Top Five Financial Mistakes Made by Retirees
By: Arvind Ven
Any mountain climber will tell you that a greater number of accidents and fatalities happen on the descent than on the ascent to the summit. Similarly, during our working lives we are busy working hard providing and saving for retirement without too much thought on having a solid plan on how to make that last longer than our lifetimes. In short, people are very focused on the accumulation phase and not paying enough attention to the distribution phase that starts right at the moment they stop receiving a regular paycheck.
Here are some of the mistakes that people make during their “pre-retirement” and retirement phases.
1. Drawing Social Security too early without understanding the implications.
Social Security is a complex and generally misunderstood retirement income source. Choosing incorrect strategies without calculating the impact of waiting longer to collect, taxation and other factors can potentially have a negative impact of hundreds of thousands of dollars over the retirement lifetimes of a married couple. Social Security can start at age 62, and the benefit goes up annually about 6% every year until age 70. There is no benefit to waiting after age 70. Ask your financial advisor to run a social security income analysis with multiple what-if scenarios of drawing income at different ages.
2. Not accounting for RMD (Required Minimum Distribution).
RMDs must start at age 70 1/2, according to IRS guidelines. At that age, approximately 3.6 percent of the total qualified assets – 401(k), IRA, retirement accounts – must be withdrawn, and the percentage increases over the years. This is due to the fact that all of this money has been growing tax-deferred for decades, and the government wants its taxes. These withdrawal amounts are taxed at ordinary income levels, and you must withdraw the minimum amounts regardless of your need. Penalties are steep if the withdrawals are not made on the schedule mandated.
3. Ignoring the impact of Long Term Care in retirement planning.
With 10,000 baby boomers retiring every day for the next 15 years, long-term care costs are forecast to increase. The Bay Area is an expensive place to live and long-term care will be no different. Calculating at $150,000 per year for a three-year period puts the cost at $450,000. Remember that this after tax money. If you are eyeing your IRA to pay for that, then you are looking at over $700,000 in a tax-deferred account to pay for care. Investigating and evaluating Long Term Care (LTC) insurance costs and options in your fifties and early sixties will be a wise thing to do.
4. Lack of awareness of sequence of returns risks.
Many advisors talk about the oft repeated ‘4% withdrawal rule’ i.e. drawing no more than 4% of your assets annually could provide for a retirement income for a lifetime. While that number could be too optimistic in today’s low interest rate environment, this does not also consider the sequence of returns risk. Consider someone who retired in 2007; if the great recession had knocked down their assets from the time they retired while they withdrew a fixed amount from their portfolio, they may run the risk of their money running out during their lifetime. However, for someone retiring in 2012, that person is catching the market on an upswing and their money may last longer. As we all know, market timing is generally not a good retirement strategy. The best options are to have good time tested and individually tailored strategies, portfolio diversification and risk mitigation.
5. Underestimating the importance of guaranteed income in retirement.
Guaranteed income streams such as Social Security, pensions, annuities, bonds, and similar income streams should be considered to generate a retirement income base or floor. While a few lucky ones have pensions, in most cases, Social Security is the only guaranteed retirement income for most people. One way to create your own pension in retirement will be to fund your own fixed annuity, either immediate or deferred. Fixed annuities are ‘bond like’ instruments and can offer portfolio diversification and risk mitigation. However, many of them have longer lock-in periods and surrender fees. You should discuss with your financial advisor and educate yourself on the pros and cons and whether these instruments fit your overall retirement income needs.
Arvind Ven is Founder/CEO of the Capital V Group, a Registered Investment Advisory firm. He has an MBA from the MIT Sloan School and a Master’s Degree in Computer Engineering.
Arvind Ven is a Registered Representative with, and securities offered through LPL Financial. Member FINRA & SIPC.