand, if you invest too heavily in growth investments, your risk is heightened.

It is common for a retiree who has worked at the same company for many years to accumulate a large amount of that company’s stock in his or her portfolio. Some retirees choose not to diversify because they have comfort in being invested in their employer’s stock. A retiree’s investment portfolio, however, should hold no more than 5% to 10% of any one particular stock, so that the portfolio can be protected and properly diversified for risk management purposes.

Not Managing Taxes and Choosing the Right Retirement Accounts to Draw From. It is also important to match different types of accounts (i.e. taxable, retirement, etc.) with particular investment strategies.  Not regularly contributing to tax efficient accounts is a common mistake in financial planning. Making increased contributions to retirement accounts including 401(k), 403(b), IRA, SEP IRA, Roth IRA, Spousal IRA (spouse not in workforce), and “backdoor” Roth IRAs can help put you on track to be prepared for retirement.

Probably the best way to accumulate funds for retirement is to take advantage of IRAs and employer retirement plans like 401(k)s, 403(b)s, and 457(b)s. The reason these plans are so important is that they combine the power of compounding with the benefit of tax deferred (and in some cases, tax free) growth. For most people, it makes sense to maximize contributions to these plans, whether it’s on a pre-tax or after-tax (Roth) basis.

No two people will have the exact same return on their retirement savings accounts. But, those who follow a specific long-term investment plan can expect to have better average returns than those who do not.