In my experience, when people say they’re planning for retirement, that simply means they’ve been putting money away every year. Don’t get me wrong – that’s an important first step – but simply saving for retirement may not count as planning for retirement. People save, but they may not have a purpose, a written goal they are trying to achieve.
While saving money is only one part of retirement planning, below are some of the common mistakes people make in planning for retirement:
1. People think of retirement as a 401(k)-only decision.
Some employers make it easy to start saving in the company’s 401(k) plan. Often times, new employees may be enrolled automatically when hired, maybe having three percent of their salary taken out, and there might even be a company match. You can increase your contributions and manage your allocations all from the plan’s online portal. You might even be able to partake in some sort of “targeted retirement” option that automatically changes your allocations as you get closer to retirement.
There’s actually a broad range of other things you should be thinking about. More on that in a second…
2. People over-rely on the market.
Over the long-term, the market tends to trend upwards, which can be great when you don’t have to use your money for 20 or 30 years. However, as you get closer to retirement, you have less time to wait out the inevitable downturns in the market.
Let’s say that someone has saved $1 million for retirement, all in growth stocks that don’t pay a dividend, and they plan to take out $50,000 a year. That first year of retirement, they sell stock to take out that $50,000, leaving $950,000. In the meantime, the market takes a 10 percent downward correction, so their account is now worth only $855,000. They now have less than they thought they had for retirement, so they are going to have to sell more stock to get their $50,000 for that second year. Their retirement account is down nearly $200,000 in just two years!
Market risk is a problem no matter how much money you have saved. It’s a problem that can be solved by incorporating tools that can provide an ongoing income stream – like stocks that pay dividends, an annuity, or commercial or residential rental real estate. Cash value life insurance is another source of cash that can be independent of the stock market.*
3. It’s not just an income issue, but also a spending and a rate of return issue.
Typically, the biggest factor in retirement success is the amount of money saved before retirement. People tend to think they might be able to save more if they had a higher income, in which they can take their raise and put it straight into savings or a 401(k). While this can be a successful strategy, most of us don’t have too much direct control over our incomes. If we can’t change our income, then we should save more, spend less (both now and in retirement), and/or get a higher rate of return on our investments. Over the long term, even small changes to these three factors can have a huge impact on our ability to retire comfortably. Spending less allows us to save more, which can especially help during our retirement years as we wouldn’t spend down our savings as quickly. A higher rate of return means that our money has the potential to grow faster and, once retired, might help keep even with our spending.
So, a big part of retirement planning should cover how we’re going to be spending in retirement as well. It’s not a given that your expenses will be lower, if, for example, you are planning to do all that overseas traveling you always promised yourself you would once you had the time.
One thing that can help is to establish a baseline retirement income stream that covers as much of your ongoing expenses as possible. Again, this can be in the form of stock dividends, annuity payments, rental income from real estate, and/or cash value life insurance. With baseline needs covered, you may not need to tap into market-based assets as much to cover ongoing expenses.
4. People underestimate their risks.
People tend to underestimate the risks they face from things like inflation and taxes, to simply living and staying healthy.
We’ve been blessed with low inflation for the past several decades, but nothing can eat away at the purchasing power of a fixed income like inflation. If you establish that baseline income stream, is it protected from inflation? Retirement planning should account for the effects of inflation over the long term.
Taxes are a significant risk. Usually people have their retirement assets either in only pre-tax 401(k) or brokerage accounts, both of which are subject to taxes when money is taken out. In the case of a 401(k), you owe income taxes on the money. For brokerage accounts, you must pay capital gains tax. It pays to consider the tax consequences of any retirement strategy, and cash value life insurance can be a tax-advantaged tool that provides a source of tax-free cash during retirement.
Longevity is another significant risk that many people overlook. People are living longer than ever, and a couple aged 65 has a 43 percent chance of at least one of them living to the age of 95. Retirement planning should hedge against the risk of outliving your money.
Healthcare costs are continuing to increase. Yes, Medicare covers a lot of medical costs, but it doesn’t cover everything, so you should consider supplemental insurance to cover those expenses. Medicare also doesn’t cover long-term nursing care, so that should also be figured into retirement planning.
There are a lot of moving parts to a good retirement plan, and every situation is different. If you’ve started saving for your retirement, that is great, but there is more to this than just save, save, save. Take some time to talk to a financial professional about how you can avoid many of the common mistakes that people make in planning for retirement.
*All guarantees are based on the claims paying ability of the issuer. Life insurance policies are subject to eligibility requirements and restrictions, and may not be right for everyone. Accessing cash value will reduce the death benefit and policy values, and may be taxable.
For educational purposes only. Penn Mutual and its affiliates do not provide tax or legal advice. This information is based upon our understanding of current laws, which is subject to change. Please talk to a financial professional regarding your specific situation.