COMMON RETIREMENT FINANCIAL MISTAKES
By Deborah Baker, CFP
Vice President and Senior Financial Planner
The formula for a successful financial retirement is straightforward: save early and consistently, incur appropriate investment risk to achieve adequate returns, and let your wealth compound during your working years, which is known as the accumulation phase.
As a general guideline, you should have approximately ten times your final annual salary saved by the time you retire to be able to maintain your pre-retirement lifestyle during the next life phase – known as the distribution period. The distribution phase represents the years when funds accumulated during working years are accessed and withdrawn - for the rest of your life.
There are common mishaps that can derail even a carefully formed retirement strategy. Avoiding these mistakes now can allow you to enjoy a retirement free from financial worries later.
There are common mishaps that can derail even a carefully formed retirement strategy. Avoiding these mistakes now can allow you to enjoy a retirement free from financial worries later.
Maintaining Insufficient Liquidity
During the accumulation phase, it is recommended that three to six months' worth of take-home pay is set aside for emergencies as a safety savings. In retirement, it is wise to maintain more than that level—some suggest up to a year's worth of basic living expenses. This liquidity allows emergency expenses to be covered without having to sell investments at inopportune times, leading to lost compound growth and/or realizing unnecessary losses.
To help avoid this situation, keep your safety savings in a high-yielding, liquid account and replenish periodically and deliberately as market conditions permit.
Overspending
While some expenses decline in retirement, such as savings/retirement contributions, work-related costs, and taxes, other expenses increase. Healthcare, travel, and leisure activity costs often rise in retirement years, particularly during the first decade. Constructing a reasonable budget or financial plan is essential to ensure that spending does not deplete funds too quickly. A general withdrawal guideline is about 3% - 4% annually, which helps balance expenditures with longevity risk.
There are several unpredictable and uncontrollable variables during your retirement—such as investment return and inflation—but discretionary spending can be controlled. Therefore, spending should be monitored and adjusted annually depending on external circumstances.
Claiming Social Security Too Early
Social Security benefits can be claimed at age 62, while ages 65 through 67 currently provide full retirement benefits depending on birth year. The fear of Social Security's future solvency and the need (or desire) for additional income prompts many people to claim benefits as early as possible. However, claiming too early - before full retirement age - permanently reduces benefits by up to 30%. Therefore, waiting until full retirement age to request benefits is recommended unless there is a critical need for income.
Delaying benefits past full retirement age increases the amount by almost 8% annually until age 70, when benefit amounts cease to grow. There is typically a customized solution for each individual or couple to determine the optimal age to claim benefits, so all scenarios should be reviewed based on specific situations.
Failing to Consider Taxes
As during working years, taxes in retirement need to be reviewed carefully. Strategies should be developed for appropriate withdrawals to maximize income and minimize adverse tax consequences. Hopefully by retirement, individuals or couples will have three "buckets" from which to choose funds: taxable, tax-deferred, and tax-free. Typically, it is advised to draw from taxable accounts first, followed by tax-deferred accounts, and finally, from tax-free accounts such as Roth IRAs or Health Spending Accounts (HSAs).
This does not mean depleting taxable accounts but balancing withdrawals among various sources. Since traditional IRA distributions are taxable income, withdrawing too much from such accounts in a given year can push retirees into higher tax brackets. Therefore, strategic withdrawals from tax-deferred accounts are advisable before reaching the age of required minimum distributions. Other strategies should be considered in years when taxable income is lower, such as Roth conversions or realizing capital gains.
Not Maintaining An Appropriate Asset Allocation
In retirement, emphasis should be placed on an overall portfolio devoted to maintaining financial security. The precise allocation depends primarily on individual risk tolerance, but several factors deserve consideration, including capital preservation, income generation, and long-term growth.
In general, a diversified portfolio includes a combination of equities, which provide growth and inflation protection, as well as fixed income, which can provide stability. Review and rebalance your portfolio annually to maintain the appropriate mix.
Ignoring Healthcare Costs
Healthcare costs can be substantial in retirement since medical expenses tend to rise with age. Supplemental Medigap policies should be reviewed, as they can help cover out-of-pocket expenses that traditional Medicare does not. Hopefully, unexpected expenses can be covered by liquid assets in the emergency fund; however, a systematic liquidation plan might need to be developed in a long-term, costly situation. If a Health Savings Account (HSA) was funded before retirement, withdrawals during this time provide tax-advantaged funds for medical purposes.
Neglecting To Update Estate Plans/Beneficiary Information
While not a direct factor for a successful retirement, it is important to acknowledge this final pitfall that often occurs during retirement. Documents such as wills, trusts, powers of attorney, and healthcare directives must be kept current; failure to do so can create legal complications, unintended asset distributions, and additional tax burdens for your estate. Without a will or proper account titling, assets can be subject to prolonged probate, which increases fees and can result in delayed inheritances. Regularly updating your estate plan ensures that your goals come to fruition. As life changes, make sure your assets will be cared for and plans are clear for those who will be managing your estate.
Working with an investment advisor and a financial planner prior to and in retirement will help ensure that your wealth is managed to support your lifestyle and longevity. A financial planner can create a suitable withdrawal strategy, assist with optimizing Social Security benefits and mitigating taxes, address healthcare concerns and costs, and help with estate planning. An investment advisor will manage investments to balance growth with risk, ensure an adequate income stream, and perform necessary portfolio rebalancing.
The Wealth Management professionals at The National Bank of Indianapolis can provide expert guidance, offering you a secure and guided roadmap to a worry-free retirement. Learn more here.