Many successful people make the same mistakes with their money. It's hard to make great choices and be truly ready for retirement. Here are nine mistakes to avoid.
If you are a farm business owner, an urban professional, or a farmer, success in your business does not mean success in wealth accumulation and preparing for retirement. Many mistakes are very common.
Most of us will be responsible for our own retirement. Pensions are disappearing. More of us own our own businesses. We will need to prioritize retirement if it is ever going to happen. But, since we have more responsibility for our success, we have a hard time taking time to deal with planning for retirement.
Here are some of the mistakes Americans make and how to avoid them.
- Underestimating your life span and overestimating investment returns.
Current assumptions are that many folks now working will live to be 90. That means that they need savings and investments sufficient to last at least 25 years in retirement. Accumulating enough resources will be harder than it used to be.
Current interest rates are at historical lows. Common wisdom has often been for workers to own more income investments as they near retirement, but that does not work right now.
Investment performance estimates are currently about 2% lower than traditional assumptions have been. In early August, the S&P 500 Index 10-year annualized return this year was 5.61 percent.
To give yourself a bit of an advantage, use a fee-only, fiduciary, financial planner to help you build a savings and investment plan based on your goals. Such a planner will review your plan regularly and adjust assumptions any time the market conditions require it.
- Being clueless about company retirement plans.
Some workers are still eligible for a pension and even if they are not, they probably have a 401(k) plan through work. Most folks don't know how their retirement savings will work in retirement. Can you take your retirement savings in a lump at retirement? Are you required to take distributions on a monthly basis? Does the money need to stay in the company plan or can it be transferred to a self-directed account? How long can you reasonable expect the money to last based on your current lifestyle?
This is another area where a fiduciary planner can really help evaluate your options and priorities so you make the best choices you can.
- Not keeping current on pension plan changes.
Hoping to trim pension obligations, many firms discontinued traditional defined benefit pension plans, in which firms promise a specific monthly benefit, or converted them to cash-balance plans, in which the firm contributes a defined percentage of the participant's compensation each year. Payouts in that type of plan are more dependent on individual investment returns.
Professionally managed cash-balance plans allow participants to contribute more pretax dollars than they could in, say, a 401(k). But in a conversion from a traditional pension plan, longtime participants sometimes experience a benefit cut because the traditional pensions accumulate most in the last few years of work. Under new retirement plan designs introduced in 2010, more firms are increasing deferrals into cash balance-type programs.
- Underestimating retirement expenses.
Even if investment returns aren't soaring as they used to, expenses such as taxes—especially state, local and property taxes—are. Housing and uninsured medical costs, including prescription drugs and dental care, become a hefty expense for most people as they age. The proportion of total spending that people over 75 spend on health care, at 15.6 percent, is nearly double that of people in the 55 to 64 age group, according to the U.S. Bureau of Labor Statistics.
- Getting a "gray divorce" and other family crises.
Unforeseen knocks hit many individuals in midlife such as the rising phenomenon of "gray divorce" among couples over 50. Advisers say that multiple marriages, late childbearing, late-life divorce and sometimes the need to support elderly parents are key reasons that many lawyers have to keep working or need more income later in life than they originally may have estimated.
- Not diversifying enough.
Asset allocation within retirement plans — and outside of them — is a stumbling block for many investors. One risk is becoming enamored of an asset class they think they know well because of their business experience. Being intelligent and well-informed, many successful business owners sometimes get carried away with investments that they think they are more informed about than most people.
Plans that include self-directed investment options with a wide array of fund and equity choices give plan participants ample opportunity to be led astray by their own biases. Studies, including one by Wharton researchers, have found that too many choices in employer-sponsored plans are counterproductive, leading to higher fees and diminished returns.
- Tying up too much money in their homes.
In another diversification mistake I see is plan participants put too much money into their own homes, and many still are paying mortgages in retirement. Downsizing isn't always as easy as it seems, and high real estate expenses can quickly deplete limited retirement income.
- Not accepting the need to reduce spending.
The most difficult part of retirement planning is accepting the shift in lifestyle that inevitably must come.
Reducing debt and expenses while you are still working should be part of the blueprint. Serious talks with your fiduciary financial planner should begin at least 3 to 5 years before the planned retirement date. Conversations with business partners and a spouse and family members about the transition also need to happen start early. Estate plans should also be reviewed every three to five years.
- Overlooking tax implications of retirement plan distributions.
In retirement, clients need to understand the taxes related to health insurance and the Affordable Care Act. I you retire before age 65, you will likely need to get private insurance until you are eligible for Medicare. Include this in the retirement budget.
Preparing early is the best defense against making serious retirement mistakes. Most people should start thinking, and maybe planning, for retirement as early as 50. A fee-only fiduciary financial planner can be an excellent resource to be sure your game plan is solid to get you to the retirement you have in mind.
Try these Best Practices to Give Yourself the Best Odds of Success
In Your 20s and 30s
- Start 401(k) and IRA saving now.
- Ask successful friends who helps them with financial goal setting and planning process.
- Pay off student loans and credit card debt.
- Be careful about debt. Even debt to buy a home or buy partnership in a firm. Be sure you are in a good position to pay it down in a timely fashion.
In Your 40s
- Diversify and rebalance your investments every year.
- Increase retirement savings rate. Shoot for 20% of your gross earnings saved for retirement each year.
- Avoid extra debt.
- Consult with experts on reducing your tax liability.
In Your 50s
- Start imagining the career end game and think about a target retirement date.
- Begin discussing business retirement plans with partners and family.
- Begin retirement projections with your fee-only fiduciary financial planner.
- Max out retirement plans with catch-up provisions.
- Update your estate plan.
In your 60s
- Firm up your business transition plans.
- Work with your financial planner and tax advisor to understand your healthcare situation after retirement and before Medicare.
- Work with your financial planner on withdrawal strategies from all your accounts. Think about which accounts to tap first.
If you want to increase your odds of retirement success, contact my office in St. Paul at firstname.lastname@example.org. I am always happy to help people improve their retirement options. Dunncreek Advisors does not provide legal or tax advice, nor is this article intended to do so.