Even the most diligent retirement savers can fall victim to mistakes that risk their retirement success. Retirement planning requires a lot more than just socking money away for your elder years. Any financial stumbles on the way can have far-reaching impacts on the money available to you when you retire.
While there are literally dozens of potential stumbling blocks in retirement planning, these are some of the most common I see through my work at Asset Preservation Wealth & Tax.
Failing to Understand Portfolio Risk
For over a decade, we enjoyed the best market conditions the world has ever seen. I’ve often remarked to clients and colleagues that even a blind chicken could have made money during those boom years. That was wonderful for the health of our retirement savings, but it also presented an often-overlooked danger: overconfidence.
When an investor becomes accustomed to incredibly high returns year after year, they frequently begin to think these types of returns will last forever. This mistake isn’t just made by amateurs! The 2008 economic collapse was in large part caused by overconfidence.
The collapse was triggered by a housing crisis resulting from a massive amount of mortgage defaults. These mortgages had been issued to people with shaky creditworthiness. The assumption made by lenders was that because housing prices would never stop rising, even if a high-risk mortgage entered default, the lender could simply repossess the home and sell it at a profit.
Of course, that assumption turned out to be disastrous. Just because homes had been increasing in value for decades did not mean they would never lose value. Anytime someone tells you an investment of any kind will never stop increasing in value, that’s a sign to be extremely cautious when investing!
People making this mistake with their retirement assets often leave too much money invested in higher-risk assets such as the stock market. As the pros did in the 2008 collapse, they assume their investment will always generate the rates of return it did for many years previously.
This assumption has already been proven wrong with recent market losses, and it’s unlikely we will see such rates of return any time in the near future. Assuming a high rate of return and relying on that assumption for your money to last throughout your retirement is a risky proposition and increases the likelihood of retirement failure.
Failing to Plan for Taxes
Many retirement savers are diligent about saving for retirement, some even being thorough and detailed enough to maximize their portfolios ahead of retiring. But the one key area they forget to take into consideration is taxes.
Tax-efficient planning is a vital component of retirement planning. Failing to plan for taxes puts your retirement at risk! One way to plan for taxes is to take advantage of the tax bracket you’re in. Under current taxation laws, tax brackets are arranged in a series of alternating small and large increases. Moving from the 10% to the 12% bracket isn’t a big deal. However, moving from the 12% to the 22% bracket can have a huge impact on your tax situation!
Failing to maximize your current tax situation while you’re in a lower tax bracket is a mistake that can cost you large sums of money in retirement, especially if you believe your income will increase significantly or you have lots of money in 401(k)s, IRAs or other tax-deferred accounts. For example, a friend of mine has enough tax deductions, in part because of having many children, to be in the 12% bracket. Once his kids become adults, he’ll automatically jump to a higher bracket even if he never gets a raise. He’s saving for retirement, but he’s doing so in tax-deferred accounts. Does that make sense?
There’s a strong argument that it doesn’t. Why not pay taxes on that money now by converting to non-tax-deferred accounts while he’ll only have to pay 12% rather than waiting until he retires? If he waits, he’ll not only be in a higher tax bracket, but will also owe taxes on any gains in those accounts! Saving money now by using tax-deferred accounts could emd up hurting him by costing a lot of money in the future.
Another advantage of converting now is that non-tax-deferred accounts like Roth IRAs don’t have required minimum distributions (RMDs). Once you’re collecting Social Security, if you also have to take RMDs, you could end up with enough income to not only put you in a higher tax bracket, but also owe taxes on 85% of your Social Security!
By deferring taxes unwisely, you risk compounding the amount you’ll lose to taxes in retirement. Financial planners often tout the advantages of compounding when retirement planning, but that works both ways. Compounding interest is wonderful, but compounding problems are not so great!
Retiring Early Without Careful Planning
Early retirement is in vogue, and understandably so. Who wouldn’t want to stop working and enjoy themselves years or decades early? However, there are a number of factors that need to be considered before you leave the workforce ahead of schedule.
If you retire before you’re eligible for Medicare, you will have to fund your own healthcare during the gap between losing your employer-sponsored health plan and being eligible for medicare when you turn 65.
Healthcare can be extremely expensive, even for well-insured people, so going into early retirement without a plan to pay for it is a poor choice! While you can’t generally use an HSA to pay for private insurance premiums in early retirement, one might be useful to pay the medical expenses your plan won’t cover.
The worst downside to early retirement is that you destroy your best earning years. Most people make more money at age 50 or 60 than they did at age 40. By retiring early, you deprive yourself of that higher earning potential. Given that, it’s vital to ensure you will earn enough from other sources such as rental properties or other passive investments to replace what should have been the highest paychecks you’d receive in your career.
Going It Alone
The biggest mistake I see people make is trying to plan for their retirement without help. Retirement planning is complex, and there are many factors that influence the likelihood of your retirement success. Taxes and return rates are only a small sampling of the factors that need to be considered for a comprehensive retirement plan. Unless all aspects of retirement finances are considered, you risk having to deal with financial problems during what should be your well-earned permanent vacation.
Many people are unprepared for retirement because they haven't saved enough during their working years. But others think they’ve prepared well, only to find mistakes made along the way reduce their retirement assets, and in some cases, even prevent them from being able to retire when they want to.
Unless you’re very well versed in retirement finance, chances are you will make a mistake while preparing for your retirement. You might not ever know you slipped up, but it could still have negative impacts on your retirement. It’s essential that you at least have an expert review your retirement preparations.
At Asset Preservation Wealth & Tax, we carefully analyze all aspects of our clients’ retirement plan, then run options through simulations to forecast the likelihood of a successful retirement. By doing this, we can catch and correct mistakes before they’re made and help put our clients on the path to a successful retirement.
Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.
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