Preparing for retirement can be one of the most exciting and nervous times of your life. This is the time to celebrate all of your professional accomplishments while also making sure you are adequately prepared for this next chapter of life. Throughout my career as a financial professional, I have helped numerous people design and implement wonderful retirement plans. I have also witnessed many mistakes that can turn this joyous occasion into a financial nightmare. In this article, I will share some of the most common retirement mistakes that I have encountered and hopefully this will help you avoid some of these common pitfalls.
- Not Having a Budget. One of the most common fears in retirement is running out of money. Creating a retirement budget is one of the most important things you can do to make sure this does not happen. Creating a budget is not an overbearing task, but this seemingly simple task is often overlooked. In the absence of a budget, many financial problems can arise down the road. Budgets are a critical component of a solid retirement plan. Some people do not like the idea of being constrained by a budget, while others simply have never used one and do not know where to start. To create a retirement budget, follow these steps:
- Start with examining how much you are currently spending
- Then, itemize this spending and determine what expenses will continue in retirement.
- Consider expenses that will change during retirement (healthcare, taxes, dining, vehicle expenses, etc.)
- Include possible lifestyle changes (new home or condo, new hobbies)
- Map out all of your retirement income (pension, social security, dividend or interest income, etc.)
- Continue to track and adjust over time
Once you know your budget, you will be able to run financial plans that can provide some insight into how long your money will last in retirement and possibly the estate that you may leave behind. There are numerous free budget tools available online and most financial planners have resources to help.
- Taking on Too Much or Too Little Market Risk. Many retirees often wonder how much risk they should be taking with their investment portfolios as they get closer to retirement. Determining your “risk tolerance” is one of the most important aspects of portfolio management. Most people believe that they should reduce their overall risk as they get close to retirement. For many investors this may be a sound strategy. However, the appropriate amount of risk can vary from person to person. Are you taking too much risk or perhaps not enough? The key is to have a defined process to determine how much risk you should have in your portfolio, as well as how much risk your current portfolio actually is taking on. Do you know how your portfolio will react to a market correction or market shock?
When you do not properly understand how much risk your portfolio has, you will likely make a mistake when markets get volatile. The most common mistake occurs when a retiree is taking on too much market risk. When the market gets volatile, they react by selling some, or all, of their equities at losses in an effort to stop the bleeding. This can be a life altering mistake and can be avoided if the appropriate risk determinations are made beforehand.
- No Tax Plan. For most retirees, taxes will be the largest expense in retirement. However, this expense can be minimized if you create a detailed tax plan. This plan must be reviewed and adjusted each year as personal circumstances and tax laws change.
If you have multiple buckets that you can draw from, you can be very strategic and avoid paying unnecessary tax throughout your retirement if planned correctly. You may be able to avoid paying Long Term Capital Gain tax on investments if your income stays below $80,800 MFJ (Married Filing Jointly) in 2021. Are you taking advantage of all the deductions or credits you have available? Your taxable income can also affect how much your Medicare Part B premiums are each month. The standard monthly Medicare Part B premium in 2021 is $148.50. However, if your modified adjusted gross income in 2019 was above $88,000 (single) or $176,000 (MFJ), you will pay $207.90. This continues to increase as your taxable income increases. It can be as high as $504.90 per month in the highest bracket.
Other important factors to consider are Roth conversions and Required Minimum Distributions (RMDs). You will be required to withdraw a portion of your retirement plan (401(k), IRA, 403(b), etc.) once you reach age 72. The percentage you are required to pull out of these accounts goes up each subsequent year. This could push you into much higher tax brackets down the road and should be considered when mapping out a long-term tax strategy. Another consideration should be Roth IRA conversions. Does it make sense to start converting some or all of your IRA over to a Roth IRA now to avoid paying higher taxes in the future? These are all questions to consider and should be part of your overall tax plan.
- Not maximizing Social Security. It is important to know when you reach “full retirement age” as defined by the Social Security Administration. For people born between 1943 and 1954, full retirement age is 66. If your birthday falls between 1955 and 1959, it gradually climbs to 67. If you are born in 1960 or later, your full retirement age is 67. If you decide to claim your benefit before your full retirement age, your monthly benefit will be reduced. You should also be aware of the earnings test if you file before your full retirement age. The earnings limit in 2021 is $18,960. If you earn more than this limit, you will forfeit $1 in benefits for every $2 you make over the earnings limit. Once you reach full retirement age, the earnings limit no longer applies.
If you make a mistake and want to reverse your decision to start drawing Social Security benefits, the Social Security Administration does allow you to withdrawal your application within the first 12 months of making a claim. You must repay all the benefits you received, including any spousal benefits, but you can later restart your benefits at the higher amount you will earn by waiting.
The earliest you can start collecting benefits based on your own earnings record is at 62 (age 60 if you are a widower and qualify). However, taking benefits before your full retirement age will result in a permanent reduction in your payments – as much as 25% to 30%, depending on when you start the payments. You can also take advantage of an 8% annual increase if you delay taking your payments after you reach full retirement age. This also includes cost-of-living adjustments. The benefit is capped at age 70 and it never makes sense to wait until after 70 to start collecting benefits.
It is important to understand how spousal benefits work. These can even work for an ex-spouse, provided that you were married to the ex-spouse for at least 10 years. The spousal benefit allows for a spouse (or ex-spouse) to receive up to 50% of the other spouse’s Social Security benefit. Just as the benefit based on your own work history is reduced if you claim before full retirement age, the same is true for a spousal benefit. A spouse born on or before January 1, 1954, has the ability to file a restricted application once they reach full retirement age and draw a spousal benefit while allowing their own benefit to continue to grow. This benefit is no longer available for anyone born after January 1, 1954.
Understanding how your Social Security benefits will be taxed is also very important. Social Security benefits lost their federal tax-free status in 1984. The income thresholds that were created in 1984 to determine how the benefits will be taxed have not changed since then. In 2021, single filers with less than $25,000 of income will not have to pay federal tax on their Social Security benefit. For single filers who have between $25,000 and $34,000 of income, 50% of their Social Security benefit will be taxable. Single filers earning over $34,000 will face the maximum amount of 85% of their Social Security benefit being federally taxed. This amount is $44,000 for joint filers. There are also 13 states that tax Social Security benefits. In Missouri, Social Security benefits are not taxed for married couples with a federal adjusted gross income less than $100,000 and single taxpayers with an adjusted gross income (AGI) of less than $85,000.
- Not being realistic about Medical Expenses. Another major expense that all retirees will face is medical expenses. According to the Fidelity Retiree Health Care Cost Estimate, an average couple age 65 in 2021 may need approximately $300,000 saved (after tax) to cover health care expenses in retirement. These medical expenses can be even higher for those who want to retire early or before they are Medicare eligible at age 65. Note, if you are still working, consider taking advantage of a Health Savings Plan (HSA). These plans allow you to save pre-tax dollars which can grow tax deferred and be withdrawn tax-free for qualified medical expenses.
Once you are Medicare eligible, it is important that you spend some time reviewing and considering all of your Medicare options carefully. Medicare planning can be complex, and it is important to understand how Parts A, B, and D as well as Medicare Advantage and supplemental insurance plans differ. There are many great Medicare specialists who can guide you through this entire process and help you make the best decision based on your unique circumstances.
It is also important to know that Long Term Care expenses and dental expenses are not covered by Medicare.
- Not hiring a Professional Financial Advisor. Retirees face numerous complex decisions, and it can be easy to make a few mistakes along the way. Many of these mistakes can be avoided if you decide to partner with an experienced financial advisor. It is important to partner with an advisor who focuses on retirement planning and has a proven track record of working with retirees. I also recommend that you work with a fiduciary advisor so you know that the advisor is working in your best interest at all times and not simply trying to sell you something.